What Are Qualified Business Income Deductions For Landlords?

Also known as the section 199A deduction, the Qualified Business Income (QBI) Deduction lets landlords potentially deduct up to 20% of their qualified business income (QBI). Let’s look at this in more detail.

Can I get the QBI deduction on rental income?

The good news is that any non-corporate landlord should qualify for the deduction.

Rentals that are classified as trades or businesses under IRC § 162 are not considered passive. If the management of the rental property rises to the level of a trade or business as defined by § 162, then it qualifies for the deduction. 

Rental properties are typically treated as passive activities—these are excluded from the definition of a qualified trade or business. But it’s important to understand the following:

1. You might qualify for the QBI if you’re organized as an S-Corporation or a pass-through LLC, estate, or trust (If you’re a C-Corp, you’re out of luck.).
2. Rental income declared on a Schedule E or K-1 also qualifies.
3. If you pass hurdle #1, you might qualify if you meet a number of conditions.
4. If you spent more than 50% of your time during a tax year in your real estate business – and that represented more than 750 hours in the same year, you passed the next hurdle. Congratulations!
5. The QBI is a deduction that you take on top of the standard deduction if don’t itemize, or the itemized deduction if you do.

But you’re not there yet. Your QBI is subject to limitations based on your taxable income that include the following:

• The type of trade or business;
• The amount of W-2 wages paid by the qualified trade or business; and
• The unadjusted basis immediately after acquisition (UBIA) of qualified property held by the business, which is the basis of the qualified property on the placed-in-service date.
  

Note that only items included in a landlord’s taxable income can be counted toward the QBI deduction. Some of the most common income sources include rent, non-refundable and forfeited deposits, late payment fees, pet fees, and federal rent subsidies (HUD). This also generally includes, but isn’t limited to the deductible part of self-employment tax, self-employed health insurance, and deductions for contributions to qualified retirement plans.

Defining “safe harbor” for landlords

The safe harbor rule comes into play when a landlord owns a handful of rentals but doesn’t qualify as a real estate professional. In this situation, he or she can still qualify for the QBI deduction, provide the rental activities constitute a trade or business.

The IRS published a notice in 2019 that provides a safe harbor for landlords to qualify for the IRC Section 199A deduction. In order to qualify the three requirements that must be satisfied:

1. Keep separate books and records to show income and expenses for each rental real estate enterprise;
2. Perform at least 250 rental services (Or other services, such as those provided by tradesmen and property managers) per year. Activities that satisfy the 250-hour requirement include landlord-related. The IRS says that rental services also include:

(i)         Advertising to rent or lease the real estate;

(ii)       Negotiating and executing leases;

(iii)     Verifying information contained in prospective tenant applications;

(iv)      Collection of rent;

(v)       Daily operation, maintenance, and repair of the property;

(vi)      Management of the real estate;

(vii)    The purchase of materials; and

(viii)  Supervision of employees and independent contractors.

3. Keep contemporaneous records of time reports, logs, or similar documents, such as hours of services performed; dates and descriptions of services performed; names of those performing such services.

Note that the safe harbor doesn’t apply to triple-net leases because the tenant is responsible for costs that would otherwise be the responsibility of the owner. As such, the IRS says that the rental income from a triple-net lease doesn’t qualify as trade or business income. It’s merely investment income.

If a landlord doesn’t qualify for the safe harbor, 20% of his or her rental income may still qualify as trade or business income, if they must meet some additional requirements

In 2021, real estate investors earning over $329,800 (if married and filing jointly) or $164,900 if filing as a single individual can claim the deduction as a percentage of wages paid with respect to the trade or business, or the combination of a percentage of wages paid, plus a percentage of the unadjusted basis of the property. These limitation thresholds are adjusted annually for inflation.

Landlords who own multiple rental properties should note that there are additional planning strategies that can maximize the IRC Section 199A deduction.

The Section 199A deduction is scheduled to automatically expire in at the end of 2025. In order to claim the current section 199A deduction, taxpayers who own real estate must be able to show that they’re operating a real estate business as a trade or business and not simply holding real estate for investment.

Keep in mind that, as helpful as this piece might be, we strongly advise that you speak to your accountant to get a firmer grasp on the implications and ramifications of the laws being discussed here. They will have a much firmer understanding of your individual circumstances and can clarify any questions this post might have raised.