The IRS released a revenue procedure today (Friday) that clarifies the treatment of rental properties and the “qualified business income” deduction.
The revenue procedure provides a safe harbor where rental activity can be presumed to be a “trade or business” for QBI purposes. This ties back into the 6-part series I posted a month ago about whether or not rental owners need to issue 1099s. As I talk about in that series, a rental activity that is a “trade or business” needs to issue 1099s.
Rental activity can often be a trade or business, based on decades of court cases. But the net investment income tax regulations contain a safe harbor where, basically, a taxpayer who meets the definition of a real estate professional is deemed to have a trade or business for NIIT purposes, and so some tax pros have said “only” real estate pros need to issue 1099s.
So with that background, here’s what the revenue procedure provides as a safe harbor for rental activity to qualify as a trade or business for QBI purposes:
- Separate books or records are maintained for the activity. (It seems to me that most rentals will meet this requirement.)
- Quoting the revenue procedure here: “250 or more hours of rental services are performed (as described in this revenue procedure) per year with respect to the rental enterprise.”
- Starting 1/1/19, the taxpayer must keep contemporaneous records to prove the time spent in the activity.
Qualifying rental services include (this is word-for-word from the revenue procedure here):
- 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
- Management of the real estate
- Purchase of materials
- Supervision of employees and independent contractors
Notably, qualifying services do NOT include:
- Arranging financing
- Looking at properties to buy
- Studying or reviewing financial statements
- Planning, managing or constructing long-term capital improvements
- Time spent traveling to and from property
(Side note: I wonder if time spent talking to your accountant counts? It almost looks like it would NOT.)
Taxpayers applying this safe harbor for QBI purposes need to attach a statement to their tax return. It looks like, if you own multiple properties you have the choice of treating each property as a separate enterprise (for QBI purposes), or grouping (for QBI purposes), but you can’t group residential rentals with commercial rentals.
What does this mean for rentals and 1099s? A few thoughts:
- The revenue procedure repeats 8 times that this is a safe harbor for QBI purposes only. Meaning, just because a rental activity doesn’t meet the QBI definition of a trade or business, it can still be a trade or business for other purposes (i.e. issuing 1099s, or taking a Section 1231 loss deduction).
- Along the same lines as item 1, the revenue procedure states that the revenue procedure is a safe harbor, but a rental activity could still qualify for the QBI deduction even if the safe harbor isn’t met. I think you’d just get additional scrutiny in this circumstance.
- I still maintain that rental activity can be a trade or business based on being involved in the management of the property on a “regular and continuous basis,” even if it doesn’t meet the QBI safe harbor (and point #2 confirms that). The Treasury Department also notes in the preamble to the NIIT regs that issuing 1099s is one way of showing an activity is a trade or business. (Look towards the middle of page 42 of the regs here.) So I think, even if, a rental owner doesn’t meet the QBI safe harbor, they could potentially still have a 1099 reporting requirement, and could also take advantage of things such as a Section 1231 loss deduction on the sale of their rental property. Decades of court cases confirm this.
- As I always say, I am NOT saying that ALL rental activity is a trade or business. Courts have said 1 rental house “could” qualify as a trade or business, but “could” is different from saying “is.”
I am off to update the presentation material for my popular 1099 webinar that I give in various places, such as CPA Academy. I love to hear from fellow tax pros on this subject, so please email me (firstname.lastname@example.org).