Mixed-use rental property passive losses pass through as QBID to Sch1 and then 1040 and offset *active* income. Why?

[micwebnet]

I ran into a TT behavior I can't explain. When my rental reports a loss it's not allowed to be deducted as my MAGI is above 150k. So far nothing out of the ordinary. Then, if I report the property as mixed-use by setting "Days of personal use" to be above 14 and 10% of "Days rented at fair rental value" all of a sudden TT

1. Changes line 22 in SchE to match 21 (i.e. lets me deduct rental real estate loss)
2. Propagates it to line 4 in QBID Smart Worksheet under "Calculated QBI allowed after passive/at-risk limits"

3. Propagates it to line 5 in Schedule 1

4. Propagates it to line 8 in Form 1040

and deducts my mixed-use rental property losses against my active income! I thought w/mixed-use rentals you can't deduct at all (regular rental accrues you passive losses till disposition, but something at least). So, how does QBI change this equation for mixed-use rentals? I've never seen a way to write off passive rental  property losses against my active income (not a real estate professional).

Best,  MM

[Anonymous_]

I'll page @Mike9241

[Mike9241]

The QBID calculations only go to form 8995/8995A and the QBID deduction, if any, only flows to 1040 line13. 

I really don' understand what's going on in your return and obviously have no access to it.  regular real estate losses and income from schedule e flow to schedule 1.   you may need the help of a professional to understand the difference between QBID and business income/loss 

[micwebnet]

The situation is pretty standard. A rental property on SchE reported for many years that kept accumulating passive activity losses, disallowed for deduction since my MAGI is above 150k. I used it for personal use part of the year, so specified "Day of personal use" higher than 10% of "Days rented at fair rental value" / 14d, which made it a mixed-use rental property. Instead of seeing all deductions disallowed (vs carried over like w/a standard rental) I saw line 22 in SchE change from 0 to the property's annual losses and then carried through QBID Smart Worksheet (line 4a and 4c) into Sch1 Line 5 "Rental real estate, royalties, partnerships, S corporations, trusts, etc.", then line 9 and then up to Form 1040 line 8 "Other income from Schedule 1, line 9.

In Form 8995A "QBID Simplified Computation" Schedule C I see the full loss under Aggregation 1 (covers my two rentals). All that loss is coming from the mixed-use rental property - when set to regular rental - this is zero. If I switch the other to mixed-use by saying I used it for personal use enough days, its losses also show up here.

TLDR: TT propagates loss on a mixed-use rental through QBI for me. This is for 2020. I can easily repro this on my other rental property's SchE by also switching it to mixed-use w/higher personal use. I also added a synthetic 100k expense and it propagated all of it, deducting against my active income, and switching me from 8995A to 8995 (cause now my taxable income would be low enough for the simpler form).

My understanding of the tax code says this shouldn't be happening, and QBI losses are undesirable as they offset QBI income, including future (through carry over). That said, Intuit also warrants that all changes via their UI are compliant with the tax code and if it lets me deduct losses against active income, I'd love to understand why. Is there a scenario where mixed-use rental income was allowed to be deducted from active income through QBI losses? Could this be specific to 2020 (Covid Tax Relief Act)?

UPDATE: This does *not* repro on my 2019 TT - there it correctly sets line 22 in SchE to zero, soon as I turn rental into a mixed-use w/number of days above 10%/14d. So, a 2020 specific behavior, which might be Covid TRA related.

Thanks,  MM

[micwebnet]

Debugged this some more. Regular rental property losses are not propagated to QBI (checked for TT 2018-22) - i.e. line 4a in QBID Smart Worksheet is zero. Soon as you switch to mixed rental use (personal use days > 10%/14d) then TT 2020-22 do propagate it to 4a, but TT 2018-19 do not. And once it's propagated it's both tracked as QBLC (loss carryforward) and is deducted from active income. Former is expected, latter is not.

Can't be a bug if it's in three versions of TT. Must be some condition that lets you deduct mix-used rental losses through QBI, while also accruing them as QBLC. One thing I noticed is that when I set "Days of personal use" TT checks SchE line G "Other passive exceptions", which is otherwise clear, but just checking it alone doesn't enact this propagation.

Hope someone knows what's driving this logic in SchE QBID Smart Worksheet for TT 2020-22.

Best,  MM

[micwebnet]

Actually, I don't think this is QBID specific. Even if I say the activity isn't QBI, TT2020-22 will still for mixed-use property propagate losses from line 21 to line 22 in SchE for me. Soon as I remove personal use days it blocks that propagation. So this is a purely TT SchE behavior question for tax years 2020+.

[micwebnet]

Ok, I think I figured this out. Starting from 2020, for mixed-user rentals, TT lets you propagate Interest/Taxes/Other expenses in SchE column C through Sch1 to 1040. Previous versions didn't propagate anything. "Allocated to personal use" portion still goes through SchA. 

The obvious benefit of this is that it can mitigate the 10k SALT limit. If you have property taxes > 10k, then by renting the place part of the year while still using it most of the year you can route portion of those taxes through Sch1 as businesses losses. When I tried TT18-19 didn't let me do that.

TT20+ still don't let you expense other categories (e.g. Supplies/Repairs/Utilities/etc.) for mixed-use rental property, so it's only Interest/Taxes (which would have gone to SchA otherwise) and Other expenses (that you are responsible to make sure are truly deductible). Since other comes from Miscellaneous expenses in UI, that's where I think TT could do better - it's not obvious which of those expenses are acceptable for mixed-use rental active income deduction and which aren't, especially for folks w/MAGI>150k.

Mystery solved.

Cheers,  MM