Safe Harbor on Two Multi Families, One Partially Owner Occupied, the Other Investment

[flamingvan]

I own a 3 family house which is an investment property.  I also own a 2 family house in which one unit is rented and the other is my residence.

I would like to claim the QBI deduction.  Should I use safe harbor on each property individually or combined?  Or should I handle this another way?

Thanks,

Moses

[ColeenD3]

Your investment property is not business property, nor is your half of the two-family house. The only property that potentially qualifies for the QBI deduction is the half of the two family that is rented for profit.

[flamingvan]

Maybe 'investment property' was the wrong term.  The three-family is a house which I own, rent out and manage on my own.  I interact with the tenants regularly and spend a significant amount of my own time maintaining, improving and repairing the house.  Does this qualify as a business property?

Thanks,

Moses

[ColeenD3]

Yes. 

Can I get the QBI deduction on rental income?

Qualified business income, or QBI, is the net income generated by any qualified trade or business under Internal Revenue Code (IRC) § 162.

Rental properties are usually treated as passive activities, and passive activities are excluded from the definition of a qualified trade or business. However, rentals that qualify as trades or businesses under IRC § 162 are not considered passive, which means they could potentially qualify for the QBI deduction.

To provide preliminary guidance to this popular question, the IRS released Notice 2019-07, the key points of which we've summarized below.

Exclusions

Real Estate Professionals

Everybody Else

[flamingvan]

Thank you for your response.  I am wondering if my four rental units combined can be considered to be a "rental real estate enterprise".  This includes the rental unit in the two family which is also my residence and a three family house which I also own.  This would be helpful to know because I must satisfy the 250 hour requirement.

[Carl]

You can do either. But if each property will qualify you for QBI on it's own merits, then I would not bother combining.

Once aggregated into a single activity, you can't de aggregate them later. One thing that means is that you can't realize any carry over losses (if any) until the last property in the aggregate is sold.

[snugglez]

Hi Carl, that is a great detail, thank you.

I also have two separate rental properties. Since I qualify for QBI separately *this* year, and it's the first year I'll be using QBI on either one, I would lean towards not using the election to combine them as a single enterprise. However, what if in some later year one or the other will not qualify unless they are combined together.

I understand from your response that once you elect to combine two properties, you cannot choose to file separately in the following years, but can you do the reverse: file separately for one or more years and then combine them at some later time?

Obviously I will carefully read the QBI info, but curious if you know this offhand. Thanks very much!

[snugglez]

And I guess as a follow up: can you point out exactly how you determined that we would need to sell both properties before capturing carryover losses from either? Again, this is incredibly useful information, so thanks again!

[Carl]

how you determined that we would need to sell both properties before capturing carryover losses from either?

I may not have been clear enough on that.

If you combine two or more properties into a single enterprise, you can't realize your losses against "other" ordinary income until you have sold or otherwise disposed of the entire enterprise. Until that happens your losses each year will be limited to:

1) The rental income and;

2) The $25K you are allowed to deduct under current tax law that went into effect for 2018 thru 2025. (assuming you have $25K of "other" income to claim/deduct it from.)

Once you sell all of the assets of a single enterprise, then your realized losses are released in their entirety, with the possibility of other limitations based on other factors such as your AGI and the such. For example, one limitation may limit you to deducting a max of $3000 a year of your losses, until that loss is all used up in a future year.

See tax topic 409 at https://www.irs.gov/taxtopics/tc409 the part titled "Limit on the deduction and carry over of losses", which doesn't relate to your question directly. I can't find the IRS pub that does address your situation directly, as I thought I had it in my bookmarks. Apparently I don't.