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 preliminary guidance to this popular question, the IRS released Notice 2019-07, the key points of which we've summarized below.
Income from these types of rentals is specifically excluded for the purposes of the QBI deduction:
- Passive rental activities that are not considered a trade or business
- For example, a single-family dwelling rented out for a year or more in which there is little or no interaction between the landlord and the tenants other than periodically collecting rent and the occasional repair
- 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
- Rentals located outside the United States
- Land rentals
If your rental or rental activities fall into any of the above categories, you can't take the QBI deduction on the income generated.
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.
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 requirements:
- Each enterprise maintains its own books and records to track income and expenses;
- At least 250 hours of rental services are performed per year per enterprise; and
- (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.