Don't Let Taxes Dictate Your Investment Decisions
Everyone hates to pay more in taxes. But this is something that has to be done. Sometimes taxes can often lead investors to make foolish investment decisions. The stock market bottomed in March 2009 and since then we have experienced the second-longest bull market rally of all time. This type of market environment typically creates a
Everyone hates to pay more in taxes. But this is something that has to be done. Sometimes taxes can often lead investors to make foolish investment decisions. The stock market bottomed in March 2009 and since then we have experienced the second-longest bull market rally of all time. This type of market environment typically creates a stockpile of unrealized gains in the equity portion of your portfolio. When you go to sell one of your investment holdings that has appreciated in value over the past few years there may be a big tax bill waiting for you. But when is it the right time to ignore the tax hit and execute the trade?
Do The Math
What sounds worse? Writing a check to the government for $10,000 in taxes or experiencing a 3% loss in your investment accounts? Most people would answer paying taxes. After all, who wants to write a check to the government for $10,000 after you have already paid your fair share of taxes throughout the year. It’s this exact situation that gets investors in a lot of trouble when the stock market turns or when that concentrated stock position takes a nosedive.
Before making this decision make sure you do the math. If you have $500,000 in your taxable investment account and the account value drops by 3%, your account just lost $15,000. It would have been better to sell the holding, pay the $10,000 in taxes, and you would still be ahead by $5,000. Before making the decision not to sell for tax reasons, make sure you run this calculation.
Gains Are Good
While most of us run from paying taxes like the plague, remember gains are good. It means that you made money on the investment. At some point you are going to have to pay tax on that gain unless your purposefully waiting for the investment to lose value or if you plan to die with that holding in your estate.
If you put $100,000 in an aggressive investment a year ago and it’s now worth $200,000, if you sell it all today, you will have to pay long term cap gains tax and possibly state tax on the $100,000 realized gain. But remember, what goes up by 100% can also go down by 100%. To avoid the tax bill, you make the decision to just sit on the investment and 3 months from now the economy goes into a recession. The value of that investment drops to $125,000 and you sell it before things get worse. While you successfully decreased your tax liability, the tax hit would have been a lot better than saying goodbye to $75,000.
As financial planners we are always looking for ways to reduce the tax bill for our clients but sometimes paying taxes is unavoidable. The more you make, the more you pay in taxes. In most tax years, investors try to use investment losses to help offset some of the realized taxable gains. However, since most assets classes have appreciated in value over the last few years, investors may be challenges to find investment losses in their accounts.
Capital Gains Tax
A quick recap of capital gains tax rates. There are long-term and short-term capital gains. They apply to investments that are held in non-retirement account. IRA’s, 401(k), and 403(b) plans are all tax deferred vehicles so you do not have worry about realizing capital gains tax when you sell a holding within those types of accounts.
In a taxable brokerage account, if you buy an investment and sell it in less than 12 months, if it made money, you realize a short-term capital gain. Short-term gains do not receive preferential tax treatment. You pay tax at the ordinary income tax rates.
However, if you buy an investment and hold it for more than a year before selling it, the gain is taxed at the preferential long-term capital gain rates. At the federal level, there are three flat rates: 0%, 15%, and 20%. At the state level, it varies based on what state you live in. If you live in New York, where we are headquartered, long-term capital gains do not have preferential tax treatment for state income tax purposes. They are taxed as ordinary income. While other states like Alaska, Florida, and Texas assess no taxes at the state level on capital gains.
The tax rate that you pay on your long-term capital gains at the federal level depends on your AGI for that particular tax year. Here are the thresholds for 2021:
long term cap gains rates
A special note for investors that fall in the 20% category, in addition to being taxed at the higher rate, there is also a 3.8% Medicare surtax that is tacked onto the 20% rate. So the top long-term capital gains rate for high income earners is really 23.8%, not 20%.
