Recently, the IRS released final regulations on a provision of the Tax Cuts and Jobs Act, most commonly known as the 20 percent Qualifying Business Income (QBI) deduction.
This deduction allows taxpayers to potentially receive 20 percent of their business income tax-free. While it may not be intuitive that QBI applies to rental income, it can, so long as certain criteria is met.
Who is Eligible for the QBI Deduction?
Generally speaking, any taxpayer is entitled to the 20-percent deduction of QBI, so long as the business is operated as a sole proprietorship or partnership, S corporation, trust or estate. Taxpayers with taxable income that exceeds $315,000 for a married couple filing a joint return, or $157,500 for all other taxpayers, are subject to certain limitations that may reduce the deduction. Any income earned through a C corporation is not eligible for the deduction.
How Does the QBI Deduction Affect Rental Owners?
There was plenty of ambiguity in previous proposals regarding rental real estate income. With the publishing of the final regulations, the IRS provided some much-needed clarification that provided relief for all parties concerned.
Let’s examine some of the major bullet points that rental owners need
to know for tax years 2019 thru 2026:
- Safe Harbor: The IRS provided Revenue Procedure 2019-7, which offered “safe harbor” conditions under which rental real estate activity will be treated as a trade or business for the sole purpose of the 20-percent QBI deduction. Notwithstanding, additional conditions must be met for a rental real estate enterprise to be deemed an eligible trade or business for QBI purposes:
- Separate Books and Records – must be maintained for each rental real estate enterprise (or combined for grouped enterprises).
- 250 Hours Requirements – The IRS provided a bright-line rule that requires at least 250 hours of rental services to be performed by the taxpayer and/or workers for the taxpayer. Rental services are explicitly outlined as: (a) advertising to rent; (b) negotiating and executing leases; (c) verifying tenant applications; (d) rent collection; (e) daily operation and maintenance; (f) management of the real estate; (g) purchasing of materials for operation of rental services; and (h) supervision of employees and independent contractors. Rental services do not include: financial/investment activities; procuring new rental property; reviewing financial statements; planning; constructing long-term capital improvements; or hours spent traveling to and/or from rental properties.
- Contemporaneous Records (starting in 2019) – to include time reports, logs or other documents regarding: (a) hours of all services performed; (b) the description of all services performed; (c) dates on which such services are performed; and (d) who performed the services.
The (Double) Bottom Line for Rental Owners
The 20-percent QBI deduction isn’t for every rental owner. If you own just one or two properties, it may be difficult to satisfy the 250-hour safe harbor requirement. On the other hand, it could provide huge deductions for others.
Here are some additional considerations:
- Rental owners looking to deduct 20 percent of their rental income must adhere to the requirements outlined above in order to be afforded safe harbor and be treated as a trade or business for Section 199A purposes. Keep detailed records.
- Rental property used as a personal residence for more than 14 days out of the year disqualifies the residence for the safe harbor deduction.
- Real estate rented under triple net leases (NNN) are not eligible for the safe harbor.
- If you make the argument that your rental is a trade or business for the 20-percent QBI deduction, then you’ll have to perform essential functions as a normal trade or business.
- Just because your rental real estate enterprise does not meet the safe harbor requirements does not necessarily preclude your rental from the 20-percent QBI deduction. Seek advice from your trusted tax professional for more information.
Our goal today was to educate you on the application of the 20-percent QBI deduction as it pertains to the business of rental properties. This area of the code is really new and fairly complex. Be sure to seek the advice of a tax professional as it pertains to your specific situation.
Adam Shay, CPA (NC License Number 35961), MBA, is managing partner of Adam Shay CPA, PLLC. Over the last several years, the firm has grown from a one-man shop to one of the largest firms in the Wilmington area. Adam focuses on minimizing taxes and improving the financial results of entrepreneurs. Those results are obtained by taking a proactive approach to all aspects of taxes and financials. Adam is actively involved in supporting the Wilmington entrepreneurial and startup community. He earned a Bachelor of Business Science in commerce from the University of Virginia and a Master of Business Administration (MBA) degree from the University of Maryland. During his spare time, Adam enjoys spending time with his two boys and wife, Sarah, as well as coaching and watching sports and spending time outdoors.