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Tax Treatment of Rental Real Estate Using the QBI Deduction

Posted by Eric Olsen, CPA on Dec 9, 2019 12:12:00 PM

The IRS has finalized guidance on a safe harbor allowing certain rental real estate interests to be considered as a trade or business for treatment as qualified business income (QBI) under IRC Section 199A. Revenue Procedure 2019-38 states that if all the requirements are met, taxpayers will be able to treat an interest in rental real estate as a qualified trade or business for the purposes of the QBI deduction.

Section 199A allows taxpayers to deduct up to 20% of QBI, effective for tax years 2018 through 2025. Taxpayers must be able to demonstrate they have trade or business income to use the QBI deduction. The QBI deduction is available for income generated by non-corporate taxpayers such as sole proprietorships, partnerships, S corporations, trusts, and estates.

The safe harbor noted in Revenue Procedure 2019-38 applies to a rental real estate enterprise that is defined as an interest in real property held to generate rental or lease income. Taxpayers or relevant passthrough entities (RPEs) can rely on this safe harbor if they directly hold each interest or through an entity not regarded as an entity separate from its owner, such as a single member limited liability company.

Related Blog: How the new Tax Cuts and Jobs Act Impacts Real Estate Investments

Types of Rental Real Estate Properties Eligible

The taxpayer’s rental real estate enterprise may be an interest in a single property or interests in multiple properties. An interest in a mixed-use property such as one that combines residential and commercial components may be treated as a single rental real estate property or split into separate residential and commercial interests. Once the taxpayer or RPE treats its interest in similar commercial or similar residential properties as a single rental real estate enterprise under the safe harbor, it must continue to do so with all similar properties including newly acquired properties.

Requirements to Qualify for the Safe Harbor

Taxpayers and RPEs must meet the following requirements to qualify for the safe harbor:

  • Maintain separate records or books to reflect income and expenses for each rental real estate enterprise.
  • At least 250 hours of rental services must be performed each year for those rental real estate enterprises in existence for fewer than four years. For other rental real estate enterprises in existence longer, 250 hours or more of rental services must be performed in at least three of the past five years.
  • Retain contemporaneous records, including time reports, logs, or similar documentation regarding the number of hours of all services performed, the dates on which services were performed, a description of all services performed, and who performed the services.
  • Attach a statement to their return filed for the tax year(s) the safe harbor is relied upon.

If a rental real estate enterprise fails to meet these requirements, it will not be able to use the safe harbor and it may be treated as a trade or business under Section 199A if it otherwise meets the definition of a trade or business under Section 1.199A-1(b)(14).

Special Considerations

Revenue Procedure 2019-38 reminds taxpayers that they may qualify their rental real estate activities for the QBI deduction under Section 199A if they can meet the definition of a qualified trade or business according to the requirements found under Section 162. Triple net leases, which are defined as a lease agreement that requires the tenant or lessee to be responsible for taxes, fees, and insurance as well as maintenance activities for a property in addition to rent and utilities, still do not qualify for the safe harbor.

Do you have questions about services we can offer for your company,  the tax treatment of rental real estate or other real estate issues? Please contact Eric Olsen at (214) 635-2538.

Note: This content is accurate as of the date published above and is subject to change. Please seek professional advice before acting on any matter contained in this article.

Topics: Real Estate & Construction, Taxes, Safe Harbor