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Schedule E and QBI

Forum|Forum|3 years ago
February 23, 2023
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This past year I inherited a property. It was in terrible shape. My family and I spent 4 months spending almost every weekend there renovating it ourselves and then listing, screening tenants, and then finally renting it late last year. Both my wife and myself have at least 350 to 400 hours of personal work on the property, not to mention the time spent by my sons. Additionally we kept a file with all of the expenses and finally income related to this rental, so I think that counts as keeping separate records.

This being said I believe we qualify for QBI this year(2022). However I'm almost certain we won't meet that threshold in 2023 if everything goes as desired, good tenants, etc.

We only have this one rental property.

My question is should I claim the QBI given that it is likely a one year thing for me? It doesn't seem to impact my return, but I think it impacts the depreciation total . Total renovation expenses were $40k plus.

Best answer by Mike9241

If a taxpayer’s rental real estate activity meets the safe harbor, then it will be treated as a trade or business for purposes of 199A.

The safe harbor sets out requirements that must be met, and includes several exclusions and caveats

The Safe Harbor – Specific Requirements

Separate books and records must be maintained to reflect income and expenses for each rental real estate enterprise (“RREE”).
At least 250 hours of rental services must be performed each year with respect to each RREE.
The taxpayer must maintain contemporaneous records, including time reports, logs, or similar documents, regarding the following: (i) hours of all services performed; (ii) description of all services performed; (iii) dates on which such services were performed; and (iv) who performed the services. Such records must be made available for inspection at the request of the IRS.

Books-and-Records Requirement.

The safe harbor also contains rules that permit a taxpayer to aggregate separate properties and treat them as a single RREE .

250-Hour Requirement.

Each RREE must satisfy the 250-hour requirement. Specifically, rental services include:

advertising to rent or lease the real estate;
negotiating and executing leases;
verifying information contained in prospective tenant applications;
collection of rent;
daily operation, maintenance, and repair of the property, including the purchase of materials and supplies;
management of the real estate; and
supervision of employees and independent contractors.

Moreover, rental services can be performed by owners, employees, agents, and/or independent contractors of the owners. Accordingly, it will become very important that vendors who perform services that could be counted towards the 250-hour requirement provide documentation.

The above list does not purport to be exhaustive. Specifically excluded are the following activities: financial or investment management activities, such as arranging financing; procuring property; studying and reviewing financial statements or reports on operations; improving property under §1.263(a)-3(d); and hours spent traveling to and from the real estate.

The 250-hour requirement is an annual requirement, but the safe harbor relaxes this once an RREE has been in existence for at least four years. At that point, the 250-hour requirement need only be satisfied in any three of the five consecutive years ending with the taxable year.

Contemporaneous Documentation Requirement

The safe harbor contains specific language that a taxpayer may provide a description of the rental services performed by such employee or independent contractor, the amount of time such employee or independent contractor generally spends performing such services for the enterprise, and time, wage, or payment records for such employee or independent contractor.

Tax Return Statement

The safe harbor cannot be utilized unless the taxpayer attaches a statement to its tax return.

If a taxpayer has more than one RREE, the statement must list the required information separately for each RREE. The statement must include the following information:

a description (including the address and category (commercial, residential, mixed-use)) of all rental real estate properties that are included in each RREE;
a description (including the address and rental category) of rental real estate properties acquired and disposed of during the taxable year; and
a representation that the requirements of the safe harbor have been satisfied.

leeloo

Yes, you can take the QBI for only one year if that is the only year you qualify, but the $40,000 you spent is not a business expense. Your property does not become business property until it is placed in service and available to rent. Once you started that process, advertising, screening tenants, etc, if there were any improvements done, those are rental costs. Any time before the building was placed in service, it is still your personal home.

You can add the cost of improvements to the FMV of the property at the time you inherited it. They will be depreciated along with the building itself. The value of your own personal time is not deductible.

J

jakwiAuthor

Thank you, that is very helpful.

Carl11_2

Employee

Both my wife and myself have at least 350 to 400 hours of personal work on the property, not to mention the time spent by my sons. Additionally we kept a file with all of the expenses and finally income related to this rental, so I think that counts as keeping separate records.

While you may qualify for the QBI in 2022, understand that your hours are not a deductible expense. I assume you are a first time landlord. One thing I can't stress enough is the requirement for absolute perfection in your first year dealing with rental property on your taxes. For that first year, perfection is not an option; it's a must. Even the tiniest of mistakes can (and will) grow exponentially over time. When you catch the error years down the road (usually in the tax year you sell the property) the cost of fixing it will be $expensive$. So if you have questions, please ask.

