Certain Real Estate Activities Will Not Qualify for Qualified Business Income Deduction

By: Patricia L. Bland

Enacted in December 2017, new Section 199A of the Internal Revenue Code (“IRC”) created by the Tax Cuts and Jobs Act (TCJA) creates a significant tax deduction for taxpayers who are owners of pass-through entities such as sole proprietorships, partnerships, or S corporations. Following its enactment, practitioners had concerns that passive real estate activities would not be eligible for the qualified business income (“QBI”) deduction. This summer, the IRS published its long-awaited regulations addressing application of Section 199A and the calculation of the QBI deduction, including limited guidance of the application of 199A to rental real estate activities.

To be eligible for the QBI deduction, the entity must, among other requirements, be a “qualified trade or business.” The IRS, in its 199A regulations, states that determinations of whether a business is a “qualified trade or business” shall be made using the definition of “trade or business” under Section 162 of the IRC. Section 162 deals generally with whether expenses are deductible “trade or business” expenses; it does not contain a clear and concise definition of a “trade or business.” Rather, Section 162 relies on a long history of case law and other IRS guidance creating the definition.

With respect to real estate activities, Section 199A and its regulations do not provide a cut and dried answer on eligibility. A determination of whether an entity is a “qualified trade or business” for 199A purposes will be made on a case-by-case basis based on the specific set of facts and circumstances for that entity or activity. The most common test applied by the courts in analyzing rental real estate activities under Section 162 is whether the management activities performed are considerable, regular, and continuous. Since the IRS intends on using the Section 162 definition, we can assume that eligibility under 199A will depend on the scope of management activities performed by the taxpayer. Where the taxpayer manages the real estate, pays taxes, expenses, and performs other activities on a regular and continuous basis, the rental real estate activity is a Section 162 trade or business. However, in a triple-net lease, where the landlord is simply passively collecting rental income, or in situations where the taxpayer has engaged a property manager to manage rentals, it is not likely that the rental activity will qualify for the QBI deduction. Under the facts and circumstances test, the IRS will be looking at what activities the taxpayer performs for the rentals on a regular basis.

Landlords may want to consider altering the terms of their lease arrangements to shift the management activities back to the landlord to be eligible for the QBI deduction. Paule, Camazine & Blumenthal’s real estate lawyers can help you understand whether your rental activities will be eligible for the QBI deduction. Contact us.

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Patricia L. Bland

Patricia L. Bland

A graduate of University of Missouri – Kansas City School of Law that also received her Master of Law in Taxation from UMKC, attorney Patricia Bland's legal practice includes the areas of business law and commercial transactions. She also handles taxation, real estate and estate planning matters.