The IRS recently provided guidance to real estate investors regarding the Qualified Business Income (QBI) deduction under the Tax Cuts and Jobs Act (TCJA.) One of the weaknesses of the QBI provision of the TCJA was a lack of clarity in section 199A, which allows some taxpayers with pass-through businesses (e.g. LLCs and S-Corps,) to deduct 20% of their qualifying income.
Until recently, there was confusion about whether real estate investment businesses would be treated as a trade or business under section 199A. The IRS provided edification in IRS Notice 2019-07. In this notice the IRS offers a safe harbor for real estate investors, and defines the level of involvement in the real estate enterprise that the taxpayer must have to be able to take the QBI deduction. The notification lists the following stipulations:
- The taxpayer must keep separate books or records for each real estate rental business.
- For taxable years beginning with 2018, up to tax year 2022, 250 or more hours of service must be provided per year to the rental enterprise, in any three of the five consecutive taxable years.
- Taxpayer must maintain contemporaneous records, including time logs which include; hours of service provided, nature of service performed, dates on which service was performed, and who performed the service.
- For purposes of tracking hours, only like-types of real estate may be aggregated (e.g. commercial property rentals cannot be combined with commercial rentals). Due to the late date of the issuance of this notice, documentation of hours will not be required for tax year 2018, but will be required in subsequent tax years.
- Services performed to the business are as follows:
- Advertising
- Negotiating and leasing
- Verifying information in tenants’ applications
- Collection of rents
- Daily operations, maintenance, repairs, management, purchase of materials
- Supervising employees and independent contractors
- Owners, agents, management companies, independent contractors time count
- May NOT include time spent financial and investment activities, planning, managing, constructing improvements
- May NOT include the rental of Triple Net Leases, where tenant is responsible maintenance
- May NOT include vacation home rental
- May NOT include property where taxpayer is a full or part-time resident
In order to take the QBI deduction on these grounds, you should include a signed statement that you have met requirements and attach it to your return. In the case of electronic filing, a scan of the statement should be attached to the filing. It should be noted that even if a taxpayer’s rental does not meet the safe harbor tests, the taxpayer may still be able to treat the rental as a trade or business if it meets the definition of Reg. §1.199A-1(b)(14). As well, the safe harbor only applies for purposes of §199A.
Do you have questions about this ruling, or any other tax questions related to real estate investing? Contact us to speak with a real estate investment tax expert.