Section 199A of the recently passed Tax Cuts and Job Act (TCJA) establishes a new rule for deducting up to 20% of qualified business income for self-employed individuals. This news has the potential to significantly lower tax liability for self-employed individuals and small business owners in traditional fields. However, since the passing of the act, there has been much debate on whether this opportunity is also available for rental income on real estate holdings.
Who Benefits from the Section 199A Deduction?
According to CPA Practice Advisor, the 199A deduction is available to owners of pass-through entities operating a business (such as those who own S-Corps) as well as LLCs and sole-proprietors. However, dividends, interest income, and capital gains and losses are to be excluded when calculating qualified business income (QBI.) The deduction is also subject to an income threshold that is affected by whether income is considered as coming from a “specified service trade or business,” which covers most service-based trades.
Does Rental Income Count in the QBI?
While these guidelines are helpful for many business owners, they do not effectively answer whether or not real estate rental income can be considered in QBI. Thankfully, the IRS recently released Notice 2019-07, which establishes the following safe-harbor rule:
• Rental activity can be treated as a business and contribute to the QBI affected by the TCJA if the taxpayer spends 250 hours or more annually on maintenance and other rental services.
This safe-harbor rule effectively treats rental activity as a service, and requires a certain amount of hours of work to verify that the service is being performed.
In order to qualify, the taxpayer must keep detailed records of rental activities including keeping separate books for the enterprise and documentation of days, hours, types of service, and the individual performing the service for any rental work.
There are also conditions that bar the taxpayer from taking the TCJA Section 199A deduction, such as:
• If the taxpayer used the property as a residence for any portion of the year
• If the property is rented on a triple net lease basis
The ruling on the TCJA deduction as it relates to rental income is still developing, and it is likely that the IRS will develop a rule to act as a more straightforward litmus test to determine what rental income will be considered for the deduction. Until then, we are all crossing our fingers and hoping that this new rule means less tax liability in the coming year.