2018 Taxes - Better Off Not Counting Expenses for Rental Property because of QBI?

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abracadabra11
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2018 Taxes - Better Off Not Counting Expenses for Rental Property because of QBI?

Post by abracadabra11 » Sat Feb 09, 2019 4:17 pm

I've entered the majority of the information needed for my taxes for 2018 and it seems that there's something strange happening this year because of the QBI deduction. When I enter only the income from the property (i.e. not including any expenses such as Advertising, Travel, Cleaning and Maintenance, Management Fees, Insurance, etc), my calculated refund is ~$600 higher than when I enter the expenses for the property.

Annual depreciation would still be used in both scenarios, but it doesn't appear to be advantageous to include any other expenses.

[Question] Given this outcome, is there any reason why I should include expenses in this year's tax return?

deskjockey
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Re: 2018 Taxes - Better Off Not Counting Expenses for Rental Property because of QBI?

Post by deskjockey » Sat Feb 09, 2019 4:31 pm

You should not be claiming QBI unless you spent 250 hours directly managing the property. Check out the discussion here in the section titled "Rental Real Estate Activities." One thing of note, the time spent traveling to and from the rental property to perform services (either by you, a contractor, or an employee) does NOT count toward the 250 hours. Unless you have a high-turnover rental, I think it will be very hard to meet the 250 hour QBI guideline with just one rental property. I know I'm nowhere near it, even when counting the time spent by contractors and our property manager.

kaneohe
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Re: 2018 Taxes - Better Off Not Counting Expenses for Rental Property because of QBI?

Post by kaneohe » Sat Feb 09, 2019 7:45 pm

I didn't do a rental but a self-employment situation instead. Could be that things depend on the specific numbers you put it but
here's one example that my tax software did (may be right or not).
Single, SE business

1) Gross Inc = 50K/Expenses=10K
total Inc =40K
AGI =37174 (deducts half of SE tax)
Std deduction=12K
QBI deduction=5035
Taxable Inc= 20139
Tax=2225
SE Tax=5652
Total Tax 7827

2)Gross Inc =50K , no expenses
AGI = 46467 (deducts half of SE tax)
std deduction=12000
QBI deduction=6893
Taxable Inc=27574
Tax=3119
SE Tax=7065
Total Tax=10184

In Ex 2) the initial tax, SE tax and total tax are all higher for the no expenses.
For a rental presumably have no SE tax so you could make those adjustments but it still looks like using expenses will
help you because it is lowering your income and taxes faster than the QBI deduction is being reduced.
Perhaps your numbers tho are special.

jebmke
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Re: 2018 Taxes - Better Off Not Counting Expenses for Rental Property because of QBI?

Post by jebmke » Sat Feb 09, 2019 8:49 pm

I haven't thought through the possibilities to form an opinion on whether it is possible to not report expenses and come out ahead on Schedule E wrt QBI.

My understanding on Schedule C is that one is not permitted to leave out expenses for the purpose of reducing one's overall tax liability (this normally would be triggered by EIC).

I don't know if the same principle applies in the case of Schedule E. For example, if one had a rental property (and assuming qualified for QBI - which is a different issue), could one choose to report the RE tax on the rental on Schedule A in order to increase the profit on Schedule E? I doubt that the IRS has thought this far ahead on the QBI deduction - they only recently clarified simply how to calculate it.

In TaxAide, we have been provided guidance that we can report SE Health Insurance on Schedule A instead of as an adjustment in order to optimize QBI so perhaps the same principle applies to RE tax. Not sure what other expenses would be movable.
When you discover that you are riding a dead horse, the best strategy is to dismount.

kaneohe
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Re: 2018 Taxes - Better Off Not Counting Expenses for Rental Property because of QBI?

Post by kaneohe » Sat Feb 09, 2019 10:05 pm

jebmke wrote:
Sat Feb 09, 2019 8:49 pm
...................................................................
In TaxAide, we have been provided guidance that we can report SE Health Insurance on Schedule A instead of as an adjustment in order to optimize QBI so perhaps the same principle applies to RE tax. Not sure what other expenses would be movable.
j...........it would be an interesting exercise to do this. We have a new instructor this yr who gave a few problems for us to do.
We then had to send pdf returns to her. One had SE income when of Medicare age. I entered the SS including the Medicare cost on the SS page as I have done for ages (which takes Medicare to Sch A). I then submitted the pdf which got gently critiqued......that I should have entered the Medicare cost, not on the SS input page, but on the Sch C SE page which takes it to the misc deductions. To my surprise, the overall tax was lower. Just in time for me to use the same trick on a client on my first day.........I came home and redid the problem the conventional way to see if the same thing happened...........it did so lower tax by using Medicare cost as SE adjustment even tho I believe QBI deduction might have been lower. Perhaps the end result is situational depending the numbers you input but so far,my limited experience is that optimizing QBI deduction is not the same optimizing total tax. Be interested in your findings.

cadreamer2015
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Re: 2018 Taxes - Better Off Not Counting Expenses for Rental Property because of QBI?