Don't Forget About The Flat Rate
Investors forget that long-term capital gains are taxed for the most part at a flat rate. If your AGI is $200,000 and you are considering selling an investment that would cause you to incur a $100,000 long-term capital gain, it may not matter from a tax standpoint whether you sell it all this year or if you split the gain between two different tax years. You are still taxed at that flat 15% federal tax rate on the full amount of the gain regardless of when you sell it.There are of course exceptions to this rule. Here is a list of some of the exceptions that you need to aware of:
Your AGI limit for the year
The impact of the long-term capital gain on your AGI
College financial aid
Social security taxation
Health insurance through the exchange
First exception is the one-time income event that pushes your income dramatically higher for the year. This could be a big bonus, a good year for the company that you own, or you sell an investment property. In these cases you have to mindful of the federal capital gains tax thresholds. If it’s toward the end of the year and you are thinking about selling an investment that has a good size unrealized gain built up into it, it may be prudent to sell enough to keep yourself out of the top long-term capital gains bracket and then sell the rest in January when you enter the new tax year. That move could save you 8.8% in taxes on the realized gains. The 23.8% to tax rate minus the 15% median rate. If you are at the beginning or in the middle of a tax year trying to make this decision, the decision is more difficult. You will have to weigh the risk of the investment losing value before you flip into a new tax year versus paying a slightly higher tax rate on the gain.
To piggyback on the first exception, you have to remember that long term capital gains increase your AGI. If you make $300,000 and you realize a $200,000 long term capital gain on an investment, it’s going to bump you up into the highest federal long term capital gains tax rate.
College financial aid can be a big exception. If you have a child in college or a child that will be going to college within the next two years, and you expect to receive some type of financial aid based on income, be very careful about when you realize capital gains in your investment portfolio. The parent’s investment income can count against a student’s financial aid package. Also, FASFA looks back two years for purposes of determining your financial aid package so conducing this tax versus risk analysis requires some advanced planning.
For those receiving social security benefit, capital gains can impact how much of your social security benefit is subject to taxation.
For individuals that receive their health insurance through a state exchange platform (Obamacare) and qualify for income subsidies, the capital gains income could decrease the amount of the subsidy that you are receive for that year. Be careful.
Don't Make The This Mistake
Bottom line, nothing is ever simple. I wish I could say that in all instances you should completely ignore the tax ramifications and make the right investment decision. In the real world, it’s about determining the balance between the two. It’s about doing the math to better under the tax hit versus the downside risk of continuing to hold a security to avoid paying taxes.
While the current economic expansion may still have further to go, we are probably closer to the end than we are the beginning of the current economic expansion. When the expansion ends, investors are going to be tempted to hold onto certain investments within their portfolio longer than they should because they don’t want to take the tax hit. Don’t make this mistake. If you have a stock holding within your portfolio and it drops significantly in value, you may not have the time horizon needed to wait for that investment to bounce back. Or you may have the opportunity to preserve principal during the next market downturn and buy back that same investment at lower level.
In general, it’s good time for investors to revisit their investment portfolios from a risk standpoint. You may be faced with some difficult investment decisions within the next few years. Remember, selling an investment that has lost money is ten times easier than selling one of your “big winners”. Do the math, don’t get emotionally attached to any particular investment, and be prepared to make investment changes to your investment portfolios as we enter the later stages of this economic cycle.
About Michael.........
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
More Taxpayers Will Qualify For The Child Tax Credit
There is great news for parents in the middle to upper income tax brackets in 2018. The new tax law dramatically increased the income phaseout threshold for claiming the child tax credit. In 2017, parents were eligible for a $1,000 tax credit for each child under the age of 17 as long as their adjusted gross income (“AGI”) was below $75,000 for single
There is great news for parents in the middle to upper income tax brackets in 2018. The new tax law dramatically increased the income phaseout threshold for claiming the child tax credit. In 2017, parents were eligible for a $1,000 tax credit for each child under the age of 17 as long as their adjusted gross income (“AGI”) was below $75,000 for single filers and $110,000 for married couples filing a joint return. If your AGI was above those amounts, the $1,000 credit was reduced by $50 for every $1,000 of income above those thresholds. In other words, the child tax credit completely phased out for a single filer with an AGI greater than $95,000 and for a married couple with an AGI greater than $130,000.
Note: If you are not sure what the amount of your AGI is, it’s the bottom line on the first page of your tax return (Form 1040).
New Phaseout Thresholds In 2018+
Starting in 2018, the new phaseout thresholds for the Child Tax Credit begin at the following AGI levels:
Single Filer: $200,000
Married Filing Joint: $400,000
If your AGI falls below these thresholds, you are eligible for the full Child Tax Credit. For taxpayers with an AGI amount that exceeds these thresholds, the phaseout calculation is the same as 2017. The credit is reduced by $50 for every $1,000 in income over the AGI threshold.
Wait......It Gets Better
Not only will more families qualify for the child tax credit in 2018 but the amount of the credit was doubled. The new tax law increased the credit from $1,000 to $2,000 for each child under the age of 17.
