The Tax Cuts and Jobs Act, or “TCJA” added a new tax deduction for business owners. It permits individuals, estates, and trusts to deduct up to 20% of their “qualified business income.” You may have heard a lot of talk in the news about a new deduction for “pass-through” income, but it’s actually available for qualified business income from a sole proprietorship, as well as from pass-through entities such as partnerships, LLCs, and S corporations.
One question that has been on everyone’s mind is whether this new deduction applies to rental real estate income and losses. Fortunately, the IRS has released a safe harbor under which a rental real estate enterprise will be treated as a trade or business for purposes of the deduction. To qualify for the safe harbor, you must—
- maintain separate books and records to reflect the income and expenses of each rental real estate enterprise;
- perform 250 or more hours of rental services per year; and
- maintain contemporaneous records (like time reports, logs, or similar documents) that show the hours of all services performed, a description of all services performed, the dates on which the services were performed, and who performed the services. Thankfully, this requirement doesn’t apply for 2018. However, if you want to take advantage of the safe harbor in 2019, you need to start maintaining contemporaneous records. We can help you find electronic solutions that will facilitate the recordkeeping process. In some instances, an electronic calendar may be sufficient as long as all relevant information is noted.
The types of rental services that qualify for the safe harbor include (1) advertising to rent the property; (2) negotiating leases; (3) verifying prospective tenant information; (4) collecting rent; (5) managing the property; (6) purchasing materials; and (7) supervising employees and independent contractors. However, we can’t count financial or investment management activities (like arranging financing), procuring property, studying and reviewing financial statements, managing long-term capital improvements, and time spent traveling to and from the property.
Also, the safe harbor doesn’t apply to real estate that you use as a personal residence. A dwelling is treated as a residence if it’s used for personal purposes for more than 14 days, or more than 10% of the number of rental days if greater. In addition, real estate rented under a triple net lease (an arrangement that requires the tenant to pay real estate taxes, fees, building insurance, and maintenance costs) isn’t eligible for the safe harbor.
Even if the safe harbor requirements described in this letter aren’t met, your activities may still be eligible for the qualified business income deduction, based on the facts and circumstances. It would just take more work on our end to make sure your enterprise qualifies as a trade or business under relevant case law.
In addition, if your rental real estate activity is closely related to another qualifying business and has common ownership and/or shared employees with that business, it may be automatically eligible for the QBI deduction as a result of the aggregation rules.
If you have any questions about whether your rental real estate business will be eligible for the special QBI deduction, please contact us.