Now the program doesn't do a very good job on some screens to clarify the information you are being asked for. On other screens it does clarify rather well, but users tend to not read the small print, causing them to provide incorrect information. So make sure you read the small print on every screen. Additionally, the below information is provided to help provide clarity where it's needed. Note that it's important to know the difference between a "repair" expense, and a property improvement.

Rental Property Dates & Numbers That Matter.

Date of Conversion - If this was your primary residence or 2^nd home before, then this date is the day AFTER you moved out, or the date you decided to lease the property – whichever is later.
In Service Date - This is the date a renter "could" have moved in. Usually, this date is the day you put the FOR RENT sign in the front yard.
Number of days Rented - the day count for this starts from the first day a renter was contracted to move in, and/or "could" have moved in. That would be your "in service" date or after if you were asked for that. Vacant periods between renters do not count for actual days rented. Please see IRS Publication927 page 17 at https://www.irs.gov/pub/irs-pdf/p527.pdf#en_US_2020_publink1000219175 Read the “Example” in the third column.
Days of Personal Use - This number will be a big fat ZERO. Read the screen. It's asking for the number of days *YOU* lived in the property AFTER you converted it to a rental. I seriously doubt (though it is possible) that you lived in the house (or space, if renting a part of your home) as your primary residence, 2nd home, or any other personal use reasons after you converted it to a rental.
Business Use Percentage. 100%. I'll put that in words so there's no doubt I didn't make a typo here. One Hundred Percent. After you converted this property or space to rental use, it was one hundred percent business use. What you used it for prior to the date of conversion doesn't count.

RENTAL PROPERTY ASSETS, MAINTENANCE/CLEANING/REPAIRS DEFINED

Property Improvement.

Property improvements are expenses you incur that Improve, restore, or otherwise “better” the property. Basically, they retain or add value to the property.

Betterments:
Expenses that may result in a betterment to your property include expenses for fixing a pre-existing defect or condition, enlarging or expanding your property, or increasing the capacity, strength, or quality of your property. An example of a pre-existing condition or defect in this context would be something such as foundation repair (slab jacking) or some other, hidden and costly, anomaly.
Restoration:
Expenses that may be for restoration include expenses for replacing a substantial structural part of your property, repairing damage to your property after you properly adjusted the basis of your property as a result of a casualty loss, or rebuilding your property to a like-new condition.
Adaptation:
Expenses that may be for adaptation include expenses for altering your property to a use that isn’t consistent with the intended ordinary use of your property when you began renting the property. Adding a wheelchair ramp would be an example.

Expenses for these types of costs are entered in the Assets/Depreciation section and depreciated over time. Property improvements can be done at any time after your initial purchase of the property. It does not matter if it was your residence or a rental at the time of the improvement. It still adds value to the property.

To be classified as a property improvement, two criteria need to be met:

1) The improvement must become "a material part of" the property. For example, remodeling the bathroom, new cabinets or appliances in the kitchen. New carpet. Replacing that old Central Air unit.

2) The improvement must retain or add "real" value to the property. In other words, when the property is appraised by a qualified, certified, licensed property appraiser, he will appraise it at a higher value, than he would have without the improvements.

There are rules that allow you to just flat-out expense and deduct some property improvements instead of capitalizing and depreciating them, if the total cost of the improvement was less than $2,500. It’s referred to as “safe harbor di-minimis” But depending on the specific situation, this may or may not be beneficial. Just be aware that not every property improvement that cost less than $2,500 qualifies for this. If this interest you, the rules can get complex. So a good place to start reading is on the IRS website at https://www.irs.gov/businesses/small-businesses-self-employed/tangible-property-final-regulations. The stuff on di-minimis starts about one page down.

Cleaning & Maintenance

Those expenses incurred to maintain the rental property and its assets in the usable condition the property and/or asset was designed and intended for. Routine cleaning and maintenance expenses are only deductible if they are incurred while the property is classified as a rental. Cleaning and maintenance expenses incurred in the process of preparing the property for rent for the very first time are not deductible.

Repair

Those expenses incurred to return the property or its assets to the same usable condition they were in, prior to the event that caused the property or asset to be unusable. Repair expenses incurred are only deductible if incurred while the property is classified as a rental. Repair costs incurred in the process of preparing the property for rent for the very first time are not deductible.

