In general, income from rental real property held for investment purposes and reported on Schedule E (Form 1040) is not eligible for the QBI deduction. However, an investor may be eligible for the QBI deduction if he or she is operating the activity as a real estate business.
Safe Harbor Rule
IRS issued on September 24, 2019 Revenue Procedure 2019-38 that has a safe harbor rule for real estate activities. Before laying out the safe harbor requirements, we need to understand what is a “real estate enterprise”.
Real Estate Enterprise
Solely for purposes of this safe harbor, IRS defines a rental real estate enterprise as an interest in real property held for the production of rents and may consist of an interest in a single property or interests in multiple properties.
Excluded real estate properties. The following properties do not qualify for the safe harbor:
- If you use the real estate as a residence under section 280A(d) and you have personal use days in the taxable year of more than the greater of 14 days, or 10% of the number of days you rented the property);
- You rented or leased the property under a triple net lease (when you require the tenant/lessee to pay taxes, fees, insurance, maintenance, in addition to rent and utilities).
- You rent the property to a trade or business which is commonly controlled under § 1.199A-4(b)(1)(i). 8
- The entire rental real estate interest if any portion of the interest is treated as an SSTB under § 1.199A-5(c)(2) (which provides special rules where property or services are provided to an SSTB).
Safe Harbor Rule Requirements For QBI Deduction
In order to qualify for the the safe harbor, you need to satisfy the following requirements:
- You need to keep separate books and records that reflect income and expenses for each rental real estate enterprise.
- If your rental real estate enterprise has been in existence less than four years, you need to have 250 or more hours of rental services performed per year. If the real estate enterprise was in existance for 4 or more years, you need to have 250 or more hours of rental services performed in at least three of the past five years.
- You maintain contemporaneous records, including time reports, logs, or similar documents, regarding the following: hours of all services performed; description of all services performed; dates for such services; and who performed the services.
- You attach a statement to the return filed for the tax year(s) in which you rely on the safe harbor rule.
What Represents Rental Services
For purposes of the safe harbor, IRS includes in rental services the followings:
- advertising to rent or lease the real estate;
- negotiating and executing leases;
- verifying information contained in prospective tenant applications;
- collection of rent;
- daily operation, maintenance, and repair of the property, including the purchase of materials and supplies;
- management of the real estate;
- supervision of employees and independent contractors.
What is not included:
- financial or investment management activities, such as arranging financing;
- procuring property;
- studying and reviewing financial statements or reports on operations;
- improving property under § 1.263(a)-3(d);
- hours spent traveling to and from the real estate.
Who can perform the rental services:
- agents of the owner(s),
- independent contractors of the owner(s).
What If You Don’t Meet the Safe Harbor Requirements
If you fail to satisfy the requirements of the safe harbor you can still qualify for the QBI deduction if you can establish that the interest in the rental real estate is a trade or business for purposes of section 199A.
These are just the highlights of the safe harbor rules for real estate rental activities. Click here if you’d like more information.
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