When the Tax Cuts and Jobs Act was signed into law back at the end of 2017, it allowed a new tax deduction under Section 199A of the tax code of 20 percent for qualified business income (QBI).
Investors who want to claim this deduction, which automatically expires in December of 2025, must demonstrate their real property assets are being used for business or trade rather than for appreciation or other potential benefit. It’s also possible to aggregate income from single-family rentals; however, there are quite a few caveats that come with this deduction. We’ll cover the basics, but investors should seek counsel from legal and tax professionals to ensure they meet safe harbor and any other requirements when trying to aggregate the 199A deduction.
How to Determine if You Qualify for the QBI Deduction
Section 199A provides sole proprietorships, partnerships, S Corps, and certain trusts or estates a 20 percent deduction of income generated from a qualifying business. Dividends earned from a real estate investment trust (REIT) also may qualify for the deduction.¹
Investors with single-family rentals must meet the following three safe harbor rules to qualify for the deduction, which were issued in 2019 under Notice 2019-7.²
- You must keep separate rental income and expense records for each property.
- You must be able to document a minimum of 250 hours of work related to each rental property. These hours can include time spent collecting rents, reviewing rental applications, working directly with tenants to resolve issues, as well as any maintenance you perform or work done by licensed contractors and property managers. Keep in mind, though, that if your property was acquired through a 1031 exchange you can’t directly work on the property; all maintenance and repair work must be done by a third party.
- You must maintain time logs, reports, and similar record-keeping documents with detailed descriptions of any services performed on your rentals, along with dates and who did the work.
Even if you keep the most nuanced records regarding your rental properties, it’s still a smart move to work with an experienced tax adviser to ensure you have all the documentation required to prove your rental properties meet the qualified business or trade requirement.
Investors who have multiple rental properties and want to aggregate their QBI face additional hurdles.
Aggregating Single-Family Rental Income for the QBI Deduction
Investors with multiple rental properties may be able to maximize the deduction offered under Section 199A through aggregation. However, there are many criteria you must meet. It’s also important to note that you can only aggregate income from like properties -- you can’t aggregate income generated from a mix of commercial and residential properties.³ You also can’t aggregate income from any residential property used as a second residence.
Your single-family rental income can be aggregated providing they meet these five criteria:⁴
- You must directly own at least 50 percent of the asset.
- You must own it for the majority of the tax year.
- You must report all items related to the property on your annual tax return.
- The property is not used as a specified service trade or business, which involves services in fields such as health, accounting, law, the performing arts, consulting, and a number of other fields.⁵
- Your properties share business synergies in accounting, legal, and other operational aspects.
If you meet all of the above criteria, you can aggregate your income from single-family rentals for the QBI deduction.
The Bottom Line
Aggregation may not be the best course of action for all taxpayers. Carefully weigh the pros and cons of aggregation with an experienced tax professional to determine if aggregation would result in a greater QBI deduction, as well as whether you can satisfy the onerous and extensive reporting and record-keeping requirements.
Lastly, while quite a bit of guidance has been issued on how to proceed with aggregation, there’s still some murky water to navigate with your tax professional. Keep all this in mind when deciding if you want to aggregate income from your single-family rentals for the Section 199A QBI deduction.
1. Tax Cuts and Jobs Act, Provision 11011 Section 199A -- Qualified Business Deduction FAQs, IRS, https://www.irs.gov/newsroom/tax-cuts-and-jobs-act-provision-11011-section-199a-qualified-business-income-deduction-faqs
2. Notice 2019-7: Section 199A Trade or Business Safe Harbor: Real Estate, Page 7, IRS, https://www.irs.gov/pub/irs-drop/n-19-07.pdf
3.Notice 2019-7: Section 199A Trade or Business Safe Harbor: Real Estate, Page 6, IRS, https://www.irs.gov/pub/irs-drop/n-19-07.pdf
4. Section 199A and the Aggregation of Trades or Businesses, The Tax Adviser, https://www.thetaxadviser.com/issues/2019/may/sec-199a-aggregation-trades-businesses.html
5.Tax Cuts and Jobs Act, Provision 11011 Section 199A -- Qualified Business Deduction FAQs, IRS, https://www.irs.gov/newsroom/tax-cuts-and-jobs-act-provision-11011-section-199a-qualified-business-income-deduction-faqs
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