Maximizing Tax Benefits with the 20 percent QBI Deduction for Rental Income

QTA Consultants, Ltd./Renata Bliumaite

QBI 20% is to expire on January 1, 2025, unless congress extends it

If you earn income from rental properties… You may be eligible to claim a nice tax break: The 20% qualified business income deduction. The QBI deduction is for self-employed individuals and owners of pass-through entities, such as LLCs, partnerships and S corporations. These individuals can deduct 20% of their QBI. The write-off also applies to some landlords with Schedule E rental income. There are lots of special rules and restrictions, most of which apply to people with taxable incomes before the QBI deduction of more than $383,900 on joint returns and $191,950 for all other returns.

The QBI write-off is temporary. It ends after 2025, unless Congress extends it.

There are two ways to qualify for the 20% QBI write-off for rental income. The first is if the rental activity rises to the level of a trade or business. For this purpose, IRS regulations refer to the standard under tax code Section 162, the statute that generally governs the deductibility of trade or business expenses. There is no statutory or regulatory definition of a Section 162 trade or business. Instead, this determination is based on a taxpayer’s specific facts and circumstances. Some relevant factors are the type of property (commercial or residential), lease terms, extent of day-to-day involvement by the lessor or his or her agents, the significance and type of ancillary services provided under the lease, and the number of rentals. Here are some best practices to treat your rental as a business: Keep expense receipts. Insure the realty. Keep separate bank accounts. And track time and services performed.

A second way to qualify rental income as QBI is to meet an IRS safe harbor. At least 250 hours must be devoted to the rental activity by the taxpayer, employees or independent contractors in a year. Time spent on tenant services, repairs, property management, advertising, collecting rents, negotiating leases and supervising workers counts. Hours put in for driving to and from the property, arranging financing and constructing long-term capital improvements aren’t included. If you own multiple rental properties, you can treat each property separately or aggregate similar rental activities into commercial or residential categories. Those who use the safe harbor must meet strict recordkeeping requirements and attach an annual statement to their returns, as detailed in Rev. Proc. 2019-38. Contemporaneous records must detail hours, dates and descriptions of the services and who performed them. If the services are done by contractors or employees, the taxpayers must keep logs of the work done by them, as well as proof of payment. The safe harbor doesn’t apply to property leased under a triple net lease or if the owner’s personal use exceeds the greater of 14 days or 10% of the days rented.

Treating rental income as QBI doesn’t change how you report that income. Real estate rental income is usually reported on Schedule E of the 1040. Also, the rental income generally isn’t subject to self-employment tax. If you qualify, you’d take the QBI write-off on Form 1040, line 13 and attach Form 8995 or 8995-A.