The Qualified Business Income Deduction (“QBID” which is also called “Section 199A deduction”) was created in the Tax Cuts and Jobs Act (TCJA) and it allows many owners of pass-through to deduct up to 20 percent of the qualified business income from their taxable income. QBID is generally available to most taxpayers with pass-through business income whose 2018 taxable income was at or below $315,000 for joint returns and $157,500 for other filers and these income thresholds are adjusted annually. Taxpayers with incomes above these annually adjusted levels may still be eligible for the deduction, but the deduction may be subject to limitations based on the type of trade or business, the amount of W-2 wages paid in the trade or business, and the unadjusted basis immediately after acquisition of qualified property. See Qualified Business Income Deduction – Overview for additional information.
To claim the Section 199A deduction on rental real estate the activity must be deemed to be a trade or business. This indicates that some rental activity such as activities engaged in by a real estate professional (as that term is defined under the passive activity rules in Publication 925) qualify for the deduction and the tax program will treat the income or loss on rental property held by a real estate professional as being eligible for the QBID. However, certain real estate activity held by passive investors would not qualify if they cannot meet the criteria of a trade or business.
The IRS issued a proposed revenue procedure, Notice 2019-07, that was in effect for 2018 tax returns and it provided a safe harbor under which a rental real estate enterprise would be treated as a trade or business solely for purposes of the section 199A deduction. This safe harbor provision was finalized by the IRS in Revenue Procedure 2019-38 which is in effect for tax years starting in 2019. The procedure for treating a rental real estate enterprise as a trade or business under this safe harbor requires the following:
First, the taxpayer must maintain separate books and records that reflect the income and expenses for each rental real estate enterprise. Solely for this safe harbor, a rental real estate enterprise is defined as an interest in real property held to produce rent and it may consist of an interest in a single property or multiple properties. The taxpayer may treat each rental property that it holds as a separate rental real estate enterprise or the taxpayer may treat all their real property as a single rental real estate enterprise for Section 199A deduction purposes. However, commercial and residential real estate may not be part of the same rental real estate enterprise. Once the taxpayer makes this determination regarding the treatment of the rental property, they cannot change it from year to year unless they can demonstrate a significant change in facts and circumstances.
Second, starting with the 2018 tax year, 250 hours of rental services must be performed with respect to the rental real estate enterprise. Rental services can be performed by the taxpayer or by others hired by the taxpayer. For the purpose of this safe harbor, rental services will consist of (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) purchase of materials; and (viii) supervision of employees and independent contractors.
Third, starting with the 2020 tax year, the taxpayer will be required to maintain contemporaneous records, including time reports, logs, or similar documents, regarding the following: (i) hours of all services performed; (ii) description of all services performed; (iii) dates on which such services were performed; and (iv) who performed the services. In future years, the IRS may request these records, but for the 2018 and 2019 tax years this provision is not in effect. When the IRS first created the safe harbor with Notice 2019-07, this contemporaneous record requirement was to commence in 2019, but it was delayed to tax years starting after 2019 with the final revenue procedure.
Finally, to utilize this safe harbor the taxpayer must attach a PDF statement to the tax return signed by the taxpayer(s) that states that “Under penalties of perjury, I (we) declare that I (we) have examined the statement, and, to the best of my (our) knowledge and belief, the statement contains all the relevant facts relating to the revenue procedure, and such facts are true, correct, and complete.”
To elect the Safe Harbor and attach it to the tax return in the tax program, from the Main Menu of the Tax Return (Form 1040) select:
- Income Menu
- Rents, Royalties, Entities (Sch E, K-1, 4835, 8582)
- Rents and Royalties
- Select New
- Enter all the information on the Schedule E Rental Property Information Menu. At the bottom of this entry menu, the Safe Harbor Option is available for the user when they select if the property Qualifies for QBI.
Once the Safe Harbor option is selected, the actual Safe Harbor Election can be found and printed for signature from the Main Menu of the Tax Return (Form 1040) by selecting:
- View Results
- Schedule E Elections
Once the Safe Harbor Election is signed by the taxpayer(s), this notice must be scanned and attached to the tax return as a PDF document. To attach the signed PDF copy of the notice to the tax return, from the Main Menu of the Tax Return (Form 1040) select:
- Income Menu
- Rents, Royalties, Entities (Sch E, K-1, 4835, 8582)
- Attach PDF Document for Rental Safe Harbor Elections
- Select New and attach the PDF copy of the notice after it is signed by the taxpayer(s) and scanned.
NOTE: This is a guide on entering the Qualified Business Income Deduction for Rental Property and Electing the Safe Harbor under Revenue Procedure 2019-38 into the Keystone Tax Solutions Pro program. This is not intended as tax advice.
Additional Resources
For tax returns filed for 2018
Notice 2019-07 – Section 199A Trade or Business Safe Harbor: Rental Real Estate
For tax returns filed for 2019 and beyond
Revenue Procedure 2019-38 – 26 CFR.1.199A-1: Trade or Business