Post by cadreamer2015 » Sat Feb 09, 2019 11:15 pm

You should not be claiming QBI unless you spent 250 hours directly managing the property.
I am not a tax professional, but I'm not sure this is strictly true. The IRS has issued a proposed safe harbor rule which does indeed require 250 hours of work (as I have understood this safe harbor rule it doesn't require you to perform all of the 250 hours - some of those hours could be performed by employees or contractors). A quote from the IRS follows:
Under the proposed safe harbor, a rental real estate enterprise may be treated
as a trade or business for purposes of section 199A if at least 250 hours of services are
performed each taxable year with respect to the enterprise. This includes services
performed by owners, employees, and independent contractors and time spent on
maintenance, repairs, collection of rent, payment of expenses, provision of services to
tenants, and efforts to rent the property. Hours spent by any person with respect to the
owner’s capacity as an investor, such as arranging financing, procuring property,
reviewing financial statements or reports on operations, planning, managing, or
constructing long-term capital improvements, and traveling to and from the real estate
are not considered to be hours of service with respect to the enterprise.
But the IRS has not issued final rules. They say:
The proposed revenue procedure, included in Notice 2019-07, allows individuals and entities who own rental real estate directly or through a disregarded entity to treat a rental real estate enterprise as a trade or business for purposes of the QBI deduction if certain requirements are met. Taxpayers can rely on this safe harbor until a final revenue procedure is issued.
So if you meet the 250 hour standard you should be safe, but there may be other ways to be lawfully considered as having earned Qualified Business Income (QBI) from rental property. The IRS has not issued final regulations, and there have not been any tax court decisions on the issue yet. I know of some tax professionals who will be considering rental income QBI on 2018 returns without meeting the 250 hour standard.
De gustibus non est disputandum

jebmke
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Re: 2018 Taxes - Better Off Not Counting Expenses for Rental Property because of QBI?

Post by jebmke » Sun Feb 10, 2019 6:38 am

kaneohe wrote:
Sat Feb 09, 2019 10:05 pm
jebmke wrote:
Sat Feb 09, 2019 8:49 pm
...................................................................
In TaxAide, we have been provided guidance that we can report SE Health Insurance on Schedule A instead of as an adjustment in order to optimize QBI so perhaps the same principle applies to RE tax. Not sure what other expenses would be movable.
j...........it would be an interesting exercise to do this. We have a new instructor this yr who gave a few problems for us to do.
We then had to send pdf returns to her. One had SE income when of Medicare age. I entered the SS including the Medicare cost on the SS page as I have done for ages (which takes Medicare to Sch A). I then submitted the pdf which got gently critiqued......that I should have entered the Medicare cost, not on the SS input page, but on the Sch C SE page which takes it to the misc deductions. To my surprise, the overall tax was lower. Just in time for me to use the same trick on a client on my first day.........I came home and redid the problem the conventional way to see if the same thing happened...........it did so lower tax by using Medicare cost as SE adjustment even tho I believe QBI deduction might have been lower. Perhaps the end result is situational depending the numbers you input but so far,my limited experience is that optimizing QBI deduction is not the same optimizing total tax. Be interested in your findings.
The system was only fixed to reflect the new regulations this week. So any tests done in training would not have reflected the SE tax or SE health adjustment to QBI. I haven't run any cases yet. With the increase in standard deduction, most of our clients will not itemize. With insurance and the high standard, you have to be in pretty bad shape to be able to itemize medical expenses to your benefit.
When you discover that you are riding a dead horse, the best strategy is to dismount.

kaneohe
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Re: 2018 Taxes - Better Off Not Counting Expenses for Rental Property because of QBI?

