Schedule E Expense and QBI / Section 199A Deduction?

[thehokie]

I have a question about claiming all Schedule E expenses I have available and the QBI / 199A Deduction.  Specifically, is there a requirement to claim all expenses?

Why I ask:

In filling out my 2019 return, I added all my income areas (W-2, Div, including 1099s from the four rental properties I have) and observed in Turbo Tax's estimate window that I was getting a very small return.  (That was fine).  However; once I got to the Schedule E areas and started putting in my expenses - mortgage interest, property manager fee, repairs, cleaning, etc + depreciation - I noticed the estimate window changed to indicate "tax due" and kept getting larger with every expense I added.  ??!  This did not make sense to me.  I have reviewed the posts on the Section 199/QBI and I seem to qualify for that.

Normally, my rentals breakeven or have a small paper loss after depreciation is added.  I reviewed my 2018 return and had a small QBI.  With all my expenses included, I have an even smaller QBI for 2019.  If I remove e v e r y expense (incl mortgage interest and depreciation), leaving just the income reported, I get a great QBI deduction and a very small refund on my federal return.  If I claim all expenses I owe $3K.

Any insights out there?   Thanks!

[Carl]

For starters,That "refund/amount due? number has absolutely no meaning to you until after you have completed your return it it's entirety and are ready to file it. This is especially true if you are using the online self-employed version, or the desktop Home & Business version.  With those versions you are entering your business income/expenses first, and for many that's barely the "tip of the iceburg" on their income and you haven't even touched deductions yet.

Therefore that number at the top of your screen that shows your refund amount or tax due amount means *ABSOLUTELY* *NOTHING*.  In the process of completing the return that number will be *all* *over* *the* *place*. That's because the program can only work with the information that *you* *personally* have entered into the program at *this* *specific* *point* *in* *time*. So until you have entered all of your data and completed the program in it's entirety, there is no way possible that number is going to be correct.

You need to ignore it completely until you have worked through the entire program and are ready to file.

If I remove e v e r y expense (incl mortgage interest and depreciation), leaving just the income reported, I get a great QBI deduction

With four rental properties, it is perfectly possible that you qualify for the QBI, but probably "just barely". I myself have three rental properties and I don't come anywhere close to having the 250 hours of "direct involvement" in managing my three properties, even with all three lumped together. In fact, I can't even break 100 hours in a year - and that includes when I did all the turn-around work myself on one property to prepare it for the next renter, between renters.

By law, you are required to claim all business expenses. But like I said above, you can probably "get away with" not claiming some of them. By not claiming expenses for the purpose of reducing your tax liability, that's a sure fire way to raise flags and get audited. Those you can't get away with:

 - You are required by law to depreciate any asset that is utilized on a recurring basis in the production of income. Your rental property and all property improvements are "in fact" used on a recurring basis to produce income. Therefore you have to depreciate them.

 - If you have a mortgage on the property and you do NOT claim the mortgage interest, that's a sure fire flag raiser. Especially since the lender reported your interest income to the IRS as they are required to do by law.

 - There is no question that you paid property taxes. So that's another flag raiser with the IRS if you don't claim them.

 - If you have other expenses that you have been claiming on a consistent basis in past years, and then those expenses "suddenly" disappear, I don't know what the probability is the IRS will question it, or if it will even raise flags. But I can't definitively say it won't raise flags.

Finally, if the IRS has reason to suspect you are filing what "could" be interpreted as a fraudulent return (that would be with intent for defraud the IRS), then the IRS can audit all of your tax returns back as far as they desire under the auspices of suspected intentional fraud. Don't go there.

[thehokie]

Carl,

Thank you for replying.  I think I may have to clarify myself.

First, I have been a Turbo Tax user for 15 years and fully intend to file a return for the appropriate tax liability (your response may have questioned that).  What I am noticing has given me a pause and why I am so late in filing this year, and turned to the community discussion for the first time.

My question maybe better stated:  Are the indications I am seeing a quirk in Turbo Tax, or is the QBI extremely advantageous for highly profitable businesses?

I am using TurboTax Premier for Mac.  I use the easy step interview to enter all my data, staring with my W-2 income and withholding.  Then progress through the "income" section with 1099-DIV / INTs, and finally the 1099s from my rental property mangers.  After looking at individual deductions I put in my rental expenses last for the Schedules E.

A prominent feature which I do not see a way to turn off is a window in the top left which shows the potential refund or tax due for both state and federal returns.  This thing constantly changes with every entry; spinning numbers up or down like you'd see on a gas pump or slot machine prize indicator.  

This year, before entering my expenses I observed that I was basically breaking even on my return.  That's pretty much what I expect to see, although with no real difference in my information had a refund last year.  As I mentioned, historically I either basically break even or have a slight paper loss for my rentals after depreciation.  This year as I entered all my Schedule E expenses I noticed the potential tax due amount kept climbing.  That struck me as unusual, as at this point I am offsetting the rental income with expenses.  I did not understand how my tax liability was increasing while the software should have been seeing less and less of a profit from the rentals.

Just out of curiosity if I found a bug in the software, I backed out all my expenses and noted the difference in projected refund or amount due.  That brings me to ask if there's a big glitch in the software, or whether the QBI favors very profitable businesses.  (If the latter is the case, the concept of breaking even on taxable rental income is an outdated model...)

For the hours involved topic - in the TurboTax interview questions you are only asked if you are a real estate professional.  I am not, so I answer "no."  The program only asks if you are an active participant in managing the rentals, and does not ask about an hour total of that participation.  I was not even aware of that concern until digging into this topic more this year.  The software interview questions may need additional amplification on this topic.  I am a very small investor, and my rentals are homes I have lived in over the past many years and kept after I moved out.  I have found Schedules E very straight forward and chose to use Turbo Tax, rather than a paid preparer over the years.  I have not been looking for any ambitious loopholes or anything to skirt the tax system; rather to just make sure all the numbers go on the right lines and add up.  If this program is exposing me to a liability for claiming the QBI deduction based on the questions it asks me than this may be my last year using it.

