Real Estate Tax Pros

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Rental Properties & the Qualified Business Income Deduction: Tread Lightly

Only business income qualifies for the 20% QBI deduction. To be considered a business, the taxpayer must have a profit motive and materially participate (work in/at) the activity. Whether rental properties rise to the level of a trade or business for purposes of the QBI deduction is a source of confusion and consternation for tax professionals and landlords alike.

On the One hand; There’s a handful of tax-related case law showing that rental properties rise to the level of a business under a variety of circumstances. Also, Congress expressly included income from Real Estate Investment Trusts (REITs) as qualifying for the 20% QBI deduction, even though most investors have absolutely no involvement in operations. Additionally, self-rentals qualify for the 20% QBI deduction when the owner works in the business renting the property (like when an accountant owns her office, and her practice pays rent for the office).

On the Other Hand; Rental income is considered passive to taxpayers who are not Real Estate Professionals (a high bar to achieve). In general terms, this means that rental activity is, by definition, not a business. Real Estate Professionals report income on Schedule C, Profit or Loss from Business, and pay self-employment tax on income. Non-real estate professionals report their rental income on Schedule E Supplemental Income and Loss (which I not used to report business income).

A fact supporting the position that a rental is not a business occurred in 2012 when congress rescinded a short-lived requirement that rental owners file Form 1099-MISC. The primary argument made by those lobbying to remove the rule was that rentals do rise to the level of a trade or business and, therefore, do not require the creation of Form 1099-MISC when needed.

Some Welcomed Guidance (Ha!): A recently released IRS safe harbor (Revenue Procedure 19-38) regarding rentals qualifying for the QBI deduction does little to ease the confusion. The safe harbor requirements are so high that very few landlords will meet it. The problem with the safe harbor is that it only makes those meeting its conditions safe from the IRS denying the QBI deduction. The safe harbor does NOT establish rules regarding rentals that do or do not qualify for the QBI deduction.

What’s the Rental Property QBI Deduction Bottom Line? The answer remains unknown. There is a consensus that self-rentals, real estate investment trusts, real estate professionals, and rentals meeting the safe harbor all qualify. We also believe that triple-net leased properties (in which the tenant pays for taxes, insurance, and maintenance) do NOT qualify.

Until we receive additional guidance or a dispute winds its way through the court system (which may take years), one should tread lightly near rental properties and the QBI deduction. If you decide to claim the deduction, make sure your property meets as many of the safe harbor requirements as possible.

Summary and Invite: We hope this article has warned you about the confusion surrounding rental properties and the Qualified Business Income Deduction. If you’re a landlord or a real estate investor, we hope you will consider as your tax preparer and advisor.

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