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When Congress added Internal Revenue Code Section 199A to the law it introduced a new 20% deduction against “trade or business income” for individuals and the rare estate or trust. This deduction was meant to equalize tax rates for individuals versus that used for regular or “C” corporations and their new 21% flat Federal income tax rate. The IRS was charged with the unenviable task of writing Regulations to guide taxpayers and preparers through the maze of conflicting information.
The new law, and the IRS’ Regulations both reference something called qualified trade or business income in Regulation 1.199A(c)(1) and define it as “the net amount of qualified items of income, gain, deduction and loss with respect to any qualified trade or business of the taxpayer.” Then, further reading to Regulation 1.199A-1(b)(14) defines a trade or business as a trade or business under Internal Revenue Code Section 162. This unbelievably poor definition leads us to Sec. 162 which does not define a trade or business! Thus, the taxpayer is required to refer to other Regulations, notices and, most importantly for rentals, court cases.
Regulation 1.199A-3(b) makes it clear that Schedules C, F and K-1’s from operating businesses all constitute trade or business income. However, guidance on rental activities is poor. Clearly (See IRS Q&A April 2019) self-rental activities qualify for the deduction, as do activities by real estate professionals. Additionally, the IRS provided a “safe harbor” election for some rental property owners to use if they wanted to automatically qualify for the deduction. We strongly pointed out from the podium last year, and continue to point out, that the safe harbor election is not a guide and, in most cases, should not be made or used as a determining factor for whether rental property qualifies for the deduction. Why? Because it excludes nearly every other rental property from qualifying when in most cases the residential rental activity will qualify for the deduction without meeting the safe harbor rules. After one year of tax season experience with this new deduction we believe that few practitioners took the QBI deduction on residential rental property because they believed the safe harbor rules were the required ways needed to qualify when, in reality, they were only 1 of many ways to meet the “trade or business” test.
Before going further, we must advise the reader that any return taking the position that the rental activity qualifies for the deduction must recognize that it is now a trade or business requiring the issuance of 1099’s when applicable, and also applies the QBI rules to losses.
In the IRS’ Summary of Comments and Explanations of the Revisions to the final Regulations the Service declined to provide additional guidance for residential rental activities and essentially left the issue open to a facts and circumstances analyses of every rental activity. Because this lack of guidance leaves the preparer in a blind hole of what to do, the preparer is therefore forced to rely on the only guidance available for trade or business determination for rental activities: US Tax, District and appellate court cases. We believe, based on our exhaustive research of cases involving single family rental activities going back to 1942 that most single family rental activities DO rise to a trade or business level and we will provide an analyses of 15 court cases in this fall’s 1040 in depth classes to prove our argument. Of course, every rental must be analyzed for owner activity, but the preparer should not fall into the “passive activity” trap of IRC Section 469 and look at rental under those rules. In summary, subject to you attending and listening to our analyses in this fall’s classes, we think most single-family rental activities do rise to a trade or business level and do qualify for the 20% QBI deduction.
Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of Manning & Associates and / or MANNINGTAX.COM. This information is published for informational purposes only.