February 28, 2019

Are Rental Real Estate Enterprises Eligible for the 20% QBI Deduction?

The Internal Revenue Code Section 199a Qualified Business Income (QBI) Deduction provides owners of pass-through entities the chance to significantly lower their tax bill by allowing them to take a deduction equal to 20% of their business income. This tax law was created as part of the Tax Cuts and Jobs Act, and ever since it was passed in December of 2017, owners of rental real estate businesses questioned whether they would be eligible for the deduction. Fortunately, when the 199a regulations were finalized in January of this year, the IRS simultaneously released Notice 2019-07. Section 6 of this notice sets forth a proposed revenue procedure that will help owners of rental real estate businesses assess their QBI Deduction eligibility.

General Rule of Thumb

Before IRS Notice 2019-07 was released, the general rule of thumb was that owners of rental real estate business would be eligible for the QBI Deduction if their enterprises were qualified trades or businesses. Unfortunately, the IRS did not clearly define “trade or business” for purposes of Section 199a. Notice 2019-07 clears up this confusion by allowing a “safe harbor” under which these rental businesses would qualify for the deduction.

Rental Real Estate Enterprise: Defined

The safe harbor applies to “rental real estate enterprises,” which are defined as interests “in real property held to produce rents and may consist of an interest in multiple properties.” The interest must be held directly by the taxpayer or through a disregarded entity (such as a single member LLC). Commercial and residential rentals are both eligible businesses, but they cannot be combined into the same enterprise.

Safe Harbor under Notice 2019-07

The IRS will treat a rental real estate enterprise as a qualified trade or business for purposes of applying the 20% QBI Deduction if they meet all three of the following requirements:

1. The taxpayer keeps separate records that shows annual income and expenses for their rental enterprise.
2. The taxpayer, their employees, agents, or independent contractors perform at least 250 hours of “rental services” annually with respect to the enterprise. Beginning in 2023, workers must perform at least 250 hours of rental services in any three of the past five years.
3. Beginning in 2019, the taxpayer maintains records that prove who performed services, for how long, what services they performed, and the dates they did the work.

“Rental services” explicitly excludes time spent making investment decisions, arranging financing, reviewing financial statements, managing capital improvements, and travelling, but it does include the following activities:

• Advertising or marketing rental units;
• Meeting daily operations needs;
• Performing maintenance and repairs;
• Purchasing supplies;
• Supervising employees or contractors;
• Processing tenant applications; and,
• Negotiating or executing leases.

If a taxpayer resides in the rental at any point during the year, or if the building is rented under a triple net lease, it cannot qualify for the QBI Deduction under the safe harbor stipulations.

Contact Us

The revenue procedure that provides for this safe harbor is not yet finalized, but the IRS states that it can be relied upon until the final revenue procedure is published. This 20% deduction can be quite powerful, and taxpayers who expend a lot of time and effort into their rental businesses will want to take notice of this safe harbor. The 199a deduction is only available for tax years 2018 through 2025, so take advantage of it while you can. If you need help determining whether or not you will be eligible for this safe harbor, contact us. We look forward to speaking with you soon.