Safe Harbor for Rental Income for Qualified Business Income Deduction
Recently the IRS released additional guidance on a large number of issues related to the Qualified Business Income (QBI) Deduction (Section 199A). This deduction allows certain taxpayers who have flow thru businesses (S Corporations, partnerships, sole proprietorships) to take a 20% deduction on the related income. To qualify, the activity has to rise to the level of a trade or business. Question: is rental activity a trade or business?
IRS Notice 2019-07 provides a safe-harbor rule for rental real estate businesses. Rental property would be treated as a trade or business for purposes of the QBI deduction if at least 250 hours of services are performed each tax year with respect to the enterprise.[1] These hours of service are not limited to owners and include hours spent by employees and independent contractors. The time spent must be on operational activities (providing services to tenants, repairs and maintenance, finding renters, collection of rents, etc.). Hours spent would not include financing arrangements or hours spent in the owner’s capacity as an investor or travel.
The safe harbor requirement applies to a “rental real estate enterprise [RREE]” which is defined as an interest in real property held for the production of rents. Several properties can be owned and can be treated individually or grouped. Real Estate held in separate LLCs could elect to be aggregated for purposes of meeting the safe harbor requirement. If there is an election to group, all similar properties would be required to be grouped, and once made this grouping is required for all subsequent years. Ownership can be either direct or via a single member limited liability company.[2]
Grouping has some exceptions including commercial and residential properties cannot be group together. The Safe Harbor requirements also have limitations for property leased under a triple net lease or property used by the taxpayer at any time as a residence (there are special rules for vacation property). The safe harbor requires that separate books and records be maintained for the rental real estate enterprise. Also relevant pass-through entities may also rely on the safe harbor rules. [3]
It should be noted that often taxpayers segregate rental property from operating businesses. Recently finalized Regulation § 1.199A-4 allows taxpayers to make an election on their tax return to aggregate their trades or businesses. An entity which rents tangible or intangible property to a business which is commonly controlled (generally majority ownership is the same), and that business is a qualified trade or business, could elect to be aggregated for purposes of the QBI deduction assuming all other requirements of 199A are met. The aggregation is separate from that of the RREE grouping.
These rules provide an opportunity for owners of certain rental properties to take advance of the QBI deduction. However taxpayers will have to take affirmative steps to utilize these rules. We recommend that taxpayers who believe they may meet these qualifications arrange to have adequate record keeping in place which includes details of the time spent and services provided by themselves, employees and contractors. If the qualifications are met, taxpayers will need to look at properly making the grouping election on their timely filed tax returns.
Richard J. Maloney, CPA, ABV | Kevin C. Kennedy, CPA, CFE | Jessica P. Wiley, CPA | Janeen A. Sorrentino, EA
[1] 2019-07 Section 3.03
[2] 2019-07 Section 3.02
[3] 2019-07 Section 3.01
2019 Rental Property andQBI Deduction