Can I get the QBI deduction on rental income?
Qualified business income, or QBI, is the net income generated by any qualified trade or business under Internal Revenue Code (IRC) § 162.
Rental properties are usually treated as passive activities, and passive activities are excluded from the definition of a qualified trade or business. However, rentals that qualify as trades or businesses under IRC § 162 are not considered passive, which means they could potentially qualify for the QBI deduction.
To provide guidance to this popular question, the IRS released Revenue Procedure 2019-38, the key points of which we've summarized below.
Exclusions
Income from these types of rentals is specifically excluded for the purposes of the QBI safe harbor:
Property used as a residence by the taxpayer for any part of the year under IRC § 280A.
This includes vacation homes, cabins, seasonal or "snowbird" residences, etc..
Triple-Net (NNN) leases, where the tenant or lessee pays real estate taxes, insurance, and maintenance in addition to rent and utilities.
Real estate rented to a trade or business conducted by a taxpayer which is commonly controlled under § 1.199A-4(b)(1)(i).
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).
If your rental or rental activities fall into any of the above categories, you can't take the QBI deduction on the income generated.
Real estate professionals
If you’re a real estate professional for tax purposes (that is, over 50% of the personal services you performed in business during the tax year were in a real estate business you materially participated in for more than 750 hours that same year) then your rental income qualifies for the QBI deduction, provided all the other conditions are met.
Everybody else
What if you own a rental — or three — but don’t qualify as a real estate professional? Turns out you can qualify for the QBI deduction, as long as your rental activities constitute a trade or business.
Generally, this means each rental real estate enterprise (a rental property or group of similar rental properties, including K-1 rental income) must satisfy these three requirements:
Each enterprise maintains its own books and records to track income and expenses.
An enterprise that has existed less than four years performs at least 250 hours of rental services per year. For an enterprise in existence for four years or more, this test needs to be met for any three of the five consecutive taxable years ending with the taxable year.
(Starting with tax year 2019) Contemporaneous records of services performed are kept which includes who performed the service, description of service, the date of the service, and how long it took (who, what, when, and how long).
Rental services can be performed by the owners or by their employees, independent contractors, or agents, and would include things like:
General operation, maintenance, and repair of the property
Purchasing materials
Property management activities
Supervising employees and contractors
Advertising the property for rent
Tenant selection and background checks
Negotiating and executing leases
Collecting and depositing rent
Activities excluded from the definition of rental services include:
Time spent traveling to and from the property
Reviewing financial statements or operational reports
Financial or investment management (for example, financing)
Procuring or acquiring property to rent
Planning, managing, or constructing long-term capital improvements
Please note that if a rental fails to satisfy these requirements, the enterprise could still be treated as a qualified trade or business for the purposes of the QBI deduction, provided it meets the definition of a trade or business under IRC § 162.