Thank you again for your response.  I still am confused on how my tax taxable income seems to be lower when I have no rental expenses entered than when I do.

[DavidS127]

As pointed out by Community user Carl, you should properly report all your income and expenses on your tax return, including for your rental properties.

As to the question of why your incomplete Schedules E showing income results in lower taxes that the properly completed Schedules E, more information may help resolve your issue.  For example, do your rental properties have "suspended" passive losses from prior years that carryforward to 2019, and if so, are those suspended passive losses also treated as QBI carryforward losses on line 29 of your Federal Carryover Worksheet?  And, what amounts are reported on your Form 1040 line 10 for the QBI deduction and Schedule 1 Part I line 5 for the rental income (loss) and Form 8582 when you properly prepare your Schedules E versus when you report inaccurate expenses? 

Also, note that the 250 hours referred to by Community user Carl is related to the "safe harbor" for a rental property to qualify for QBI.  You don't get a specific question about 250 hours in TurboTax, you get a screen that asks "Do you want to use a safe harbor to qualify this property for a deduction?".  The 250 hours is an an element of that safe harbor.

See the IRS article on the rental real estate safe harbor at this link for an overview of the safe harbor requirements.  I've pasted a summary of those here:

"The following requirements must be met by taxpayers or RPEs to qualify for this safe harbor:

• Separate books and records are maintained to reflect income and expenses for each rental real estate enterprise.
• For rental real estate enterprises that have been in existence less than four years, 250 or more hours of rental services are performed per year. For other rental real estate enterprises, 250 or more hours of rental services are performed in at least three of the past five years.
• The taxpayer maintains contemporaneous records, including time reports, logs, or similar documents, regarding the following: hours of all services performed; description of all services performed; dates on which such services were performed; and who performed the services.
• The taxpayer or RPE attaches a statement to the return filed for the tax year(s) the safe harbor is relied upon."

More details are about "rental services" are in the IRS Revenue Procedure 2019-38 section .04 Rental Services. on page 7 of the PDF at this link, including what qualifies as rental services and what doesn't, and making clear that rental services performed by a management company "count".  

[Carl]

WHile I've been a landlord with three properties for 30 plus years now, as well as a TTX user since 2003/4, one of the things with the Home & Business version is that you enter your business income *FIRST*, before anything else. So that "tax due/refund due" number doesn't mean jack squat at that point. No ther income has been entered and absolutely no SCH A deductions have been entered. LIkewise, all the credits one may qualify for haven't been taken into account, because they can't be so early in the program - at least not accurately.

As for the QBI stuff, I'm only about 40-50% up to stuff on the subject. That's because even with all three of my rental properties combined as a single enterprise, I can't come anywhere close to the 250 hours directly involved requirement. That includes the year I had to rentals go empty and I did the turnaround myself. For that particular year, I didn't even break 100 hours "directly involved" in all three properties combined. So for someone who has three or less rental properties I do find it questionable about them qualifying for the QBI. But then, who am I to question your active involvement? One person may have rental properties that require extremely little maintenance with good tenants, while another person may have properties that are high maintenance with not-so-good tenants.

The irony for me is, one of my three properties *is* high maintenance compared to the other two. But what I consider high maintenance, another may consider just the opposite. It just depends on what one has available for comparisons.

Now for expenses, if you look at IRS Publication 527 page 3 at https://www.irs.gov/pub/irs-pdf/p527.pdf it doesn't come out and directly say you "have" to claim rental expenses. But if you think you're reducing your tax liability by not claiming them, that train of thought is just wrong.  Remember, what that "tax owed/refund due" number says at the top of the program means absolutely nothing until the tax return has been completed in it's entirety and you are ready to file. So until you are finished, that number is going to be all over the place.

What I do before actually e-filing the return, is print it. Then I can go through everything and "follow the money" with the worksheets and calculation forms to see exactly how the program arrived at a figure. I can say that doing that for my 2019 taxes I was able to identify a major problem area that was missed in years past. Thankfully the issue I found didn't affect me directly. It only affects those who rent out a part of their primary residence and it only affects them in the first tax year of doing so.

[Critter]

The annoying Refund-O-Meter can be hidden at will ... click HIDE ...

[trevecpa]

I am trying to amend my 2018 tax return for QBI on rental properties. I am running into the same issue.  If I amend as qualified for QBI and stop there.  I get the predictable change in my net return due amount.  However, if I see that I missed an expense item, which I did by missing a property tax statement, the calculator goes crazy and starts indicating a tax due amount.  This is an issue with TT. 

I read the answer from TT.   Why TT attacking the user and not answering the question about entering more expense?  Is TT going to require the user to show evidence they worked all the hours, etc. The TT answer is not an answer to the question and is very distasteful and unprofessional.

I am still experiencing the same error.

[trevecpa]

Update.  I am using TT on Windows 10.

[ThomasM125]

The main instance where your tax due increases as your income decreases is when you have an earned income credit. Within certain income ranges, your earned income credit, which decreases your tax, can decrease as your income decreases, resulting in an increase in your tax due.

That is why the IRS requires you  to enter all expenses and deductions applicable to your rental property.

The QBI deduction is a deduction from your taxable income, but it does not factor into your earned income credit, so I don't think that is negatively affecting your tax.

It is also remotely possible that you are not reading the refund meter properly. If the meter shows a tax due, then you reduce your income, the tax due may decrease and that can sometimes be misinterpreted to be a reduction in your refund.