The Treasury Department and IRS have issued much needed final regulations and guidance addressing implementation of the new qualified business income (QBI) deduction. The QBI deduction was arguably one of the more complicated changes to come out of the TCJA. Through QBI, eligible businesses have the potential to reduce their tax bills. Part of the final regulations is a proposed revenue procedure that provides a safe harbor for rental real estate enterprises to be considered a trade or business and qualify for the deduction.
This deduction is available for tax years beginning after December 31, 2017, and before January 1, 2026. There is speculation whether a future Congress will uphold individual provisions, but in the meantime, it will be essential to determine eligibility.
- Definition Test
The first condition you must meet is the definition test. The IRS defines a rental real estate enterprise as an interest in real property held for the production of rents and may consist of an interest in multiple properties.
According to the IRS, the individual or relevant pass-through entity (RPE) relying on the revenue procedure must hold the interest directly or through an entity disregarded as an entity separate from its owner under Reg. § 301.7701-3. Taxpayers must either treat each property held for the production of rents as a separate enterprise or treat all similar properties held for the production of rents as a single enterprise. Commercial and residential real estate may not be part of the same enterprise. Taxpayers may not vary this treatment from year-to-year unless there has been a significant change in facts and circumstances. Relevant pass-through entities (RPEs), may use the safe harbor to determine whether a rental real estate enterprise is a trade or business.
If your real estate enterprise meets the above conditions, the next test in qualifying for the treatment outlined in Notice 2019-7, is to meet the following requirements during the tax year. Rental owners must
- Maintain separate books and records that reflect income and expenses for each rental real estate enterprise;
- Either assign to employees, agents, or independent contractors; or directly perform 250 hours or more of rental services* (defined below) per year
- Keep contemporaneous records, including time reports, logs, or similar documents, regarding the following: hours of all services performed; description of all services performed; dates on which such services were conducted; and who performed the services; and
- Readily furnish records for inspection at the request of the IRS
Under the proposed revenue procedure, rental services* include:
- Advertising to rent or lease the real estate,
- Negotiating and executing leases,
- Verifying information contained in prospective tenant applications,
- Collecting rent,
- Performing daily operation, maintenance, and repair of the property,
- Managing the real estate,
- Purchasing materials, and
- Supervising employees and independent contractors.
Rental services do not include:
- Arranging financing, procuring property, studying and reviewing financial statements or reports on operations
- Planning, managing or constructing long-term capital improvements
- Hours spent traveling to and from the real estate
It is important to note that if the real estate is used by the taxpayer (including an owner or beneficiary of an RPE relying on this safe harbor) as a residence for any part of the year under section 280A or is rented or leased under a triple net lease, the enterprise is no longer eligible for the safe harbor provision.
If you’ve met the conditions above, you may be well-qualified for this deduction. However, if you don’t meet the tests above that does not eliminate you from the deduction, but means the facts and circumstances of each rental activity must be analyzed. To discuss your options regarding the QBI deduction and to confirm your eligibility under this safe harbor, call us today.