Real Estate Investors & the QBI Deduction

Real estate investors can take the Qualified Business Income (QBI) deduction, but certain conditions must be met to qualify. The eligibility of real estate activities for the QBI deduction hinges on whether the activities rise to the level of a "trade or business" under IRS guidelines.

When Real Estate Activities Qualify as a Trade or Business

To qualify for the QBI deduction, the real estate activity must be considered a trade or business under Section 162 of the Internal Revenue Code. This generally means that the activity must be conducted with regularity, continuity, and with the primary purpose of making a profit. Here are some key factors that determine whether real estate activities qualify:

• Extent of Involvement: The level of involvement in managing the property is crucial. Investors who are actively involved in managing, maintaining, and improving properties are more likely to qualify. This includes landlords who personally handle property management tasks like tenant relations, maintenance, and lease agreements.

• Scale of Operations: The size and scale of the real estate operation also matter. Investors with multiple properties, significant rental income, or those who manage properties full-time are more likely to meet the trade or business standard.

• Intent to Earn a Profit: The intent to generate a profit is key. Real estate activities must be conducted with a profit motive. Occasional rental activities or passive investments without active management typically do not qualify.

Safe Harbor Rule for Rental Real Estate

The IRS has provided a "safe harbor" rule that can help real estate investors determine if their rental activities qualify as a trade or business for the QBI deduction. To meet the safe harbor requirements, the following criteria must be satisfied:

• Separate Books and Records: The taxpayer must maintain separate books and records for each rental real estate enterprise.

• 250 Hours of Rental Services: The taxpayer must perform at least 250 hours of rental services per year for the rental enterprise. This can include time spent on tasks like advertising, tenant selection, lease management, maintenance, and repairs. The 250-hour requirement can be met by the owner, employees, agents, or independent contractors working on behalf of the owner.

• Contemporaneous Records: The taxpayer must maintain contemporaneous records, including time logs, that detail the hours of service performed, services rendered, and who performed them.

• Exclusions: Triple net leases (where the tenant pays for property taxes, insurance, and maintenance) and properties used by the taxpayer as a residence for any part of the year do not qualify for the safe harbor.

If these conditions are met, the rental real estate activity is deemed a trade or business, making the income eligible for the QBI deduction. However, even if the safe harbor requirements are not met, real estate investors may still qualify based on the facts and circumstances of their activities.

Types of Real Estate Income That Qualify for QBI Deduction

When real estate activities qualify as a trade or business, the following types of income may be eligible for the QBI deduction:

• Rental Income: Income derived from leasing property can qualify if the activity meets the trade or business standard.

• Property Management Income: Income earned from managing properties, whether for oneself or for others, can qualify.

• Gains from the Sale of Real Estate: If the sale of property is connected to a trade or business, gains may qualify, but this is less common as capital gains typically do not qualify as QBI.

Limitations and Considerations

Real estate investors need to be mindful of certain limitations and considerations:

• Specified Service Trade or Business (SSTB): Generally, real estate activities do not fall under the SSTB classification, which means they are not subject to the stricter income thresholds that apply to SSTBs for the QBI deduction.

• Aggregation of Activities: Investors with multiple rental properties may be able to aggregate their activities to meet the trade or business standard, potentially qualifying for the QBI deduction across all properties.

• Income Thresholds: Like other businesses, real estate investors are subject to the same income thresholds and phase-outs that apply to the QBI deduction. If taxable income exceeds certain levels, the deduction may be limited or phased out.

Conclusion

Real estate investors can indeed take advantage of the QBI deduction if their activities meet the IRS criteria for being considered a trade or business. By ensuring active involvement, maintaining proper records, and possibly leveraging the safe harbor rule, real estate investors can reduce their taxable income significantly through this deduction. As with any tax-related matter, consulting with a tax professional is highly advisable to navigate the complexities and maximize the benefits of the QBI deduction.