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Rental property owners may benefit from Qualified Business Income Deduction under new IRS guidance

Jan 28, 2019

By Carol A. Magyar, CPA, MST
Tax Director

Owners of rental real estate – either commercial or residential – may be able to benefit from one of the new tax law’s most significant deductions by observing record-keeping rules detailed in recent guidance from the IRS.

The rules detailed in IRS Notice 2019-7 give taxpayers a “safe harbor” to treat rental real estate as a trade or business solely for the purpose of the Qualified Business Income Deduction. This deduction, also known as a Sec. 199A deduction, was created by the Tax Cuts and Jobs Act of 2017, and primarily applies to pass-through entities such as S Corporations, partnerships, limited liability companies and sole proprietorships.

This safe harbor exception is notable because it enables individual taxpayers who own rental property to benefit from the 20 percent QBI deduction.

In order to qualify for the safe harbor exception, commercial and residential real estate may not be part of the same enterprise. Other requirements are:

  • Separate books and records must be maintained to reflect income and expenses for each rental real estate enterprise.
  • At least 250 hours of rental services must be performed each year. Such services include:
    Advertising to rent or lease property
    Negotiating and executing leases
    Verifying information for prospective tenant applications
    Collection of rent
    Daily operation, maintenance and repair of property
    Management of real estate
    Purchase of materials
    Supervision of employees and independent contractors

Qualifying rental services do not include arranging financing; procuring property; studying and reviewing financial statements or reports on operations; planning, managing or constructing long-term capital improvements, or hours spent traveling to and from the property.

  • Contemporaneous records, including time reports, logs or similar documents, are kept by the taxpayer regarding the following:
    Hours of all services performed
    Description of all services performed
    Dates on which services were performed
    Names of individuals who performed services

Such contemporaneous records will apply only to taxable years beginning on or after January 1, 2019.

The IRS stresses that taxpayers should be consistent in reporting expenses related to rental real estate. For example, taxpayers who treat rental activity as a trade or business for purposes of the Sec. 199A deduction also should comply with Form 1099 information reporting requirements related to any independent contractors who perform work on their properties.

It is important to note that this safe harbor exception is not available in cases where the taxpayer occupies the real estate as a residence for any part of the year, or in cases where the real estate is rented or leased under a triple net lease.

If an enterprise does not meet these safe harbor requirements, it may still be treated as qualified business income under other IRS rules.

Contact us to discuss how you might benefit from these rules regarding treatment of rental property income.

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