The Qualified Business Income Deduction (also known as Section 199a deduction) has provided many Denver area pass-through business owners a new tax savings opportunity. The deduction allows certain taxpayers to take a deduction equal to 20% of their qualifying business income. The incentive which was passed as part of the Tax Cuts and Jobs Act (tax reform) has provided a welcome tax saving opportunity for many, but has left others wondering if they are able to take advantage of the opportunity. In particular owners of real estate rental businesses questioned whether they qualified under existing IRS regulations and guidance. Earlier this year, the IRS issued final regulations on the Section 199a deduction which provided answers and clarification on a handful of issues and concerns raised by taxpayers. While it didn’t specifically address the qualification question for these real estate companies, the IRS did release Notice 2019-07 which will help assess the qualification. To help clients, prospects and others understand the rules and whether they qualify, Hanson & Co. has provided a summary of key information below.
What is a Rental Real Estate Enterprise?
The safe harbor applies to “rental real estate enterprises,” which are defined as “interests in real property held to produce rents and may consist of an interest in multiple properties.” The interest must be held directly by the taxpayer or through a disregarded entity (such as a single member LLC). Commercial and residential rentals are both eligible businesses, but they cannot be combined into the same enterprise.
What are the Criteria for Qualification?
There are conditions that must be met for a rental real estate enterprise to be considered a qualified trade or business. It’s important to remember that all three criteria must be satisfied in order to qualify.
- The taxpayer keeps separate records that shows annual income and expenses for their rental enterprise.
- The taxpayer, their employees, agents, or independent contractors must perform at least 250 hours of “rental services” annually with respect to the enterprise. Beginning in 2023, workers must perform at least 250 hours of rental services in any three of the past five years.
- Beginning in 2019, the taxpayer maintains records that prove who performed services, for how long, what services they performed, and the dates they did the work.
“Rental services” explicitly excludes time spent making investment decisions, arranging financing, reviewing financial statements, managing capital improvements, and travelling, but it does include the following activities:
- Advertising or marketing rental units;
- Meeting daily operational needs;
- Performing maintenance and repairs;
- Purchasing supplies;
- Supervising employees or contractors;
- Processing tenant applications; and,
- Negotiating or executing leases.
If a taxpayer resides in the rental at any point during the year, or if the building is rented under a triple net lease, it cannot qualify for the QBI Deduction under the safe harbor stipulations.
The notice issued by the IRS will help owners of rental real estate companies determine if they can be considered a qualified trade or business. While the revenue procedure for the notice has not yet been finalized, the IRS has indicated that taxpayers can rely on it until the final procedure is published. If you have questions about the Notice, need assistance determining if you qualify, or would like help with another tax planning matter, Hanson & Co. can help. For additional information please call us at 303-388-1010 or click here to contact us. We look forward to speaking with you soon.