Tax Win: IRS Provides Clear Test on How 20% Deduction Applies to Rental Income, Exchanges

The Internal Revenue Service has issued final rules on the 20 percent business income deduction (Sec. 199A of the Tax Code) that was enacted in late 2017 as part of the Tax Cuts and Jobs Act.

Among other things, the rules confirm that the deduction applies to your business income, as a real estate agent or broker, if you operate as a sole proprietor or owner of a partnership, S corporation, or limited liability company. It applies even if your income exceeds a threshold set in the law of $157,500 for single filers and $315,000 for joint filers.

In addition, the rules provide guidance that NAR has been seeking on two other provisions of importance to you: 1) whether any real estate rental income you have is eligible for the deduction, and 2) how the deduction applies for properties you’ve exchanged under Sec. 1031 of the tax code.

Eligibility of rental income

If you generate rental property income, that income can also qualify for the new deduction, as long as you can show that your rental operation is part of a trade or business. The IRS has released proposed guidelines that include a bright-line test, or safe harbor, for showing that your rental income rises to the level of a trade or business. Under that safe harbor, you can claim the deduction if your rental activities—which include maintaining and repairing property, collecting rent, paying expenses, and conducting other typical landlord activities—total at least 250 hours a year. If your activity totals less than that, you can still try to take the deduction, but you’ll have to be prepared to show the IRS that your activity is part of a trade or business.

Eligibility of 1031 like-kind exchanges

Under earlier proposed regulations, if your income was above threshold levels set in the tax law—$157,500 for single filers, $315,000, for joint filers—and you had exchanged one property for another to defer taxes under Sec. 1031 of the tax code, the amount of the new deduction might be reduced because of the swap. NAR and other trade groups reached out to the IRS to change this treatment, and the IRS has made that change. Under the final rules, you can use the unadjusted basis of the depreciable portion of the property to claim at least a partial deduction. “The final rules are the result of several months of advocacy and collaboration between NAR, our members, and the administration,” says NAR President John Smaby. “They reflect many changes that NAR sought to ensure the new 20 percent deduction applies as broadly as possible.”

Source: https://www.nar.realtor/taxes/irs-provides-clear-test-on-how-20-deduction-applies-to-rental-income-exchanges

Editor’s Letter – Winter 2019

Dear Apartment Owners and Investors,

We saw some softening of pricing in the apartment market last year as a result of buyers more aggressive negotiating and rising interest rates. Rates rose over the 12 month period from 3.75% at the low end and moved to 4.75% for most commercial property lenders.

This affects pricing as investors are forced to put more down on a property. In turn, they want higher CAP rates and that forces the prices down. If you were in the market last year, and not in an exchange, you had the opportunity to purchase Marin County apartment properties at nice discounts from years past.

For instance, a six unit property in downtown Mill Valley was listed in May of 2018 at $3,650,000 and stayed on the market for months before attracting an offer. It finally sold for $3,000,000 to an investor that hopes to upgrade units and raise rents.

In other apartment news, the statewide rent control Proposition 10 was soundly defeated in November. The measure would have repealed the Costa-Hawkins Rental Housing Act. The l995 act limits the use of rent control in the state and allows cities and counties to have local control over rental housing.

In Marin, the County Board of Supervisors passed a Rental Housing

Dispute Resolution Ordinance, which went in to effect on January 11, 2018. The measure applies to the 2,000 rental housing units in the unincorporated areas of Marin, including Kentfield, Tam Junction in

Mill Valley and West Marin, and allows tenants and landlords to mediate rental increases at 5% or above in a 12 month period. This is a mandatory dispute resolution program that is operated by the County of Marin.

The Board of Supervisors is now considering a Just Cause Eviction Ordi-nance which would make it very difficult to evict tenants for ANY reason if challenged by the tenant. Most landlords see these two measures as the first two steps towards a County wide rent control ordinance.

If you want details about these new and pending laws that affect your property management please give me a call at 415-302-7730 or email me at katherine@khiggins.com.