Additional clarifications: Painting a room does not qualify as a property improvement. While the paint does become “a material part of” the property, from the perspective of a property appraiser, it doesn’t add “real value” to the property.

However, when you do something like convert the garage into a 3^rd bedroom for example, making a 2-bedroom house into a 3-bedroom house adds “real value”. Of course, when you convert the garage to a bedroom, you’re going to paint it. But you will include the cost of painting as a part of the property improvement – not an expense separate from it.

J

jakwiAuthor

I assume you are a first time landlord. - Yes we are.

I can't stress enough is the requirement for absolute perfection in your first year dealing with rental property on your taxes.- We have done our absolute best to do this correctly. I kept every receipt, and tracked our mileage etc. The house is a 2 hour drive from my primary residence so tracking dates worked and time there is fairly easy. I have gas receipts to prove I went, and our tendency was to go there spend two or three 10 hour days working. Basically it was a gut and renovate for the entire house. Some drywall was replaced due to the leaking roof, repaint, refloor the entire place, new kitchen, and bathrooms. New roof, new exterior paint etc. I put about $800 down for repairs, but essentially the entire budget went to a complete renovation that more than doubled the value of the property overall.

Date of conversion - My father passed away last march, We cleaned the property between then and june, but at that point we were still unsure of what direction to take. after that we started the renovations in earnest. Going every weekend and sometimes during the week for months. It was finally listed for rent in late october. It was never our primary residence. So I put 0 personal use, and 100% business use down.

As far as QBI, I of course want to take advantage of every tax benefit, but if its' sketchy or not correct at all it's not worth doing for me. And this is doubly true if it will lead to an audit. That being said I think we legitimately qualify. The only part that might be questionable is records of time spent. I have dates we went, and when we went we worked 10 to 12 hour days. Is that sufficient?

M

Mike9241Answer

If a taxpayer’s rental real estate activity meets the safe harbor, then it will be treated as a trade or business for purposes of 199A.

The safe harbor sets out requirements that must be met, and includes several exclusions and caveats

The Safe Harbor – Specific Requirements

Separate books and records must be maintained to reflect income and expenses for each rental real estate enterprise (“RREE”).
At least 250 hours of rental services must be performed each year with respect to each RREE.
The taxpayer must maintain contemporaneous records, including time reports, logs, or similar documents, regarding the following: (i) hours of all services performed; (ii) description of all services performed; (iii) dates on which such services were performed; and (iv) who performed the services. Such records must be made available for inspection at the request of the IRS.

Books-and-Records Requirement.

The safe harbor also contains rules that permit a taxpayer to aggregate separate properties and treat them as a single RREE .

250-Hour Requirement.

Each RREE must satisfy the 250-hour requirement. Specifically, rental services include:

advertising to rent or lease the real estate;
negotiating and executing leases;
verifying information contained in prospective tenant applications;
collection of rent;
daily operation, maintenance, and repair of the property, including the purchase of materials and supplies;
management of the real estate; and
supervision of employees and independent contractors.

Moreover, rental services can be performed by owners, employees, agents, and/or independent contractors of the owners. Accordingly, it will become very important that vendors who perform services that could be counted towards the 250-hour requirement provide documentation.

The above list does not purport to be exhaustive. Specifically excluded are the following activities: financial or investment management activities, such as arranging financing; procuring property; studying and reviewing financial statements or reports on operations; improving property under §1.263(a)-3(d); and hours spent traveling to and from the real estate.

The 250-hour requirement is an annual requirement, but the safe harbor relaxes this once an RREE has been in existence for at least four years. At that point, the 250-hour requirement need only be satisfied in any three of the five consecutive years ending with the taxable year.

Contemporaneous Documentation Requirement

The safe harbor contains specific language that a taxpayer may provide a description of the rental services performed by such employee or independent contractor, the amount of time such employee or independent contractor generally spends performing such services for the enterprise, and time, wage, or payment records for such employee or independent contractor.

Tax Return Statement

The safe harbor cannot be utilized unless the taxpayer attaches a statement to its tax return.

If a taxpayer has more than one RREE, the statement must list the required information separately for each RREE. The statement must include the following information:

a description (including the address and category (commercial, residential, mixed-use)) of all rental real estate properties that are included in each RREE;
a description (including the address and rental category) of rental real estate properties acquired and disposed of during the taxable year; and
a representation that the requirements of the safe harbor have been satisfied.