Should QBI deduction be reduced by non-QBI rental property loss?

[melisvik]

I have qualified business income from my freelance business, net income $25,000. 

I also owned a rental property last year, abroad in Finland, which we converted from our personal residence to a rental when we moved to the USA in Jan 2018. It was not a qualified business because we didn't spend much time managing it. 

I sold that apartment in June 2019 at a loss of $26,000. 

My question is, should the loss on the sale of the non-QBI rental property affect my QBI deduction?

The reason I am asking is because I was using H&R Block, which is reducing my QBI income to 0 because of the rental loss, even though I have told it the rental is not QBI. This confused me so I opened a TurboTax account to see how TT handles the situation. In TT the rental sale loss does not affect my QBI deduction, resulting in a greater refund. 

I am just wondering which is the correct way of handling this situation? I don't want to go with TT just for a bigger refund if it's not the proper way of handling it.

[AmeliesUncle]

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@melisvik wrote:

I also owned a rental property last year, abroad in Finland, which we converted from our personal residence to a rental when we moved to the USA in Jan 2018. 

I sold that apartment in June 2019 at a loss of $26,000. 

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Before anybody should answer your actual question, we need to check if you actually have a deductible loss or not.   When calculating the loss for a property that was converted to rental use, your starting point is the LOWER of (1) your Adjusted Basis when converted to rental use (usually purchase price plus cost of improvements, minus any prior depreciation, such as from a Home Office) or (2) the Fair Market Value when it was converted to rental use.

In other words, was there a loss of that amount based on the time period of January 2018 to June 2019?

That same calculation is what you should have been using for depreciation.

So again, before anybody gets to your actual question, do you actually have a loss?

[melisvik]

Yes, there was a loss. Here are the numbers:

Adjusted basis at conversion (purchase price plus cost of improvements, and there was no depreciation taken prior to conversion): $222,654

Fair market value at conversion: $222,877

Depreciation taken after conversion: $10,190

Sale price: $190,370

Sale expenses: $4683

Loss: -$26,777

[AmeliesUncle]

Great, then in answer to your question ... the answer is "maybe".    :(

The deduction is largely based on the LOWER of (1) Qualified Business Income (QBI) or (2) "taxable income" (adjusted for net capital gains, before the QBI deduction).

So the non-QBI rental would not affect Qualified Business Income.  But it WOULD affect your "taxable income" (and could affect the adjustment for the net capital gain).  So it depends on the rest of your tax return.

Do you have other income besides your freelance income?  If so, about how much?  What is your pre-QBI "taxable income" (Line 8a minus Line 9 of your Form 1040)?

The answer is Form 8995 (or 8995A, depending on your situation) because that is where the calculation is.  Unfortunately, I don't think you can access that form on either H&R Block or TurboTax until AFTER you pay for the software.  

[melisvik]

Yes, we have other income. My husband has a regular W-2 job which he earned $109,000 gross. After the $26,000 loss on the property sale and the standard deduction etc, our total taxable income, pre-QBI, comes to $78,000. 

Does that help you understand the situation better?

[AmeliesUncle]

Then it seems like H&R Block is doing it wrong and is treating the rental loss as QBI.  You may want to review the questions in that software, and possible even contact their customer support.  If you have already paid for the H&R software, I suggest printing out the Form 8995 (or 8995A) to look at the numbers on there.

[melisvik]

Do you know if the loss from that rental property sale is considered section 1231 loss?

[AmeliesUncle]

Yes it is.

One other thing to double check on the H&R software is to verify it that IS treating your business as QBI.    If you missed something there, it may not be the rental that is affecting the QBI deduction.

[melisvik]

Yes, it is definitely treating my business as QBI. 

I found this paragraph from this article: https://www.bdo.com/insights/tax/federal-tax/final-regulations-of-section-199a#:~:text=Items%20Treat...

Under the final regulations, taxpayers must first net their Section 1231 gains and losses in order to determine whether the amounts will be treated as a capital gain or ordinary loss.  If the net result is an excess gain, the character of the gain is capital and is excluded from QBI.  If the net result is an excess loss, the character of the loss is ordinary and reduces QBI.

Could this be the reason?

[AmeliesUncle]

Because the §1231 loss from the rental is non-QBI, that would not apply to the QBI.  However, it is possible that H&R Block is incorrectly doing.  Without actually seeing the forms and worksheets it is difficult to know.

But at any rate, if H&R Block is continuing to miscalculate it, you may need to use TurboTax or some other software (personally, I would use TaxAct over TurboTax, but that's just me).

[melisvik]

It sounds like the above paragraph is saying that whether section 1231 is treated as QBI or not depends on whether it is a net gain or net loss across all section 1231 properties, which this is a net loss. So in that case could TT be doing it wrong by not taking that into account?

[AmeliesUncle]

Although that paragraph does make it sound that way, the Final Regulations do not say that.  That section in the Final Regulation discuss what is (and is not) included as QBI for your "Trade or Business".  If the 1231 loss is not part of your "Trade or Business" (such as your rental), that is not involved in the calculation.

[melisvik]

OK, well, thank you for all your help and support, I really appreciate it.

May I ask why you prefer TaxAct?

[AmeliesUncle]

There are MANY errors in TurboTax that the developers refuse to fix, so I recommend against TurboTax.  While I can't 'vouch' for the accuracy of TaxAct, I do like the layout of it.