Marin County Apartment Market Trends for 2019

  • We still have very low inventory in both the 2-4 unit category and apartment properties that are over 5 units. But with the rising interest rates and increasing buyer caution regarding investment properties, sellers can expect properties to remain longer on the market and sale prices to be at least 5% off the asking price.
  • During the sales process buyers will bargain hard to get the best price and sellers will be forced to give more con-cessions on price and deferred maintenance items. We are back to a more balanced market between buyers and sellers.
  • It’s even more important for sellers to be realistic about property values and be aware that we are in a softening rental market which makes buyers cautious. Correctly pricing properties in this changing market is crucial to get-ting the property sold.

Marin County Apartments Closed Sales 2018 – 3-4 Units

Address Price # Units Price/Unit GRM COE
558 Miller, Mill Valley $1,075,000 3 $358,333 16.2 3/13/18
318 San Marin, Novato $1,175,000 3 $391,666 11.9 8/24/18
300 San Marin, Novato $1,202,500 3 $400,833 17.1 10/17/18
40 Canyon, San Anselmo $1,125,000 3 $375,000 15.1 5/29/18
1509 SA Ave, San Anselmo $1,400,000 3 $466,666 16.6 3/22/18
43 E. Crescent San Rafael $940,000 4 $235,000 13.2 1/18/18
163 Novato, San Rafael $1,060,000 4 $265,000 11.3 8/23/18
532 Fifth, San Rafael $1,190,000 3 $595,000 14.3 8/15/18
11 Valencia, San Rafael $1,279,000 3 $426,333 14.6 1/31/18
18-22 Elizabeth, San Rafael $1,421,000 3 $473,661 15.7 11/21/18
139 Ross, San Rafael $1,450,000 4 $362,500 17.4 4/16/18
253 D, San Rafael $1,485,000 3 $495,000 21.1 10/25/18
11-19 Mooring, San Rafael $1,735,000 3 $578,333 15.2 3/16/18
207 Valley, Sausalito $2,400,000 4 $600,000 17.3 6/8/18
2 L. Crescent, Sausalito $2,500,000 3 $833,333 16.5 3/27/18
501 Bridgeway, Sausalito $2,750,000 3 $916,666 21.2 1/5/18

Marin County Apartments Closed Sales 2018 – 5+Units

Address Price # Units Price/Unit COE GRM
142 Willow, Corte Madera $1,550,000 5 $310,000 19.2 6/29/18
103-109 Live Oak, Fairfax $1,404,000 6 $234,000 12.5 8/10/18
55 Park Rd., Fairfax $1,675,000 5 $335,000 11.3 1/24/18
131 Kent, Kentfield $2,800,000 8 $350,000 21.8 9/18/18
190 Throckmorton, Mill Valley $3,000,000 6 $500,000 19.8 10/19/18
45 Reed Blvd., Mill Valley $4,275,000 10 $427,500 15.5 3/7/18
22 Tamalpais, San Anselmo $2,585,000 5 $430,000 15.7 2/9/18
289 Woodland, San Rafael $2,305,000 6 $384,166 12.5 10/11/18
1533 4th, San Rafael $3,640,000 6 $606,666 14.2 12/28/18
12-14 Second, Sausalito $2,500,000 5 $500,000 14.3 12/28/18
561 Bridgeway, Sausalito $3,500,000 8 $437,500 24.1 6/21/18
124 Merrydale, San Rafael $16,900,000 46 $367,391 1/26/18
101 Piper Crt. Fairfax $7,800,000 27 $288,889 1/30/18
109 Prof Center, San Rafael $6,550,000 20 $327,500 12/21/18
1052 Redwood, Mill Valley $6,356,000 30 $254,240 1/26/18
19 Merrydale, San Rafael $6,135,000 18 $340,833 1/31/18
150 Belvedere, San Rafael $5,800,000 28 $207,142 11/8/18
1704 Lincoln, San Rafael $5,500,000 12 $458,333 9/13/18
1400 Lincoln, San Rafael $2,750,000 11 $305,556 6/5/18