For owners of pass-through entities to claim the 20% qualified business income (QBI) deduction, they must be in a trade or business. When it comes to real estate activities, it’s sometimes difficult to determine whether they are a business or merely investments. The IRS has created a safe harbor that can be used show that certain rental real estate activities are a trade or business and amount to a rental real estate enterprise for which the QBI deduction may be claimed (Rev. Proc. 2019-38).
There are four conditions to be a rental real estate enterprise:
- You must keep separate books and records 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, you must perform rental services of 250 or more hours of rental services each year. For other rental real estate enterprises, the test is 250 or more hours of rental services performed in at least three of the past five years.
- You must maintain 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. This requirement is for tax years beginning on or after January 1, 2020.
- You must attach a statement to the return filed for any tax year that you use the safe harbor.
Note: If you fail to meet the safe harbor, you can still rely on case law and IRS rulings on Code Sec. 162 to show that your rental real estate activities amount to a trade or business.