Many freelancers own residential or commercial rental real estate properties, the income from which helps to supplement their client work. If you are one of them, this article is a must-read because the rules related to rental property income are changing under tax reform (also known as the Tax Cuts and Jobs Act or TCJA). The following summarizes the key changes that may impact your tax situation.
Key tax reform provisions which may apply to freelancers with rental properties:
How the new QBI deduction and loss disallowance rules apply to rental income:
As mentioned above, a highlight of tax reform for many small business owners is the new 20 percent tax deduction based on qualified business income (QBI) from a pass-through business entity. This deduction generally applies to sole proprietorships, limited liability companies (LLCs) treated as a sole proprietorship, partnerships, LLCs treated as a partnership, and S corporations.
The QBI deduction may offset net income from any rental real estate activity that you generate a profit from through a pass-through entity. However, if you experience a tax loss from your rental property activities, you need to be familiar with passive activity loss (PAL) rules which only allow you to deduct passive losses in proportion to passive income from other sources, including that from other rental properties or gains from selling such property. Passive losses beyond that of your passive income are not allowed unless you have enough income or gains, or until you sell the property on which you took a loss.
The TCJA adds the following provision to the existing PAL rules: For tax years 2018 through 2025, any excess business loss cannot be deducted in the current year. Essentially, any current-year business losses can’t offset more than $250,000 of income from such other sources for single filers or more than $500,000 for a married joint-filing couple.
If you have an excess business loss, it will be carried over to the next tax year and can be deducted as a net operating loss (NOL) carryforward as long as your loss meets the PAL rules as a valid deduction.
How like-kind property exchanges fit into the picture:
The TCJA still allows the sale of appreciated properties with an indefinite deferral of federal income tax through like-kind exchanges of commercial (not personal property). Under tax reform, you can trade the property you have for a replacement property and delay paying taxes until you sell the replacement property. In theory, you can perpetually trade properties and continue deferring taxes. In the case of personal property, the TCJA eliminates tax-deferred like-kind exchanges for 2018 and beyond. If you transacted a personal property exchange on or before December 31, 2017 and one end of it remained open after that date, the prior rules on like-kind tax deference still apply.
Be sure to check how these new tax reform rules impact your real estate rental income.
As you can see, the TCJA has some new benefits tied to real estate rental property income as well as some changes which may not be as beneficial, depending on your unique situation. If you have questions, ask a tax professional for advice so you can be sure you are optimizing your tax situation and the rental income you are using to supplement your freelance work.
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