In 2017, a married couple, with three children, with an AGI of $200,000, would have received nothing for the child tax credit. In 2018, that same family will receive a $6,000 tax credit. That’s huge!! Remember, “tax credits” are more valuable than “tax deductions”. Tax credits reduce your tax liability dollar for dollar whereas tax deductions just reduce the amount of your income subject to taxation.
Tax Reform Giveth & Taketh Away
While the change to the tax credit is good news for most families with children, the elimination of personal exemptions starting in 2018 is not.
In 2017, taxpayers were able to take a tax deduction equal to $4,050 for each dependent (including themselves) in addition to the standard deduction. For example, a married couple with 3 children and $200,000 in income, would have been eligible received the following tax deductions:
Standard Deduction: $12,700
Husband: $4,050
Wife: $4,050
Child 1: $4,050
Child 2: $4,050
Child 3: $4,050
Total Deductions $32,950
Child Tax Credit: $0
This may lead you to the following question: “Does the $6,000 child tax credit that this family is now eligible to receive in 2018 make up for the loss of $20,250 ($4,050 x 5) in personal exemptions?”
By itself? No. But you have to also take into consideration that the standard deduction is doubling in 2018. For that same family, in 2018, they will have the following deductions and tax credits:
Standard Deduction: $24,000
Personal Exemptions: $0
Total Deductions: $24,000
Child Tax Credit: $6,000
Even though $24,000 plus $6,000 is not greater than $32,950, remember that credits are worth more than tax deductions. In 2017, a married couple, with $200,000 in income, put the top portion of their income subject to the 28% tax bracket. Thus, $32,950 in tax deductions equaled a $9,226 reduction in their tax bill ($32,950 x 28%).
In 2018, due to the changes in the tax brackets, instead of their top tax bracket being 28%, it’s now 24%. The $24,000 standard deduction reduces their tax bill by $5,760 ($24,000 x 24%) but now they also have a $6,000 tax credit with reduces their remaining tax bill dollar for dollar, resulting in a total tax savings of $11,760. Taxes saved over last year: $2,534. Not a bad deal.
For many families, the new tax brackets combined with the doubling of the standard deduction and the doubling of the child tax credit with higher phaseout thresholds, should offset the loss of the personal exemptions in 2018.
This information is for educational purposes only. Please consult your accountant for personal tax advice.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
Business Owners: Strategies To Reduce Your Taxable Income To Qualify For The New 20% Qualified Business Income Deduction
Now that small business owners have the 20% deduction available for their pass-through income in 2018, as a business owner, you will need to begin to position your business to take full advantage of the new tax deduction. However, the Qualified Business Income ("QBI") deduction has taxable income thresholds. Once the owner's personal taxable
Now that small business owners have the 20% deduction available for their pass-through income in 2018, as a business owner, you will need to begin to position your business to take full advantage of the new tax deduction. However, the Qualified Business Income ("QBI") deduction has taxable income thresholds. Once the owner's personal taxable income begins to exceed specific dollar amounts, the 20% deduction with either phase out or it will trigger an alternative calculation that could lower the deduction.
First: Understand The 20% Deduction
If you are not already familiar with how the new 20% deduction works, I encourage you to read our article:"How Pass-Through Income Will Be Taxes In 2018 For Small Business Owners"If you are already familiar with how the Qualified Business Income deduction works, please continue reading.
The Taxable Income Thresholds
Regardless of whether you are considered a “services business” or “non-services business” under the new tax law, you will need to be aware of the following income thresholds:
Individual: $157,500
Married: $315,000
These threshold amounts are based on the “total taxable income” listed on the tax return of the business owner. Not “AGI” and not just the pass-through income from the business. Total taxable income. For example, if I make $100,000 in net profit from my business and my wife makes $400,000 in W-2 income, our total taxable income on our married filing joint tax return is going to be way over the $315,000 threshold. So do we completely lose the 20% deduction on the $100,000 in pass-through income from the business? Maybe not!!
The Safe Zone
For many business owners, to maximize the new 20% deduction, they will do everything that they can to keep their total taxable income below the thresholds. This is what I call the “safe zone”. If you keep your total taxable income below these thresholds, you will be allowed to take your total qualified business income, multiply it by 20%, and you’re done. Once you get above these thresholds, the 20% deduction will either begin to phase out or it will trigger the alternative 50% of W-2 income calculation which may reduce the deduction. The phase out ranges are listed below:
Inidividuals: $157,500 to $207,500
Married: $315,000 to $415,000
As you get closer to the top of the range the deduction begins to completely phase out for “services businesses” and for “non-services business” the “lesser of 20% of QBI or 50% of wages paid to employees” is fully phased in.
