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Does Your Real Estate Rental Income Qualify for a QBI Deduction?

Drew Barnes, CFP®
April 10, 2019

The Tax Cuts and Jobs Act (TCJA) offers a potential tax deduction of 20% of your Qualified Business Income (QBI) for pass-through business entities. This income may be derived from a partnership, S corporation, or sole proprietorship. While there are many requirements that must be met to qualify for this deduction, one area that has raised questions is that of real estate rental income.

Under the recently proposed IRS regulations, only income from a qualified trade or business is eligible for the QBI deduction. A trade or business is an activity carried on regularly and continuously for the purpose of making a profit. Sporadic or hobby activities don’t qualify. So, landlords who spend substantial amounts of time managing rental properties will most likely qualify for the deduction.

The IRS and courts generally use a facts and circumstances test to determine if a rental real estate activity is a trade or business (as opposed to an investment). Various factors are considered, including the following:

  • The landlord’s efforts to rent the property.
  • The maintenance and repairs supplied by the landlord (or an agent of the landlord).
  • The landlord’s employment of labor to manage the property or provide services to tenants.
  • The purchase of materials, the payment of expenses, and the collection of rent.

These factors must show that the rental activities are regular and continuous enough to constitute a trade or business. Note: landlords who use an agent to manage the properties can still be engaged in a trade or business.

Fortunately, the IRS released IRS Notice 2019-07, providing a safe-harbor for when a rental property can qualify as a business for the purposes of the Section 199A deduction.  In order for your rental to qualify for the 20% QBI deduction, it must be owned directly by the taxpayer or by an eligible pass-through entity.  Also, at least 250 total hours of “rental services” activity must be performed in order to qualify.  This includes rental services performed by the owner(s), employees, independent contractors and time spent on maintenance, repairs, rent collection, payment of expenses, provision of services to tenants, and any efforts to rent the property.  Separate accounting (ie. books, records, bank accounts) must be maintained separately by the entity.  However, simply satisfying the proposed safe harbor does not necessarily determine in and of itself if the rental enterprise is to be treated as a section 162 business.  Similarly, failing to meet the safe harbor may not preclude rental services from being a section 162 business.

However, since there are no explicit safe-harbor tests in Section 199A regarding rental income, real estate professionals must rely on case law to prove that their activities amount to a trade or business.

The IRS and courts also consider the type of lease signed by the parties. One arrangement that is of particular concern is the triple net lease. This is where the tenant pays rent, as well as real estate taxes, building insurance, and maintenance costs. In this scenario, it might be difficult to argue that the property owner is regularly and continuously involved in a trade or business.

There is a special rule, however, for self-rentals. Under rules proposed by the IRS, the rental or licensing of property to a commonly controlled trade or business is treated as a trade or business for purposes of the qualified business income deduction. For this rule to apply, the same person or group of persons must own 50% or more of the rental activity and the related trade or business.

Let's Talk

The more involvement you (or an agent) have in your rental real estate, the more likely your income may be included in your QBI deduction. We are happy to sit down with you to discuss your specific situation and recommend you consultant with your tax accountant for advice.  Feel free to read this article for the supporting details and additional information.

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The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Links are being provided for informational purposes only. Raymond James is not affiliated with and does not endorse, authorize or sponsor any of the listed websites or their respective sponsors. Raymond James is not responsible for the content of any website or the collection or use of information regarding any website's users and/or members.

*While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax and legal matters with the appropriate professional.

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