Need clarifications: Section 162 for rental properties to get QBI deduction

[manbeing]

I have read section 162, but I am still not sure how to use Section 162 to define the rental property as a business so that it could receive QBI deduction. What is the criteria defined in Section 162 of  rental properties to be qualified as business?

[Anonymous_]

You want Section 199A, not Section 162.

See https://www.law.cornell.edu/uscode/text/26/199A

There is also a safe harbor:

https://www.irs.gov/pub/irs-drop/rp-19-38.pdf

[manbeing]

I don't meet the safe harbor criteria. This is from Form 8995a 

"Rental real estate that doesn’t meet the
requirements of the safe harbor may still be
treated as a trade or business for purposes
of the QBI deduction if it is a section 162
trade or business"

[Mike9241]

162 does not define businesses eligible for the QBI deduction - rather the tests come from court cases and other IRS pronouncements,

the safe harbor rule 

If a taxpayer’s rental real estate activity meets the safe harbor, then it will be treated as a trade or business for purposes of 199A.  

The safe harbor sets out requirements that must be met, and includes several exclusions and caveats

The Safe Harbor – Specific Requirements

1. Separate books and records must be maintained to reflect income and expenses for each rental real estate enterprise (“RREE”).
2. At least 250 hours of rental services must be performed each year with respect to each RREE.
3. The taxpayer must maintain contemporaneous records, including time reports, logs, or similar documents, regarding the following: (i) hours of all services performed; (ii) description of all services performed; (iii) dates on which such services were performed; and (iv) who performed the services.  Such records must be made available for inspection at the request of the IRS.

Books-and-Records Requirement.

The safe harbor also contains rules that permit a taxpayer to aggregate separate properties and treat them as a single RREE .

250-Hour Requirement.

Each RREE must satisfy the 250-hour requirement. Specifically, rental services include:

• 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, including the purchase of materials and supplies;
• management of the real estate; and
• supervision of employees and independent contractors.

Moreover, rental services can be performed by owners, employees, agents, and/or independent contractors of the owners. Accordingly, it will become very important that vendors who perform services that could be counted towards the 250-hour requirement provide documentation.

The above list does not purport to be exhaustive. Specifically excluded are the following activities:  financial or investment management activities, such as arranging financing; procuring property; studying and reviewing financial statements or reports on operations; improving property under §1.263(a)-3(d); and hours spent traveling to and from the real estate.

here's a link to the regs

https://www.irs.gov/pub/irs-drop/td-reg-107892-18.pdf 

which are wishy-washy as to whether the rental real estate qualifies if the safe harbor rules aren't met.  See section 3. in effect, if you don't meet the safe harbor rules, it is a judgment call.

here's the subpart I think is important (page 16)

In determining whether a rental real estate activity is a section 162 trade or
business, relevant factors might include, but are not limited to (i) the type of rented
property (commercial real property versus residential property), (ii) the number of
properties rented, (iii) the owner’s or the owner’s agents day-to-day involvement, (iv) the
types and significance of any ancillary services provided under the lease, and (v) the
terms of the lease (for example, a net lease versus a traditional lease and a short-term
lease versus a long-term lease).
Providing bright line rules on whether a rental real estate activity is a section 162
trade or business for purposes of section 199A is beyond the scope of these
regulations. Additionally, the Treasury Department and the IRS decline to adopt a
position deeming all rental real estate activity to be a trade or business for purposes of
section 199A.

[Anonymous_]

Generally, in order to qualify as an active trade or business, the owner needs to provide substantial services to the renters (much like a hotel, motel, or bed and breakfast) or rent real estate in the course of being a real estate dealer.

[manbeing]

@Anonymous_  @Mike9241 so most likely, for most of part-time landlords having one or two rentals, if they don't meet the Section 199A safe harbor criteria, there is very low possibility that their rentals will be treated as an active business  under Section 162 to be qualified for QBI deduction?

