Along with final regulations and other guidance on the new qualified business income deduction, the Treasury Department and the IRS issued a notice on a proposed revenue procedure providing a safe harbor that enables many rental real estate owners to claim the section 199A tax deduction (aka the QBI deduction).
The deduction is only available to non-corporate taxpayers whether in real estate or not. (Let’s revisit 199A: Congress enacted section 199A to provide a deduction to non-corporate taxpayers up to 20 percent of the taxpayer’s qualified business income for each of the taxpayer’s qualified trades or businesses, including those operated through a partnership, S corporation, or sole proprietorship, as well as a deduction of up to 20 percent of aggregate real estate investment trust (REIT) dividends and qualified publicly traded partnership income. A qualified business or trade cannot be a specified service trade or business (SSTB) or business of performing services as an employee.) Phew!
Who Gets the Deduction?
So, when does owning rental real estate qualify as a trade or business for purposes of this deduction? Good question! The IRS published a “proposed revenue procedure” to provide some guidance regarding rental real estate enterprises as a trade or business solely for purposes of the section 199A deduction. So they are trying to give us a clue if we qualify!
You might still be able to qualify, even if you do not meet the guidelines given here, but only your tax specialist can define your unique situation for you!
So first, you have to have ownership in property for the purpose of collecting rent for that property. Your direct interest can be as an individual or through a “relevant passthrough entity” (RPE) like that LLC you formed, for example. Your “rental real estate enterprise” may be made up of one property or multiple properties. You can treat each property as a separate enterprise, or group all similar properties into an enterprise. Keep records on each enterprise. Commercial and residential real estate may not be part of the same enterprise. You may not vary it from year-to-year unless there has been a significant change in facts and circumstances.
What Do You Need To Do?
So again, you need to keep separate books reflecting income and expenses for your rental real estate. If you have multiple real estate enterprises, say residential and commercial, you have to have separate books and records for each.
You need to show 250 or more hours of rental services were performed during the year with respect to each enterprise. To do this, you have to keep “contemporaneous records”, or records at the time the services happen. This would include a log with the date, time and description of a service that was performed including who performed the service. Again, keep this log as things happen! This SHOULD NOT be a recap done at the end of the year.
Such services may include:
- Advertising to rent or lease the real estate
- Negotiating and executing leases
- Verifying information contained in prospective tenant applications
- Collection of rent
- Daily operation, maintenance, and repair of property
- Management of the real estate
- Purchase of materials
- Supervision of employees and independent contractors
You, as the owner, can perform these services, or have someone else do them. The key is to properly track them.
Unfortunately, you can’t count time with your banker or accountant as part of your “rental services”. Arranging financing and reviewing financial statements is not allowed for purposes of calculating the 250 hours. Neither is time spent planning, managing, or constructing long-term capital improvements. And one more thing…no counting travel time to and from the property.
Are There Exclusions?
There are a few other exclusions to consider – if you, the owner, use the rental property as a residence for any part of the year, you cannot include it for purposes of the QBI deduction. (That includes use by owner or any beneficiary of an RPE – relevant passthrough entity.)
Further, real estate rented under at triple net lease is also not eligible for this safe harbor. That means, the lease will not qualify toward the deduction if the tenant or lessee pays (part or all of the) taxes, fees, and insurance, and is responsible for maintenance activities for (part or all of) the property in addition to rent and utilities. (That concludes your very short lesson in triple net for this blog!)
There are some procedural requirements including attaching the appropriate statement and signing it, so please consult your tax professional.