What Reduces "Total Taxable Income"?
There are four main tools that business owners can use to reduce their total taxable income:
Standard Deduction or Itemized Deductions
Self-Employment Tax
Retirement Plan Contributions
Timing Expenses
Standard & Itemized Deductions
Since tax reform eliminated many of the popular tax deductions that business owners have traditionally used to reduce their taxable income, for the first time in 2018, a larger percentage of business owners will elect taking the standard deduction instead of itemizing. You do not need to itemize to capture the 20% deduction for your qualified business income. This will allow business owners to take the higher standard deduction and still capture the 20% deduction on their pass-through income. Whether you take the standard deduction or continue to itemize, those deductions will reduce your taxable income for purposes of the QBI income thresholds.
Example: You are a business owner, you are married, and your only source of income is $335,000 from your single member LLC. At first look, it would seem that your total income is above the $315,000 threshold and you are subject to the phase out calculation. However, if you elect the standard deduction for a married couple filing joint, that will reduce your $335,000 in gross income by the $24,000 standard deduction which brings your total taxable income down to $311,000. Landing you below the threshold and making you eligible for the full 20% deduction on your qualified business income.
The point of this exercise is for business owners to understand that if your gross income is close to the beginning of the phase out threshold, somewhere within the phase out range, or even above the phase out range, there may be some relief in the form of the standard deduction or your itemized deductions.
Self-Employment Tax
Depending on how your business is incorporated, you may be able to deduct half of the self-employment tax that you pay on your pass-through income. Sole proprietors, LLCs, and partnership would be eligible for this deduction. Owners of S-corps receive W2 wages to satisfy the reasonable compensation requirement and receive pass-through income that is not subject to self-employment tax. So this deduction is not available for S-corps.
The self-employment tax deduction is an “above the line” deduction which means that you do not need to itemize to capture the deduction. The deduction is listed on the first page of your 1040 and it reduces your AGI.
Example: You are a partner at a law firm, not married, the entity is taxed as a partnership, and your gross income is $200,000. Like the previous example, it looks like your income is way over the $157,500 threshold for a single tax filer. But you have yet to factor in your tax deductions. For simplicity, let’s assume you take the standard deduction:
Total Pass-Through Income: $200,000
Less Standard Deduction: ($12,000)
Less 50% Self-Employ Tax: ($15,000) $200,000 x 7.5% = $15,000
Total Taxable Income: $173,000
While you total taxable income did not get you below the $157,500 threshold, you are now only mid-way through the phase out range so you will capture a portion of the 20% deduction on your pass-through income.
Retirement Plans – "The Golden Goose"
Retirement plans will be the undisputed Golden Goose for purposes of reducing your taxable income for purposes of the qualified business income deduction. Take the example that we just went through with the attorney in the previous section. Now, let’s assume that same attorney maxes out their pre-tax employee deferrals in the company’s 401(k) plan. The limit in 2018 for employees under the age of 50 is $18,500.
Total Pass-Through Income: $200,000
Less Standard Deduction: ($12,000)
Less 50% Self-Employ Tax: ($15,000)
Pre-Tax 401(k) Contribution: ($18,500)
Total Taxable Income: $154,500
Jackpot!! That attorney has now reduced their taxable income below the $157,500 QBI threshold and they will be eligible to take the full 20% deduction against their pass-through income.
Retirement plan contributions are going to be looked at in a new light starting in 2018. Not only are you reducing your tax liability by shelter your income from taxation but now, under the new rules, you are simultaneously increasing your QBI deduction amount.
When tax reform was in the making there were rumors that Congress may drastically reduce the contribution limits to retirement plans. Thankfully this did not happen. Long live the goose!!
Start Planning Now
Knowing that this Golden Goose exists, business owners will need to ask themselves the following questions:
How much should I plan on contributing to my retirement accounts this year?
Is the company sponsoring the right type of retirement plan?
Should we be making changes to the plan design of our 401(k) plan?
How much will the employer contribution amount to the employees increase if we try to max out the pre-tax contributions for the owners?
Business owners are going to need to engage investment firms and TPA firms that specialize in employer sponsored retirement plan. Up until now, sponsoring a Simple IRA, SEP IRA, or 401(K), as a way to defer some income from taxation has worked but tax reform will require a deeper dive into your retirement plan. The golden question:
“Is the type of retirement plan that I’m currently sponsoring through my company the right plan that will allow me to maximize my tax deductions under the new tax laws taking into account contribution limits, admin fees, and employer contributions to the employees.”