[Anonymous_]

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@Mike9241 wrote:

.....in effect, if you don't meet the safe harbor rules, it is a judgment call.

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It is almost silly since if an owner can meet the criteria listed, the owner can almost certainly meet the requirements set forth in the safe harbor.

[Anonymous_]

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@manbeing wrote:

@Anonymous_  so most likely, for most of part-time landlords having one or two rentals, if they don't meet the Section 199A safe harbor criteria, there is very low possibility that their rentals will be treated as an active business to be qualified for QBI deduction?

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Correct and I would say almost no possibility. If you cannot meet the safe harbor, the likelihood of otherwise qualifying is virtually zero.

[AmeliesUncle]

Unfortunately, there is no clear-cut definition of a Section 162 "trade or business".

For purposes of the Qualified Business Deduction, (Section 199A), personally, I use the "Safe Harbor" (which includes the 250 hour requirement) as a guideline for what the IRS thinks is a "Trade or Business".

The IRS says that 250 hours (and other requirements" is "Safe".  How far away are you from 250 hours?  While less than 250 hours CAN qualify as a Section 162 business, in my opinion, the farther you are away from 250 hours, the less likely the IRS will think it is a "Trade or Business".  So if you are at 200 hours, maybe/probably.  If you are 150 hours, maybe???  But if you are at 50 hours (or less), do you really think the IRS would think it is a "Trade or Business"?

[Anonymous_]

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@AmeliesUncle wrote:

....While less than 250 hours CAN qualify as a Section 162 business, in my opinion, the farther you are away from 250 hours, the less likely the IRS will think it is a "Trade or Business".  So if you are at 200 hours, maybe/probably.  If you are 150 hours, maybe???......

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Now, I have a question. Why would the IRS go through the trouble of researching and publishing a minimum hour requirement and incorporate that minimum into a safe harbor if a scenario existed where fewer hours would qualify? Following that line of reasoning, the IRS could easily have made the safe harbor 150 hours, or 100 hours, or 4 hours. 

Maybe we should note that the safe harbor is applicable to a rental real estate enterprise and whether or not that activity would be treated as a trade or business, not some other activity.

[AmeliesUncle]

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@Anonymous_ wrote:

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Now, I have a question. Why would the IRS go through the trouble of researching and publishing a minimum hour requirement and incorporate that minimum into a safe harbor if a scenario existed where fewer hours would qualify? Following that line of reasoning, the IRS could easily have made the safe harbor 150 hours, or 100 hours, or 4 hours. 

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So many things are subject to facts-and-circumstances, and are subject to personal interpretation.  That is why the IRS sometimes has a "Safe Harbor", to indicate they WON'T question something due to facts-and-circumstances if they meet certain criteria.

For example, let's consider the Reduced Maximum Exclusion for a Principal Residence in Regulation §1.121-3.  If you look at (b), there is list of six things that could be subject to interpretation based on the specific facts-and-circumstances.  But that is why the IRS/Treasury gives the "Safe Harbor" situations (or example, a job change that is 50 miles further) so you don't need to 'think' about and question whether it qualifies or not.  But if the taxpayer does not meet the "Safe Harbor" (such as the 50 mile job-change test), then they need to interpret whether it qualifies based on the six criteria.

Similarly, the "Safe Harbor" for the QBI deduction is so you don't need to 'interpret' anything - it is a given.  But if you don't meet the Safe Harbor test, you need to closely analyze the situation based on the facts-and-circumstances.  And perhaps your analysis of the situation may different from another person, or the IRS.  So that is why the IRS gives "Safe Harbors", so there are fewer 'arguments' if the specific facts-and-circumstances qualify or not.

[maglib]

@manbeing  most landlords actually can claim it as Rental services can be performed by the owners or by their employees, independent contractors, or agents to meet the number of hours.  

