DOUBLE TAXATION

Do Self-Rentals Qualify for the 20% QBI Deduction?


The new qualified business income deduction has stirred a fair amount of buzz over the past few months with many taxpayers wondering if they too qualify for this lucrative tax deduction. It’s no wonder taxpayers are clamoring to know more about these potential tax savings because eligible taxpayers may be able to deduct up to 20% of their business income from their taxable income. Although there is understandable excitement surrounding these new tax law provisions, there exist substantial hurdles for many taxpayers that can limit or even completely eliminate the deduction.

Specifically, the rules regarding the eligibility of self-rentals for the qualified business income deduction can either hurt some taxpayers or help other taxpayers who are looking to claim the deduction. This article will shed light on the rules regarding self-rentals and their eligibility for the qualified business income deduction.

Background

Section 199A of the Internal Revenue Code (IRC) provides owners of pass-through businesses with a deduction for qualified business income (QBI) from a qualified trade or business. Eligible taxpayers may be entitled to a deduction equaling 20 percent of their QBI from a domestic operated sole proprietorship, S corporation, trust or estate.

Qualified trade or businesses include any trade or business with the exception of:

  • Specified service trade or business (SSTB) – trade or business involving performance of services in the field of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, investing and investment management, trading, dealing in certain assets or any trade or business where the principal asset is the reputation or skill of one or more of its employees. Taxpayers who own an SSTB may still qualify for the deduction if a taxpayer’s taxable income does not exceed $315,000 for a married couple filing a joint return, or $157,500 for all other taxpayers.
  • Performing services as an employee.

Rental Real Estate Eligibility

To be eligible for the 199A deduction a rental activity must rise to the level of a section 162 trade or business. Factors that determine if a rental is a qualified trade or business include the following:

  • The type of rented property (commercial real property vs residential property)
  • The number of properties rented
  • The owner’s day-to-day involvement in the business
  • The types of ancillary services provided under the lease
  • The terms of the lease (rentals under a triple net lease are ineligible under the safe harbor rules)

The Treasury Department recently released safe harbor rules for taxpayers to determine if their rental activity rises to the level of a section 162 trade or business. In essence, a taxpayer must show substantial involvement in the rental property to be eligible for the deduction.

Self-Rental Eligibility

For most owners of self-rentals (i.e. owners of the business and the building in which it operates) meeting the safe-harbor requirements for a rental trade or business is almost impossible. For example, under the proposed safe harbor rules, a rental real estate enterprise may be treated as a trade or business for purposes of section 199A if at least 250 hours of services are performed each taxable year with respect to the enterprise.

Luckily, the final regulations include a provision that automatically raises self-rentals to the level of a section 162 trade or business. Solely for the purposes of section 199A, the rental of tangible property to a related trade or business is treated as rising to the level of a trade or business if the rental activity and the other trade or business are commonly controlled. Taxpayers must be aware, however, that the owner of the building must be an individual or a pass-through entity, a C corporation that owns the self-rental building is ineligible for this caveat. Essentially, if you own a business that pays rent to a rental property, which you also own, then you may be able to claim a section 199A deduction on that rental income.

Self-Rental and Common Ownership of an SSTB

In an attempt to prevent taxpayers from circumventing the SSTB income limitations by shifting SSTB income to a non SSTB income the final regulations add a caveat for self-rentals under common ownership.

The final regulations provide special rules for services or property provided to an SSTB by a trade or business with common ownership. In effect, the portion of the trade or business providing property to the commonly owned SSTB is treated as part of the SSTB with respect to the related parties if there is 50 percent or more common ownership.

For example, if a building owned by a group of lawyers in a law practice leased 90 percent of it’s building to the law firm and 10 percent to an unrelated dentist, the 10 percent would be classified as non SSTB income while the 90 percent would be treated as SSTB income. Therefore, although a rental real estate trade or business is not treated as an SSTB, subject to the taxable income limitations if there is common ownership of 50 percent or more than the rental income attributable to the commonly controlled SSTB is treated as if it were SSTB income.

Final Notes

Generally speaking, rental income from a self-rental may be eligible for the 20% qualified business income deduction. However, the rules are complex and every taxpayer’s circumstance is different. To get answers related to your specific set of circumstances please consult with your Withum tax advisor by filling out the form below.


Withum’s Tax Services

Author:Jeremias Ramos, CPA |
[email protected]

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