Post by kaneohe » Sun Feb 10, 2019 8:34 am

[quote=jebmke post_id=4373252 time=1549798728 user_id=1
The system was only fixed to reflect the new regulations this week. So any tests done in training would not have reflected the SE tax or SE health adjustment to QBI. I haven't run any cases yet. With the increase in standard deduction, most of our clients will not itemize. With insurance and the high standard, you have to be in pretty bad shape to be able to itemize medical expenses to your benefit.
[/quote]

Do you know if the training software was also updated? I only do the what ifs on the training side.

jebmke
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Re: 2018 Taxes - Better Off Not Counting Expenses for Rental Property because of QBI?

Post by jebmke » Sun Feb 10, 2019 12:51 pm

kaneohe wrote:
Sun Feb 10, 2019 8:34 am
Yes, the Practice Lab for 2018 reflects the changes now.
When you discover that you are riding a dead horse, the best strategy is to dismount.

kaneohe
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Re: 2018 Taxes - Better Off Not Counting Expenses for Rental Property because of QBI?

Post by kaneohe » Sun Feb 10, 2019 6:28 pm

jebmke wrote:
Sun Feb 10, 2019 6:38 am

...................................................................
In TaxAide, we have been provided guidance that we can report SE Health Insurance on Schedule A instead of as an adjustment in order to optimize QBI so perhaps the same principle applies to RE tax. Not sure what other expenses would be movable.
.................................................................................................................

The system was only fixed to reflect the new regulations this week. So any tests done in training would not have reflected the SE tax or SE health adjustment to QBI. I haven't run any cases yet. .........................................
Thanks for the status update. The example in a post above w/ SE income w/ & w/o expenses was done yesterday so should be the updated version. The tax w/ expenses had a lower overall tax despite having a lower QBI deduction

I did a similar SE problem w/ & w/o the Medicare deduction.

30K SE income; 15 SS income; 1.5K Medicare cost

I) Medicare taken for itemized deduction (therefore not used)
1)Taxable SS = 5674
2)SE income = 30K
3)Total income = 35674
3A)AGI = 33555
4)Std deduction = 13600
5) QBI deduction = 3991
6) Taxable income = 15964
7) Tax = 1727
8)SE Tax = 4238
9) Total Tax= 5965

II)Medicare taken as SE deduction
1)Taxable SS = 4441
2)SE income = 30K
3)Total income = 34441
3A)AGI = 30822
4)std deduction = 13600
5)QBI deduction = 3444
6)Taxable Income= 13778
7)Tax = 1463
8)SE Tax = 4238
9) Total Tax = 5701

Note that even though in Ex 1) above the QBI deduction is larger because the Medicare deduction was effectively not used,
the income remained higher and therefore the total tax was higher in Ex 1. I was surprised to find that the taxable amount
of SS was different in the 2 cases. The SS wksht shows that the SE medicare deduction(and deductible part of SE tax) was used to reduce the income for the wksht to calculate taxable SS. Also interesting to notice is that there are 2 alternate ways to calculate the QBI deduction ......the first is the "conventional" 20% net SE income (but also net of deductible part of SE tax and SE health insurance) and the other calculation is 20% of the taxable income before QBI deduction. In Ex II, the latter prevailed.....was lower.
Lots of moving parts.........it is nice that TS printout shows how the various things were calculated........hopefully in the correct manner.

jebmke
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Re: 2018 Taxes - Better Off Not Counting Expenses for Rental Property because of QBI?

Post by jebmke » Sun Feb 10, 2019 6:51 pm

^ sure is good they simplified the tax code. :P
When you discover that you are riding a dead horse, the best strategy is to dismount.

rustyjim
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Re: 2018 Taxes - Better Off Not Counting Expenses for Rental Property because of QBI?

Post by rustyjim » Sun Feb 10, 2019 7:38 pm

I have had rental properties the past 30+ years. Just finished my 2018 tax return yesterday. The QBI title caught my attention since I had to deal with it for the first time.

Imagine a rental scenario with 100k of gross rents and 40k of expenses leaving 60k net rent. Take away 12k (the 20% for QBI) leaves 48k of taxable income from Scedule E.

Now the same scenario without deducting the 40k of expenses. 100K gross less 0 expenses leaves 100k net rent. Take away 20k (the 20% for QBI) leaves 80k of taxable income Schedule E.

Not deducting the expenses adds 32k to taxable income. Not a good thing.

And remember, the 40k of expenses was actually spent in both cases so don't think you did not spend it just because it was not deducted in the one example.

I have no idea what is going on with your software. Are you under the income levels for QBI?

I use a product from #2pencil.com and it seems to work.

rustyjim

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