Does Your Rental Real Estate Qualify for the 20% QBI Deduction?
One of the most talked about components of the Tax Cuts and Jobs Act (TCJA), the 20% Qualified Business Income (QBI) deduction, was finally given some clarity when the IRS issued final regulations. IRS Notice 2019-07 was issued in conjunction with the final regulations and is of particular interest to the real estate world. Notice 2019-07 includes a new safe harbor provision under which a “rental real estate enterprise” (RREE) will be treated as a trade or business under Section 199A of the Internal Revenue Code, thus making it eligible for the QBI deduction.
What qualifies as a rental real estate enterprise (RREE)?
Solely for the purposes of this safe harbor, a RREE is defined as an interest in real property held for the production of rents and may consist of an interest in multiple properties. Individual taxpayers and entities must either treat each property held for the production of rent as a separate enterprise or treat all similar properties held for the production of rents as a single enterprise. It’s important to note that commercial and residential properties may not be part of the same enterprise. Taxpayers cannot vary this treatment from year to year unless there has been a significant change in facts and circumstances.
How do I determine if an RREE is eligible for the QBI deduction?
Once RREEs are established, taxpayers must determine if they qualify as a ‘trade or business’ and, as such, are eligible for the QBI deduction. To assist with this determination, Notice 2019-07 provides safe harbor tests. If the following requirements are satisfied during the taxable year, an RREE is considered to be a trade or business for purposes of the QBI deduction:
- Separate books and records are maintained for each RREE
- 250 or more hours of rental services are performed for each RREE
- Applicable in 2019 and beyond, taxpayer maintains contemporaneous records documenting hours of service, services performed, dates of service and who performed the services
Clearly, the 250 hour rule is the key to meeting the new safe harbor requirement. Please note, these services can performed by the owner or contracted out. For purposes of the 250 hour rule, the following are considered rental services:
- Advertising to rent or lease real estate
- Negotiating or executing leases
- Verifying information in prospective tenant applications
- Collection of rent
- Daily operation, repairs and maintenance
- Management of the real estate
- Purchase of materials
- Supervision of employees and independent contractors
Anything else I should know about RREEs?
A few important items to note:
- RREEs can qualify as a trade or business for purposes of the QBI deduction even if they fail to meet the safe harbor tests
- Real estate used by the taxpayer as a residence for any part of the year is not eligible for this safe harbor
- Real estate rented under a triple net lease is not eligible for this safe harbor
- Triple net leases between related parties with common control (50% or more) generally qualify for the QBI deduction
- Taxpayers making the safe harbor election must include a statement with their tax return indicating they have met all safe harbor requirements
Please contact an Anders advisor to discuss questions about your specific situation, or learn more about the Anders Real Estate and Construction Teams. Visit our Tax Reform Resource Center for videos, blog posts and resources on how tax reform will impact you, your family and your business.