Rental real estate may constitute a qualifying trade or business for purposes of the qualified business income deduction if it meets the definition of a trade or business or meets the safe harbor criteria. This post is intended to highlight criteria for considering rental property a trade or business for purposes of the IRC §199 Qualified Business Income Deduction (20%). Remember, it is not always advantageous to classify rental properties as a trade or business. Often, rentals generate losses which will reduce other qualifying trade or business income or carry forward to reduce future qualifying business income.
Trade or Business
There is no clear definition or criteria of when a rental activity rises to the level of a trade or business. You are left with conflicting guidance from court cases when determining if a rental activity rises to the level of a trade or business. However, it is reasonable to conclude that to rise to the level of a trade or business, the taxpayer must be involved in the activity with continuity and regularity and the primary purpose for engaging in the activity must be for income or profit. In addition, to help establish the activity as a trade or business, which is possible without meeting the 250 hour threshold under the safe harbor, taxpayers should maintain separate accounts for the activity, document what work was done (including the time spent by the taxpayer and any agents such as property managers, landscapers, etc.), and send out 1099s as applicable.
Certain rental real estate interests meeting the safe harbor criteria will be treated as a trade or business solely for purposes of IRC §199A and the regulations thereunder. Passthrough entities may also use this safe harbor to determine whether a rental real estate enterprise is a trade or business however, the determination is made at the entity level, not the shareholder, partner, or member level.
The safe harbor requirements are applied annually. Solely for the safe harbor, a rental real estate enterprise is defined as an interest in real property held to produce rents and may consist of an interest in a single property or multiple properties. The following four requirements must be satisfied during the taxable year with respect to the rental real estate enterprise:
- Separate books and records must be maintained to reflect income and expenses for each rental real estate enterprise.
- A minimum of 250 hours of rental services must be performed per year with respect to each rental enterprise.
- Contemporaneous records must be maintained, including time reports, logs, or similar documents (effective 1/1/2020).
- The individual taxpayer or passthrough entity must attach a statement to a timely filed original return for each taxable year in which the safe harbor is relied upon. For more than one rental real estate enterprise relying on the safe harbor, the taxpayer may submit a single statement with the required information listed separately for each.
The statement each taxpayer must attach to the year the safe harbor provisions apply contains the following:
- A description including the address and rental category of all properties that are included in each rental real estate enterprise.
- A description including the address and rental category of all properties acquired and disposed of during the year.
- A representation that the requirements of Rev. Proc. 2019-38 have been satisfied.