Rental Property Tax Strategies - First Time Filling

[Josh M.]

I apologize in advance for the number of questions. I have tried to phrase them in such a way that it provides my conclusion and I am mostly looking for confirmation.

If a CPA wants to do a quick review my return and do a Q&A session over the phone in the next week, I will be happy to Venmo you for your "unofficial" review. PM me.

My main concern is setting up something incorrectly that is going to cause headaches down the line or leave tax benefits on the table.


Top Level Info:
- Located in Texas
- Married filing jointly; we both have W2 jobs
- Converted primary residence into rental, placed in service on 3/15/2019
- Rental Income is labeled as "Passive Activity", "Active Participant"
- Net Income reported is showing 0
- Loss of ~4,400 (paid 2018 property taxes in 2019)
- Using TaxAct

General Questions:

- Qualified Joint Venture: I set up the business under me only. I owned the home before we were married so everything is in my name and am the more "active" participant in operating the rental property. Is there any benefit to setting up the rental as a "Qualified Joint Venture" between my wife and I vs. solely under me?

- Personal Use: If I am understanding the guidance properly, I do NOT need to input any thing for Personal Use since it was placed into service after we moved out. Correct?

- Repair Regulation Elections: I currently do not have any selected. Is there any benefit to choosing to Capitalize or the Small Taxpayer Harbor (I don't fully understand the requirements)?

- Mortgage Costs: I claimed the 10 months it was in service. Should I claim the entire year since I technically owned the asset?

- Asset acquired before 1987: The house was built before 1987 but I acquired the property in 2011 so I would answer it was acquired after 1987. Correct?

- Amortization: I am currently claiming nothing. Are there items that are typically claimed on former primary residences that have been converted into rental?

- Section 199A: I selected Section 199A and I do not believe it should be labeled as Safe Harbor since I did not spend more than 250 hours performing rental services. Correct?

- Qualified Business Income Deduction / Adjustment: Answering the TaxAct prompts yielded $0 for 2019. Is that to be expected given my situation?


Depreciation Questions:

- Cost Basis: There have not been any material improvements since purchasing. My understanding is to take purchase price in 2011 * % of the house/improvement value from my current tax assessment?

- Straight Line vs. Alternative: TaxAct and my reading suggested Straight Line since it is 100% business use. Correct?

- Asset Life Years: TaxAct suggested 27.5 years. I plan to keep this as a rental long term (10+ years). The home was built in 1979, purchased by me in 2011. Does that seem correct?

[Brian Davis]

Josh-you are on the right track, and you're asking some great questions, here are some responses that I hope help out!

Personal Use - You are correct here. Nothing for personal use since it was placed in service after you moved out.  Fair rental days will start from the day you placed in service until December 31st (Example: placed in service on March 15th, would mean 292 Fair Rental Days and 0 Personal Use days on your Schedule E)

Repair Regulation Regulations - This is where you let the IRS know how you will be treating your repair expenses ($2,500 or less) that are for the "betterment, restoration or adaption" of your property.

---Q: Should you deduct these expenses in full (100% deduction in 2019) or over time (capitalizing with depreciation over multiple years)?  

---A: That depends on your overall tax strategy, overall income and tax situation (there are other rules limiting your overall deductible loss from rentals based on your income, other passive investment activity, etc).  The good thing about this election is that you can choose to take it one year, opt-out the next year, then opt-in the year after--you decide every year by taking or not taking the election. Capitalizing adds to your basis, which could lower your taxable profit/capital gains tax if you are planning on selling in the near future.  Capitalizing basically means you take deductions on those items over multiple years (instead of all at once in 2019).  If you expect your taxable income (from other sources) to go up in future years, those deductions may save you more money if taken over time instead of all in year 1.  So for this one it really depends. 

Mortgage Costs - To be safe I would only take only the mortgage interest and real estate taxes from the date you placed it in service (March 15-December 31).  The mortgage interest and real estate taxes you paid from January 1st through March 15th would be deductible on Schedule A if you are itemizing-I know most people are now using the standard deduction so those may not help.

Asset acquired before 1987 - You are correct here, they are asking if the property was acquired after 1987 (not the year built).

