As we enter the 2019 filing season we now have a year of the Tax Cuts and Jobs Act (TCJA) of 2018 under our belts. During the 2018 filing season there was still a lot of “gray area” when it came to the Qualified Business Income Deduction (QBI) and what qualified for the deduction.
The QBI deduction allows a 20% deduction for qualified business income, including qualified rental real estate activity. The deduction for “business” income seemed pretty straightforward but the question then became what qualifies a rental real estate activity as a “trade or business”. Rentals have traditionally been thought of as passive activities, not subject to the same rules as business income, which caused some confusion as it relates to the QBI deduction.
The IRS offered guidance on this and gave taxpayers two options to qualify their rental real estate activities. You have the choice to use one of the following methods: 1. Use the safe harbor rules, or 2. Claim that your rental is a trade or business under existing tax law.
Most of you may be thinking using the safe harbor rules would be the “safe” option as the name implies. But before making that decision you need to understand what is required to use this election. In order to make the safe harbor election you must make sure the following requirements are satisfied:
- Separate books and records are maintained for each rental real estate enterprise,
- You and your employees or agents perform 250 or more hours of “rental services” during the year, and
- You maintain contemporaneous records, including time reports, logs, or similar documentation, regarding the following: hours of all services performed, description of services performed, date of services performed, and who performed the services.
And once you feel you have met these requirements a statement must be attached to your return stating that under penalties of perjury you have satisfied the above requirements. Note that triple net leases will not qualify for the safe harbor election.
Is This Really Necessary?
This begs the question, is this really necessary? If you meet all these requirements aren’t you a trade or business under existing tax law? Once again we have hit a gray area. The IRS provides no fast, hard rule on what is considered a business but refers to code section 162 which says in order to be considered a trade or business the taxpayer needs regular, continuous and considerable involvement and the intent to earn a profit. Seems easy enough, right? But be aware this too will require record-keeping and documentation.
When comparing the two, many taxpayers may say option 2 seems like the easier option, there is no specific hours requirement, no additional statement under penalties of perjury.
However, it does not come without its own stringencies. One, if you are going to argue that you are trade or business under section 162 1099s are required to be sent to any independent contractors that have performed services on your rental properties and have been paid $600 or more during the year. That in itself can be a daunting task depending on the number of vendors paid.
Under the safe harbor method 1099s are not required. Also as with the safe harbor method you must still maintain contemporaneous records proving your regular, continuous and considerable involvement. So though you may not have to meet 250 hours you still need documentation to prove you are regularly and continuously performing services for the rental properties.
The Bottom Line
Bottom line, careful consideration should be given to whether you can qualify your rentals as eligible for the qualified business deduction, and if you can, make sure you are maintaining the records in order to support your position.