If you are not familiar with all of the different retirement plans that are available for small businesses, please read our article “Comparing Different Types Of Employer Sponsored Plans”.
DB / DC Combo Plans Take Center Stage
While DB/DC Combo plans have been around for a number of years, you will start to hear more about them beginning in 2018. A DB/DC Combo plan is a combination of a Defined Benefit Plan (Pension Plan) and a Defined Contribution Plan (401k Plan). While pension plans are usually only associated with state and government employers or large companies, small companies are eligible to sponsor pension plans as well. Why is this important? These plans will allow small business owners that have total taxable income well over the QBI thresholds to still qualify for the 20% deduction.
While defined contribution plans limit an owner’s aggregate pre-tax contribution to $55,000 per year in 2018 ($61,000 for owners age 50+), DB/DC Combo plans allow business owners to make annual pre-tax contributions ranging from $60,000 – $300,000 per year. Yes, per year!!
Example: A married business owner makes $600,000 per year and has less than 5 full time employees. Depending on their age, that business owner may be able to implement a DB/DC Combo plan prior to December 31, 2018, make a pre-tax contribution to the plan of $300,000, and reduce their total taxable income below the $315,000 QBI threshold.
Key items to make these plans work:
You need to have the cash to make the larger contributions each year
These DB/DC plan needs to stay in existence for at least 3 years
This plan design usually works for smaller employers (less than 10 employees)
Shelter Your Spouse's W-2 Income
It's not uncommon for a business owner to have a spouse that earns W-2 wages from employment outside of the family business. Remember, the QBI thresholds are based on total taxable income on the joint tax return. If you think you are going to be close to the phase out threshold, you may want to encourage your spouse to start putting as much as they possibly can pre-tax into their employer's retirement plan. Unlike self-employment income, W-2 income is what it is. Whatever the number is on the W-2 form at the end of the year is what you have to report as income. By contrast, business owners can increase expenses in a given year, delay bonuses into the next tax year, and deploy other income/expense maneuvers to play with the amount of taxable income that they are showing for a given tax year.
Timing Expenses
One of the last tools that small business owners can use to reduce their taxable income is escalating expense. Now, it would be foolish for businesses to just start spending money for the sole purpose of reducing income. However, if you are a dental practice and you were planning on purchasing some new equipment in 2018 and purchasing a software system in 2019, depending on where your total taxable income falls, you may have a tax incentive to purchase both the equipment and the software system all in 2018. As you get toward the end of the tax year, it might be worth making that extra call to your accountant, before spending money on those big ticket items. The timing of those purchases could have big impact on your QBI deduction amount.
Disclosure: The information in this article is for educational purposes. For tax advice, please consult your tax advisor.
About Michael.........
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
How Rental Income Will Be Taxed In Years 2019+
Tax reform will change the way rental income is taxed to landlords beginning in 2018. Under current law, rental income is classified as "passive income" and that income simply passes through to the owner's personal tax return and they pay ordinary income tax on it. Beginning in 2018, rental income will be eligible to receive the same preferential tax
Tax reform will change the way rental income is taxed to landlords beginning in 2018. Under current law, rental income is classified as "passive income" and that income simply passes through to the owner's personal tax return and they pay ordinary income tax on it. Beginning in 2018, rental income will be eligible to receive the same preferential tax treatment as the "qualified business income" (QBI) for small business owners.
20% Deduction
Starting in 2018, taxpayers with qualified business income (including rental income), may be eligible to take a tax deduction up to 20% of their QBI. Determining whether or not you will be eligible to capture the full 20% deduction on your rental income will be based on your total taxable income for year. The taxable income thresholds are as follows:Single filers: $157,500Married filing joint: $315,000"Total taxable income" is not your AGI (adjusted gross income) and it's not just income from your real estate business or self-employment activities. It's your total taxable income less some deductions. The IRS has yet to provide us with full guidance on the definition of "total taxable income". For example, let's assume you have three rental properties owned by an LLC and you net $50,000 in income from the LLC each year. But your wife is a lawyer that makes $350,000 per year. Your total taxable income for the year would be $400,000 landing you above the $315,000 threshold.
Below The Income Threshold
If your total taxable income is below the income thresholds listed above, the calculation is very easy. Take your total QBI and multiply it by 20% and that's your tax deduction.
