Sidney Kess

Owners of pass-through entities may be able to take a 20 percent deduction for their qualified business income (QBI) (Code §199A). This personal deduction lowers the effective tax rate on profits from business activities. The question that many tax professionals have been asking since the QBI deduction was created by the Tax Cuts and Jobs Act of 2017 is whether this write-off applies to real estate activities. The IRS has helped to answer this question with respect to certain rental properties. See Notice 2019-7.


The QBI deduction applies only to eligible income from a trade or business. Unfortunately, Code §199A governing the deduction does not clearly define the term “trade or business.” It refers to the definition of a trade or business under Code §162, other than the trade or business of performing services as an employee (an employee cannot qualify for the QBI deduction).

Over the years, there has been controversy on when rental real estate activities amount to a trade or business (Code §162) or are merely properties held for investment (Code §212). The courts have grappled with the matter. More than 30 years ago, the U.S. Supreme Court, in a case focusing on whether gambling activities were a trade or business for purposes of the alternative minimum tax, provided some guidance: “We accept the fact that to be engaged in a trade or business, the taxpayer must be involved in the activity with continuity and regularity and that the taxpayer’s primary purpose for engaging in the activity must be for income or profit.” Groetzinger, 480 U.S 23 (1987). More recently, the Tax Court examined the definition of trade or business with respect to a manager of venture capital funds. Degres, 136 TC 263 (2011). The court said: “An activity that would otherwise be a business does not necessarily lose that status because it includes an investment function” and zeroed in the personal skills and endeavors of the taxpayer in the activity to conclude this was a trade or business.

IRS Safe Harbor

For purposes of the QBI deduction, the IRS has created a safe harbor that can be relied upon until a final revenue procedure is issued. The safe harbor applies to a “rental real estate enterprise.” This is an interest in real property held for the production of rents. It may consist of an interest in multiple properties. A taxpayer must either treat each property held for the production of rents as a separate enterprise or treat all similar properties held for the production of rents as a single enterprise. Commercial and residential real estate cannot be part of the same enterprise. A taxpayer may not vary this treatment from year-to-year unless there has been a significant change in facts and circumstances.

If the safe harbor is met, then the rental real estate enterprise is treated as a trade or business for purposes of the QBI deduction. Under the safe harbor, all of the following conditions must be met:

(1) Separate books and records are maintained to reflect income and expenses for each rental real estate enterprise;

(2) For taxable years beginning prior to Jan. 1, 2023, 250 or more hours of rental services are performed per year with respect to the rental enterprise. For taxable years beginning after Dec. 31, 2022, in any three of the five consecutive taxable years that end with the taxable year (or in each year for an enterprise held for less than five years), 250 or more hours of rental services are performed per year with respect to the rental real estate enterprise; and

(3) The taxpayer maintains contemporaneous records beginning after Dec. 31, 2018, including time reports, logs, or similar documents, regarding the following: (1) hours of all services performed; (2) description of all services performed; (3) dates on which such services were performed; and (4) who performed the services. Such records are to be made available for inspection at the request of the IRS.

Rental services include advertising to rent or lease the real estate; negotiating and executing leases; verifying information contained in prospective tenant applications; collecting rents; daily operation, maintenance, and repair of the property; management of the real estate; purchasing materials; and supervising employees and independent contractors. Rental services do not include financial or investment management activities (such as arranging financing; procuring property; studying and reviewing financial statements or reports on operations; planning, managing, or constructing long-term capital improvements) or the hours spent traveling to and from the real estate.

Owners need not perform the rental services personally. They can be performed by the owner’s employees or independent contractors; their services count toward the owner’s hours.

Certain types of rental real estate arrangements are excluded from the definition of a real estate enterprise. These are any rentals of a taxpayer’s home during the year (Code §280A) and any real estate rented or leased under a triple net lease. This arrangement calls for the tenant or lessee to pay taxes, fees, and insurance, and to be responsible for maintenance activities of a property in addition to rent and utilities.

Using the Safe Harbor

A taxpayer relying on this safe harbor must attach a statement to his or her income tax return on which the QBI deduction is claimed. The statement must be signed under penalty of perjury by the taxpayer or an authorized representative.

The failure to meet the safe harbor does not conclusively mean that real estate activities won’t qualify for the QBI deduction. A taxpayer is permitted to establish that the real estate activities amount to a trade or business by relying on case law and prior IRS guidance. Again, as mentioned earlier, the courts have made it clear that the skills and endeavors of the taxpayer are critical to a finding of the activity being a trade or business as opposed to a mere investment.

Related Matter

The IRS instructs taxpayers treating a rental real estate activity as a trade or business to be consistent. For example, they must comply with Form 1099 information reporting requirements (Code §6041) (T.D. not yet announced, Jan. 18, 2019). For example, such taxpayers paying independent contractors $600 or more during the year must issue them Form 1099-MISC. Real estate held for investment is excluded from this requirement (payments beginning in 2012 were to be subject to information reporting but this requirement was repealed by the Comprehensive 1099 Taxpayer Protection and Repayment of Exchange Subsidy Overpayments Act of 2011 before it ever took effect). Taxpayers who fail to issue Form 1099-MISC may be demonstrating that they are not in a trade or business.


There is no separate form or schedule for figuring the QBI deduction. Use a worksheet in the instructions to Form 1040 if taxable income does not exceed $157,500 if single or $315,000 on a joint return. Otherwise, figure the deduction using a worksheet in IRS Publication 535.

Sidney Kess, CPA-attorney, is of counsel at Kostelanetz & Fink and senior consultant to Citrin Cooperman & Company.