Understanding the Qualified Business Income (QBI) Deduction for Rental Real Estate Enterprises

The introduction of the Tax Cuts and Jobs Act (TCJA) brought about significant changes to the tax landscape, and one of the notable components was the 20% Qualified Business Income (QBI) deduction. This deduction has garnered attention and discussion, and the Internal Revenue Service (IRS) recently issued final regulations that provide clarity on one crucial aspect of the deduction: how it applies to rental real estate enterprises.

Defining a Rental Real Estate Enterprise (RREE)
The IRS issued Notice 2019-07 along with the final regulations, and this notice is particularly relevant to the real estate sector. It introduces a safe harbor provision that allows a “rental real estate enterprise” (RREE) to be treated as a trade or business under Section 199A of the Internal Revenue Code, making it eligible for the QBI deduction.
For the purpose of the safe harbor provision, an RREE is defined as an interest in real property held to generate rental income. This enterprise can consist of multiple properties, but taxpayers must treat each property as a separate enterprise or treat similar properties as a single enterprise. Importantly, commercial and residential properties cannot be combined in the same enterprise unless there’s a significant change in circumstances.

Qualifying for the QBI Deduction
Once an RREE is established, taxpayers need to determine if it qualifies as a trade or business and therefore qualifies for the QBI deduction. To help with this determination, Notice 2019-07 sets forth safe harbor tests. If the following requirements are met during the taxable year, the RREE is considered a trade or business for QBI deduction purposes:

1. Separate books and records are maintained for each RREE.
2. At least 250 hours of rental services are performed for each RREE annually.
3. Starting in 2019, taxpayers must maintain contemporaneous records documenting hours of service, the nature of services, dates of service, and the individuals who performed the services.

It’s worth noting that the 250-hour rule is a pivotal factor in meeting the new safe harbor requirement. These rental services can be carried out by the owner or contracted out. Activities that count as rental services include advertising, lease negotiation, rent collection, property maintenance, and more.

Key Points to Consider
Several important points should be kept in mind when dealing with RREEs and the QBI deduction:

1. Even if RREEs fail to meet the safe harbor tests, they can still qualify as a trade or business for the QBI deduction.
2. Real estate used by the taxpayer as a personal residence at any point during the year is not eligible for this safe harbor.
3. Real estate rented under a triple net lease does not qualify for this safe harbor.
4. Triple net leases between related parties with common control (50% or more ownership) generally qualify for the QBI deduction.
5. Taxpayers who choose to make the safe harbor election need to include a statement with their tax return confirming compliance with all safe harbor requirements.

The Complexity of Classification
Determining whether a rental activity constitutes a trade or business for tax purposes can be intricate. The QBI deduction provides tax benefits for those qualifying as a trade or business, and the safe harbor provision under Notice 2019-07 simplifies this determination for rental real estate enterprises. However, taxpayers should still analyze their specific situations and consider seeking professional advice to ensure accurate classification and maximum tax benefits.
In conclusion, the interaction between rental real estate activities and the QBI deduction involves several intricate factors. While the safe harbor provision offers a clear path for some real estate enterprises to qualify, each taxpayer’s situation is unique, and careful consideration is needed to ensure accurate classification and potential tax savings. As tax regulations and interpretations can evolve, staying informed and seeking professional guidance is essential for navigating the complexities of the tax code.

About the Author:
Jamie Pope is a seasoned real estate tax expert with a passion for helping investors achieve maximum tax efficiency. With a wealth of experience and a dedicated team, Jamie specializes in identifying and executing smart tax strategies tailored to the unique needs of real estate professionals. To embark on your tax savings journey, contact Jamie Pope today via his website jamiepope.com, or by phone (615-429-7883) . Start maximizing your real estate investment potential now.