Above The Income Threshold
If your total taxable income is above the thresholds, the calculation gets more complex. If you exceed the income thresholds, your deduction is the LESSER of:
20% of QBI
The GREATER OF:
50% of W-2 wages paid to employees
25% of W-2 wages paid to employees PLUS 2.5% of the unadjusted asset basis
The best way to explain the calculation is by using an example. Assume the following:
I bought a commercial building 3 years ago for $1,000,000
I have already captured $100,000 in depreciation on the building
After expenses, I net $150,000 in income each year
The LLC that owns the property has no employees
I'm married
I own a separate small business that makes $400,000 in income
Since I'm over the $315,000 total taxable income threshold for a married couple filing joint, I will calculate my deduction as follows:The LESSER of:
20% of QBI = $30,000 ($150,000 x 20%)
The GREATER of:
50% of W-2 wage paid to employees = $0 (no employees)
25% of W-2 wages page to employees plus 2.5% of unadjusted basis
(25% of wages = $0) + (2.5% of unadjusted basis = $25,000) = $25KIn this example, my deduction would be limited to $25,000. Here are a few special notes about the calculation listed above. In the 11th hour, Congress added the "2.5% of unadjusted basis" to the calculation. Without it, it would have left most landlords with a $0 deduction. Why? Real estate owners typically do not have W-2 employees, so 50% of W-2 wages would equal $0. Some larger real estate investors have "property management companies" but they are usually set up as a separate entity. In which case, the W-2 income of the property management company would not be included in the calculation for the QBI deduction. If you are someone who owns a property or properties and is need of a Property management company to help you with organizing and operating your property, then doing research in your general area to find a real estate company that can help you with that is important.Another special note, 2.5% is based on an unadjusted basis and it's not reduced by depreciation. However, the tangible property has to be subject to depreciation on the last day of the year to be eligible for the deduction. Meaning, even though the 2.5% is not reduced for the amount of depreciation already taken on the property, the property must still be in the "depreciation period" on the last day of the year to be eligible for the QBI deduction.Tony Nitti, a writer for Forbes, also makes the following key points:
The depreciable period starts on the date the property is placed in service and ends on the LATER of:
- 10 years, or- The last day of the last full year in the asset's "regular" (not ADS) depreciation periodMeaning, if you purchase a non-residential rental building that is depreciated over 39 years, the owner can continue to capture the depreciation on the building but that will not impact the 2.5% unadjusted basis number for the full 39 years of the depreciation period.
Any asset that was fully depreciated prior to 2018, unless it was placed in service after 2008, will not count toward the basis.
Shareholders or partners may only take into consideration for purposes of applying the limitation 2.5% his or her allocable share of the basis of the property. So if the total basis of commercial property is $1,000,000 and you are a 20% owner, you basis limitation is $1,000,000 x 20% x 2.5% = $5,000
Phase-In Of The Threshold
The questions I usually get next is: "If I'm married and our total taxable income is $320,000 which is only $5,000 over the threshold, do I automatically have to use the more complex calculation?" The special calculation "phases in" over the following total taxable income thresholds:Single filers: $157,500 - $207,500Married filing joint: $315,000 - $415,000I won't get into the special phase-in calculation because it's more complex than the special "above the income threshold" calculation that we already walked through but just know that it will be a blend of the straight 20% deduction and the W-2 & 2.5% adjusted basis calculation.
Qualified Trade or Business Requirement
In August 2018, the IRS came out with further clarification of how the QBI deduction would apply to real estate. In order to qualify for the QBI deduction for real estate income, your real estate holdings have to qualify as a "trade or business". The definition of a trade or business for QBI purposes deviates slightly from the traditional IRS definition. There is a safe harbor that states if you spend more than 250 hours a year working on that business it will qualify for the deduction.There are a few items to consider in the 250 hour calculation. So called "drive bys" where the owner is spending time driving by their properties to check on them does not count toward the 250 hours. If you have a property management company, the hours that they spend managing your propoerty can be credited toward your 250 hour requirement. However, the property management company has to provide you with proper documentation to qualify for those credited hours.
Consult Your Accountant
I'm a Certified Financial Planner®, not an accountant. I wrote this article to give real estate investors a broad view of what tax reform may have instore for them in 2018. If you own rental property, you should be actively consulting with our accountant through the year. As the IRS continues to release guidance regarding the QBI deduction throughout 2018, you will want to make sure that your real estate holdings are positioned properly to take full advantage of the new tax rules.
About Michael.........
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