You should read the IRS guidance and TT notice . https://ttlc.intuit.com/turbotax-support/en-us/help-article/tax-credits-deductions/get-qbi-deduction... and https://www.irs.gov/newsroom/irs-finalizes-safe-harbor-to-allow-rental-real-estate-to-qualify-as-a-b...

R-2019-158, September 24, 2019

WASHINGTON — The Internal Revenue Service today issued Revenue Procedure 2019-38PDF that has a safe harbor allowing certain interests in rental real estate, including interests in mixed-use property, to be treated as a trade or business for purposes of the qualified business income deduction under section 199A of the Internal Revenue Code (section 199A deduction).

If all the safe harbor requirements are met, an interest in rental real estate will be treated as a single trade or business for purposes of the section 199A deduction. If an interest in real estate fails to satisfy all the requirements of the safe harbor, it may still be treated as a trade or business for purposes of the section 199A deduction if it otherwise meets the definition of a trade or business in the section 199A regulations.

This safe harbor is available for taxpayers who seek to claim the section 199A deduction with respect to a "rental real estate enterprise." Solely for purposes of this safe harbor, a rental real estate enterprise is defined as an interest in real property held to generate rental or lease income. It may consist of an interest in a single property or interests in multiple properties. The taxpayer or a relevant passthrough entity (RPE) relying on this revenue procedure must hold each interest directly or through an entity disregarded as an entity separate from its owner, such as a limited liability company with a single member.

The following requirements must be met by taxpayers or RPEs to qualify for this safe harbor:

• Separate books and records are maintained to reflect income and expenses for each rental real estate enterprise.
• For rental real estate enterprises that have been in existence less than four years, 250 or more hours of rental services are performed per year. For other rental real estate enterprises, 250 or more hours of rental services are performed in at least three of the past five years.
• The taxpayer maintains contemporaneous records, including time reports, logs, or similar documents, regarding the following: hours of all services performed; description of all services performed; dates on which such services were performed; and who performed the services.
• The taxpayer or RPE attaches a statement to the return filed for the tax year(s) the safe harbor is relied upon.

For more information about this and other TCJA provisions, visit IRS.gov/taxreform.

[Anonymous_]

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@AmeliesUncle wrote:

.....perhaps your analysis of the situation may different from another person, or the IRS.  So that is why the IRS gives "Safe Harbors", so there are fewer 'arguments' if the specific facts-and-circumstances qualify or not.

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I understand that, but there is almost always a rationale for selecting a specific number (as in 250 hours) as there must be for selecting $2,500 as the initial figure for the de minimis safe harbor election.

Regardless, again, there is significance is the sense that this particular safe harbor is only applicable to real estate activities and not any other form of activity. Thus, in my opinion, not being able to satisfy the safe harbor but, instead, trying to make a case based upon facts-and-circumstances for this activity is not a great approach (I believe this posture is particularly cogent given the fact that the IRS allows almost anything to count toward the minimum 250-hour requirement).

[AmeliesUncle]

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@Anonymous_ wrote:

Thus, in my opinion, not being able to satisfy the safe harbor but, instead, trying to make a case based upon facts-and-circumstances for this activity is not a great approach.

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I agree that a large degree of caution should be used if they don't meet the Safe Harbor, but it *IS* only a Safe Harbor.  So that means they can potentially qualify based on the facts-and-circumstances that don't meet the Safe Harbor.

But my original point was that if they were nowhere near the Safe Harbor criteria, it would likely be a REALLY 'hard sell' to claim they meet the facts-and-circumstances.

[Anonymous_]

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@AmeliesUncle wrote:

But my original point was that if they were nowhere near the Safe Harbor criteria, it would likely be a REALLY 'hard sell' to claim they meet the facts-and-circumstances.

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I absolutely agree with that statement. 

Nevertheless, I still question the inability to meet the safe harbor minimum based upon the facts stated in the posts. With more than one rental property and handling all of the management functions, tenant services, leases, hiring (and perhaps supervising) contractors, et al., I would think 250/yr would not be a reach.