Amortization - This can be taken on those closing costs (see your 2011 Closing Statement) such as appraisal, inspection, title fees, loan origination fees, recording fees.  Taken over the life of the loan, if you sell the property in let's' say 10 year, you will be able to deduct these in the year of the sale, so be sure to keep track of these.  Are you including these in your depreciable cost basis? Some tax returns that I've seen include these as acquisition costs for depreciation basis instead of taken as amortization over the life of the loan.  This doesn't make a huge difference to the bottom line (taking it as depreciation over 27.5 years vs. taking amortization over the life of the loan, usually a standard 30 year mortgage).  Just make sure you are not double-dipping (taking the same deduction twice)!

Section 199A - Yes you are right on target with this.  Since you don't meet the 250 hour requirement you will not be able to take the QBI deduction on this since it's not considered a "trade or business".  The IRS clarified this last year for everyone, but yes you are correct. https://www.irs.gov/newsroom/irs-finalizes-safe-harbor-to-allow-rental-real-estate-to-qualify-as-a-business-for-qualified-business-income-deduction

Qualified Business Income Deduction / Adjustment - Yes, $0 for this sounds right. Section 199A or QBI -those are all talking about the same thing.  This is the 20% deduction that was created by the 2017 Tax Cuts and Jobs Act.  Based on your less than 250 hours you wouldn't qualify (this is a 20% deduction on the net rental profit, if any, after depreciation).  Related to your rental property net taxable income, this is a usually a small number since net profit (for QBI calculation) is after depreciation and all of those other deductible expenses. To get a quick estimate of what ends up on your tax return I tell my clients to estimate: +positive cash flow, +(plus)principal pay down, -(minus) depreciation and amortization.

So don't worry that you can't take this deduction now, it may not be as much as you think.  If you start investing more time >250 hours in the future, you'll probably have higher profits and you'll be able to take that 20% QBI deduction once you exceed that threshold.

Depreciation Questions:  

Cost Basis - The IRS says the use the LESSER of Fair Market Value or your Adjusted Cost Basis (Fair Market Value - "This is the price at which the property would change hands between a willing buyer and a willing seller, neither having to buy or sell, and both having reasonable knowledge of all the relevant facts. Sales of similar property, on or about the same date, may be helpful in figuring the fair market value of the property." -from IRS Pub. 527).  So you should only use the fair market value if it is lower than your adjusted basis.

Straight Line vs. Alternative - TaxAct is correct you should be depreciating the residential real property using 27.5 year straight-line.  Remember the Land portion of your asset is not depreciable, and should be setup as a separate asset (Land) that does not depreciate.

Asset Life Years - Yes 27.5 is the straight line depreciation for residential rental property.  Depreciation on major improvements (roof, bathroom remodel, kitchen, etc.) you have the options of taking those all in year one (De Minimis Safe Harbor <$2500), 100% Special Depreciation or over its' useful life.

One thing I must tell you to keep in mind for the near future, is that if you lived in the house for for 2 years out of the last 5 years (from the date of your a potential sale), you may qualify for an exclusion of $500,000 in profit if you sell that property.  There would be a small depreciation recapture on the depreciation taken while you have it as a rental (Years 3-5) but other than that, this could mean a huge tax savings specifically for taxpayers who sell their primary residence at a gain, the proceeds can be used for investing in other properties, or anything else.  This could potentially be a tax SAVINGS, different than a tax DEFERRAL (such as a 1031 exchange). 

Just something to keep in mind as you get closer to that date and have to decide whether you want forego that savings to hold it long term, or sell it and use the proceeds for another property or multiple properties, etc.

-You'll notice I completely avoided your first question on Qualified Joint Venture! For that one I'd say to consult with a real estate attorney or maybe an attorney here on BiggerPockets can chime in to talk about the pros and cons of a QJV. The way I normally see this setup is as a Single Member (you) LLC, disregarded entity filing Schedule E (attachment to your Married Filing Jointly 1040). There are special rules for a QJV in community property states like where I am (in Florida), and for you (in Texas), so if that's something you want to explore further, I would consult with a TX attorney on that.

I'm a Tax Accountant (CPA) in Fort Lauderdale, FL and I invest in real estate in South Florida and Atlanta. I have clients that live and also have investment properties throughout the US, including Dallas.