IRS Allows Rental Real Estate To Be Qualified Business Income Deduction

The Tax Cuts and Jobs Act added a new section 199A deduction equal to 20 percent of qualified income from a business operated directly by a taxpayer or through a pass-through entity. This deduction is only available with respect to income from a trade or business. But it was unclear when rental activity rose to the level of a trade or business, allowing the rental income to be eligible for the 20 percent deduction or the rental loss to reduce the deduction.

The Internal Revenue Service has issued a safe harbor that allows certain interests in rental real estate, including interests in mixed-use property, to be treated as a trade or business by your Missouri CPA for purposes of the qualified business income deduction if the following conditions are met.

Under the safe harbor, a “rental real estate enterprise” is treated as a trade or business for purposes of Sec. 199A if at least 250 hours of services are performed each tax year with respect to the enterprise. For rental real estate enterprises that have been in existence for at least four years, the 250-hour requirement will be met if, in any three of the five consecutive tax years that end with the tax year, 250 or more hours of rental services are performed per year for the rental real estate enterprise.

The IRS says these hours include services performed by owners, employees, and independent contractors and time spent on maintenance, repairs, rent collection, payment of expenses, provision of services to tenants, and efforts to rent the property. However, hours spent in the owner’s capacity as an investor, such as arranging financing, procuring property, reviewing financial statements or reports on operations, and traveling to and from the real estate, will not be considered hours of service for the enterprise.

If all the safe harbor requirements are met, an interest in rental real estate will be treated as a single trade or business for purposes of the section 199A deduction by your Missouri tax preparer. If an interest in real estate fails to satisfy all the requirements of the safe harbor, it may still be treated as a trade or business for purposes of the section 199A deduction by your Missouri CPA if it otherwise meets the definition of a trade or business in the section 199A regulations.

This safe harbor is available for taxpayers who seek to claim the section 199A deduction with respect to a “rental real estate enterprise.” Solely for purposes of this safe harbor, a rental real estate enterprise is defined as an interest in real property held to generate rental or lease income.

It may consist of an interest in a single property or interests in multiple properties. The taxpayer or a relevant passthrough entity (RPE) relying on this revenue procedure must hold each interest directly or through an entity disregarded as an entity separate from its owner, such as a limited liability company with a single member.

If a taxpayer has a real estate rental that qualifies to be included in calculating the qualified business income deduction they must attach a signed statement attesting that the rental activity meets the above requirements.

At Schultz Wood & Rapp, your Missouri CPA can help you determine whether your rental properties are eligible for the safe harbor and, if not, consider changes to help qualify for the safe harbor. Even if the safe harbor is not available, we can evaluate whether there is a way for your rental activities to qualify as a business without the safe harbor based on factors established by IRS and the courts. We can also explore whether any changes to your leases could improve your tax situation.