Tax season is finally over for individual returns! There were a lot of changes this year, and I had firsthand knowledge of how these changes confused many of my clients. One of the biggest changes in the tax code was the introduction of the Qualified Business Income Deduction and many people were confused about whether this could include income from real estate rentals.
This provision allows taxpayers with a “qualified business” to deduct up to 20% of the business income from their Adjusted Gross Income before it is taxed. Under most provisions of the tax code, rental real estate does not qualify as a business. However, IRS Notice 2019-07 provides some safe harbor rules to qualify rental real estate as a business for purposes of the Qualified Business Income Deduction.
First, the rental real estate must be owned by an individual or a pass-through entity that is owned by one or more individuals. Eligible pass-through entities are S corporations, partnerships, and limited liability companies. C corporations do not qualify.
Second, a total of at least 250 hours of documented “rental services” must occur during the year. Going forward, taxpayers using this safe harbor rule will need to provide documentation to the IRS in order to claim the deduction.
The documentation must include:
- The number of hours performed for each rental service activity.
- A description of the rental services performed.
- The dates on which the rental services occurred.
- The person who performed the rental services. The services can be performed by the owner, agents of the owner, employees of the business, and/or independent contractors.
Rental services 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 the property.
- Management of the real estate.
- Purchase of materials.
- Supervision of employees and independent contractors.
Rental services do not include:
- Financial or investment management activities, such as arranging for financing.
- Purchasing rental property.
- Studying and reviewing financial statements or reports on operations of the rental activity.
- Planning, managing, or constructing long-term capital improvements.
- Hours spent traveling to and from the real estate.
If you own both residential and commercial real estate, they cannot be grouped together. The 250 hours of service rule must be met for each group—250 hours for residential rental real estate and 250 hours for commercial rental real estate. Also, if the rental real estate was used as a personal residence for any part of the year, the rental activity does not qualify for the deduction.
Hopefully this served to clear up any misconceptions about the Qualified Business Income Deduction as it relates to to rental real estate. If you believe you qualified and did not get the deduction this year, please reach out. I’ve love to help!Judith Ackland has more than 26 years of experience in accountancy and financial planning, including seventeen years as a CFO of a diverse business. She started Crystal Financial in 2010 to help a wide array of individuals, families, and business owners better understand their finances and how good financial management could help them achieve their goals. Judith has an MA in Professional Accountancy from the University of Nebraska at Lincoln as well as a Certified Public Accountant Certificate and a Certified Financial Planner designation.