How Real Estate Investors Can Do To Claim 20% QBI Deduction
What is at Stake?
- The IRS does not give a clear answer to the question whether a ‘rental real estate operation’-enterprise is a “trade or business” for purposes of Section 199A of the Internal Revenue Code. Enterprises that are considered a “trade or business” in terms of the same qualify for the 20% deduction provided for, so the stakes are high.
- To be considered as a “trade or business” by the IRS the real estate enterprise in question is now provided with a revenue procedure that can result in it being deemed a “trade or business” for Section 199A if the requirements for it are met.
- However, in typical IRS style, the fine print here is a bit confusing:
Even if the enterprise does not meet the requirements set out in the new revenue procedure, it will still be considered a trade or business insofar as it conforms to the definition of a trade or business as set out in the Act in § 1.199A-1(b) (14).
- Put differently, for those enterprises that missed the mark in terms of the above mentioned Act and could not strictly speaking be considered a “trade or business” a second chance is now available. Despite not qualifying strictly according to the Act, the enterprise might now enter the proposed ‘Safe Harbor” and be deemed a “trade or business” by the IRS if they fulfill the requirements of the proposed revenue procedure.
I Need More Background to Understand What All of This Means
What 20% deduction?
On December 22nd, 2017 Section 199A was enacted to provide up to a 20% deduction to non-corporate taxpayer’s qualified business income. The deduction is available for all the taxpayer’s qualified trades or businesses, even those operated through a partnership, S corporation, sole proprietorship and also for real estate investment trust (REIT) dividends and (qualified) publically traded partnership income.
So what is a qualified trade or business?
- Section 199(d) specified service trade or business (SSTB) and trade or business of performing services as an employee, are expressly excluded from a qualified trade or business for purposes of the deduction.
- In Section 1.199A-1(b) (14) a trade or business is defined as a trade or business under section 162 other than the trade or business of performing services as an employee.
- Both Treasury and the IRS admitted that it is tough to figure out whether a rental real estate enterprise is a trade or business.
- To solve this problem, the proposed revenue procedure we will discuss below will provide a Safe Harbor for rental real estate enterprises to achieve the status of a trade or business for Section 199A alone.
When will this apply?
- The revenue procedure will apply to taxpayers for taxable years ending after December 31st,
- The good news is that taxpayers do not have to wait for the final publication of the revenue procedure before they can start using the Safe Harbor as set out in the proposal, for purposes of determining whether their rental real estate enterprise can be treated as a trade or business in respect of Section 199A.
The Rules Proposed
- The Safe Harbor in the proposed revenue procedure is available for taxpayers who want to claim the deduction available under section 199A for rental real estate enterprises.
- If the taxpayer meets the requirements, it will be treated as a trade or business exclusively to apply the regulations under section 199A.
- It is worthwhile to repeat that failure to meet the Safe Harbor requirements does not automatically preclude the taxpayer from qualifying as a trade or business as defined in section 199(d).
Defining a Rental Real Estate Enterprise
- A rental real estate enterprise holds an interest in one or more real properties to produce rental income.
- The person or RPE who wish to rely on the revenue procedure must hold this interest directly or through another entity disregarded as one separate from its owner in respect of § 301.7701-3.
- The taxpayer has to make a choice. It can either treat each of the above-mentioned properties separately as distinct enterprises or as a single enterprise as long as commercial and residential real estate are never part of the same enterprise.
- Taxpayers cannot vary this treatment from year-to-year unless substantial changes require the same.
Safe Harbor Requirements for Rental Real estate Enterprise
- Every rental real estate enterprise kept separate books to reflect income and expenses.
- For tax years beginning before January 1st, 2023, 250 hours or more of rental services are performed per year by the rental enterprise.
- Rental services include
- Advertising to rent or lease real estate
- Negotiating and executing leases
- Verifying prospective tenant application information
- Collecting rent
- The operation, repair, and maintenance of the real estate
- Management of real estate
- Purchase of materials
- Supervision of employees and independent contractors
- Rental services exclude
- Financial or investment management activities (arranging financing; procuring property; studying financial statements; planning, managing or construction of long-term capital improvements or hours spent traveling to and from real estate.
- Rental services include
- For tax years beginning after December 31st, 2022, in any three of the five consecutive taxable years that end with the taxable year ( or in each year for an enterprise held for less than five years), 250 or more hours of rental services are performed for the rental real estate enterprise.
- The taxpayer maintains time reports, logs and other documents to record:
- The hours the services were performed
- Description of the services performed
- Identity of those who completed the same
These records must be available for inspection by the IRS. The requirement that the records be kept contemporaneously will not apply to taxable years beginning before January 1st, 2019.
Rental Real Estate That is Excluded From the Safe Harbor Proposal
- Any real estate that had been used by the taxpayer (includes the owner or beneficiary of an RPE relying on the Safe Harbor) as a residence is not eligible.
- A triple net lease for the procedure includes a lease agreement that requires the tenant or lessee to pay taxes, fees, insurance and maintenance over and above the payment for rent and utilities or a portion thereof.
- The taxpayer (or RPE) has to include a statement attached to its return claiming the section 199A deduction or passes through section 199A information that the requirements in section 3.03 of the revenue procedure have been satisfied.
- The statement has to be signed by the taxpayer, his authorized representative or RPE.
- The undersigned statement has to state:
“Under penalties of perjury, I (we) declare that I (we) have examined the statement, and, to the best of my (our) knowledge and belief, the statement contains all the relevant facts relating to the revenue procedure, and such facts are true, correct, and complete.”
- Whoever undersigns the statement must have personal knowledge of the facts and circumstances related to the statement.
Readers should note that this article is only intended to convey general information on these issues and that FAS CPA & Consultants (FAS) in no way intends for the contents of this article to be construed as accounting, business, financial, investment, legal, tax, or other professional advice or services. This article cannot serve as a substitute for such professional services or advice. Any decision or action that may affect the reader’s business should not rely solely on the contents of this article, but should rather be consulted on with a qualified professional adviser. FAS shall not be responsible for any loss sustained by any person who relies on this presentation. This article is subject to change at any time and for any reason.
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