We have one rental which we took a loss on for 2018. Qualified Business Income - Do we answer yes because its a rental or no because we took a loss?

[WIPam]

Qualified Business Income Question - how do you answer?

[DawnC0 · Accepted solution]

Since it was a loss, no deduction will calculate for that rental property anyway.  But, for the QBI question, you can answer yes if you are a real estate professional or if your rental activities constitute a trade or business.   QBI on Rental Income

Generally, this means each rental real estate enterprise (a rental property or group of similar rental properties, including K-1 rental income) must satisfy these requirements:

1. Each enterprise has its own books and records to track income and expenses;
2. At least 250 hours of rental services are performed per year per enterprise; and
3. (Starting with tax year 2019) Contemporaneous records of services performed are kept which includes who performed the service, description of service, the date of the service, and how long it took (who, what, when, and how long).

[Ben-FL]

WHY for 2019 do I not get to deduct my Residential RENTAL Property loss??

[tagteam]

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@Ben-FL wrote:

WHY for 2019 do I not get to deduct my Residential RENTAL Property loss??

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If you are not a real estate professional who materially participates in the rental activity (outlined in the answer above), you can carry a net rental loss forward to the following tax year.

Further, you may be able to take advantage of the $25,000 (maximum) special allowance if you actively participate in the rental activity and fall within the modified adjusted gross income (MAGI) guidelines.

https://www.irs.gov/instructions/i8582#idm140476817099568

[Carl]

WHY for 2019 do I not get to deduct my Residential RENTAL Property loss??

First, understand there is a difference between "active participation" and "material participation".

Active participation is a way of working that supports an individual's right to participate in the activities and relationships of everyday life as independently as possible. The individual is an active partner in their own care or support rather than being passive. (I.e. You do not actually have to "do something" on a recurring basis to earn the money. An example would be rental or royalty income.)

Material participation in an income-producing activity is, generally speaking, an activity that is regular, continuous, and substantial. Income-producing actions, in which the taxpayer materially participates is an active income or loss. (I.e. you actually "do something" on a regular basis to "earn" the money.)

When it comes to long term residential rental real estate, it's not all that common to show a taxable profit "on paper" at tax filing time. It's more common to show a loss every year. That's because when you add up the amount of depreciation you are required to take by law, with the mortgage interest, property taxes, property insurance and other allowed rental expenses, those expenses will most likely exceed the total rental income for the tax year. So you have a loss.

Since rental income is passive, so are rental expenses. If you do not materially participate in the rental activity, your passive rental expenses can only be deducted from your passive income. Once your rental expenses get your taxable rental income to zero, if you are not an "active participant" then that's it. You can't deduct from any other "ordinarly" income, such as W-2 income. The excess loss just gets carried over to the next year.

Therefore, your carry over losses will continue to grow with each passing year. You will not be able to "realize" those losses until the tax year you sell the property. In that tax year you "will" be able to claim those excess losses against other ordinary income.

Now with rental property, if you are an "active participant" in the management of the property, you can deduct up to a maximum of $25,000 from other ordinary income. But it depends on other things such as your AGI and if you actually have any "other" taxable ordinary income to claim the loss against.

When it comes to determining if you are an active participant, for most (but I stress, NOT ALL) it's relatively simple. If you are the one who makes or participates in making management decisions, then you actively participate. For example, if you are the one who decides who the property will be rented to, or you are the one to decides which contractor will be paid for work done, and approve the amount being charged.

But if you contract with a property management company and empower them to make all the decisions, then most likely you do not actively participate in the management decisions. It would depend on the terms of the contract between you and the management company.

With active participation it's perfectly possible to not have a carry over loss. It's also perfectly possible to always have a carry over loss. It just depends on the rental income to expense ratio each year.

[tagteam]

@Ben-FL 

You can also use the official IRS interpretation of the following terms:

Material participation tests.

You materially participated in a trade or business activity for a tax year if you satisfy any of the following tests.

1. You participated in the activity for more than 500 hours.

2. Your participation was substantially all the participation in the activity of all individuals for the tax year, including the participation of individuals who didn’t own any interest in the activity.

3. You participated in the activity for more than 100 hours during the tax year, and you participated at least as much as any other individual (including individuals who didn’t own any interest in the activity) for the year.

4. The activity is a significant participation activity, and you participated in all significant participation activities for more than 500 hours. A significant participation activity is any trade or business activity in which you participated for more than 100 hours during the year and in which you didn’t materially participate under any of the material participation tests, other than this test. 

5. You materially participated in the activity (other than by meeting this fifth test) for any 5 (whether or not consecutive) of the 10 immediately preceding tax years.

6. The activity is a personal service activity in which you materially participated for any 3 (whether or not consecutive) preceding tax years. An activity is a personal service activity if it involves the performance of personal services in the fields of health (including veterinary services), law, engineering, architecture, accounting, actuarial science, performing arts, consulting, or any other trade or business in which capital isn’t a material income-producing factor.

7. Based on all the facts and circumstances, you participated in the activity on a regular, continuous, and substantial basis during the year.

You didn’t materially participate in the activity under test (7) if you participated in the activity for 100 hours or less during the year. Your participation in managing the activity doesn’t count in determining whether you materially participated under this test if:

• Any person other than you received compensation for managing the activity, or

• Any individual spent more hours during the tax year managing the activity than you did (regardless of whether the individual was compensated for the management services).

Active participation.

Active participation isn’t the same as material participation. Active participation is a less stringent standard than material participation. For example, you may be treated as actively participating if you make management decisions in a significant and bona fide sense. Management decisions that count as active participation include approving new tenants, deciding on rental terms, approving expenditures, and similar decisions. Only individuals can actively participate in rental real estate activities.

See https://www.irs.gov/publications/p925