Rental Properties - Safe Harbor

[syoung123]

Hello, I have three rental properties that I own for over 20 years.  In the past, I have not used the "safe harbor" deductions because in 2019 and 2020, I had just a small net income on one property, and net losses on the other two properties (the years before I had net losses on all the properties).  When I input safe harbor in TurboTax, it did not seem to change the tax amount for the properties with losses.  In 2021, two rental properties had more net incomes, and one had several thousand dollars net loss.  I am trying to decide whether I can use the safe harbor to decrease the taxes on the rental incomes for 2021.

1.  If I have not been using "safe harbor" in the past, can I start using it now?

2.  It seems that I would need to apply safe harbor to all the properties, not just the ones that had net income, in order to be consistent?

3.  All the properties are managed by property mgt companies.  It appears that this would meet the safe harbor rules per the TurboTax software.  Is it correct?

4.  Can I use "safe harbor" for one year, and not use it for another year (for instance, if I have net losses on all the rental properties again in 2022, it may not worth the effort to use safe harbor.  In the past years when I had net losses on all the properties, and I input safe harbor using TurboTax, it did not seem to change the taxes, decrease or increase.)?

4.  What would be a good Pub to read up on safe harbor rules?

Thank you for your help

[RobertB4444]

You can use the safe-harbor method or straight deduction method any year and take the one that best benefits you each year.  You can change every year if it works best for you.

You qualify for the safe harbor method if your rental real estate is a continuously operated business that is engaged in for profit and has 250 hours of activity involved in it during the course of the year.  (The 250 hours don't just have to be by you.  Anyone you hire - including management companies - has their time counted towards that 250 hours.)  You must also have a profit from your real estate ventures and not have a negative overall taxable income for the year. 

If you qualify TurboTax will run the numbers for you both ways.  The safe harbor just deducts 20% of your rental income as a deduction for expenses.  If your actual expenses are equal to or greater than 20% then you won't be taking the safe harbor.

Here is the IRS notice on Safe Harbor from 2019.

[syoung123]

Thank you for the information.  Could you clarify the following?

1.  "use the safe-harbor method or straight deduction method" - what is the "straight deduction method"? At first I did not select safe harbor in Turbotax, and it gave me a set of numbers.  Then I changed the input by selecting safe harbor, and it gave me a different set of numbers which seem to calculate out 20% of the net rental income and apply the 20% as deduction to calculate the tax liability (reduced tax).

2.  When I selected safe harbor for all 3 properties (2 with net income, one with net loss), it seems to reduce the 20% deduction for the 2 properties with net income.  For instances, if I only select safe harbor for the 2 properties with net income, the total deduction is $1,000.  But when I also select safe harbor for the one property with net loss, the total deduction becomes $800. 

3.  " If your actual expenses are equal to or greater than 20% then you won't be taking the safe harbor." - I am not sure what that means.  Greater than 20% of what number?

Thank you again.

[DianeW777]

Here are the answers to your questions about the qualified business income deduction (QBID) and how it relates to rental real estate with the safe harbor rules. 

1. The straight deduction method would mean that you are not electing that the rental real estate is eligible for the (QBID). This would apply if you do not meet the safe harbor rules. See the safe harbor rules below.
   1. Separate books and records are maintained to reflect income and expenses for each rental real estate enterprise.
   2. 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.
   3. 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.
   4. The taxpayer or relevant passthrough entity (RPE) attaches a statement to the return filed for the tax year(s) the safe harbor is relied upon.
      • Final Safe Harbor Rules for Rental Property
2. Solely for purposes of this safe harbor, a rental real estate enterprise is defined as an interest in real property held to generate rental or lease income. It may consist of an interest in a single property or interests in multiple properties. If you are using all properties to arrive at the 250 hours you must select to use this option for all properties.  The one's selected must meet the requirements.
3. The QBID is calculated on the next result of the rental activities include for the deduction.  Therefore if one has a loss it will offset the income of the ones showing a profit and the net result will be allowed for the QBID.

[syoung123]

Thank you for the info.  A few more clarifications:

1.  I have the rental properties for over 20 years, and I think the "safe harbor" for rental properties started in 2019?  if I have not used the "safe harbor" before, can I use it now?  Or is it supposed to be used retroactive or from the beginning when it started?

2.  If I can use the "safe harbor" for tax year 2021, can I choose not to use it in 2022 and beyond?

3.  Per question 2 above, can I use it one year but not to use it another year, depending upon which way would have the most tax deductions?

[RobertB4444]

You can use the rental safe harbor in any year where it would benefit you.  So you can switch back and forth from year to year as is best for you.