QBI & Rental Properties

[BrentonD]

Taxpayer is fully employed in a non-real estate occupation. He also owns three rentals/condos, in which he collects the rents, hires repairmen, etc. (he is the property manager). He doesn't qualify for the 250 hour safe harbor. The rentals return a profit each year. Don’t his rentals qualify as a sec 162 trade or business for QBI purposes? He regularly and continuously manages the properties, and they return a profit.

[taxed2max]

My question too.  Same scenario, he also keeps separate records in Quicken, etc.  Issues 1099s to all vendors when required.  Also new idea, since managing these condos which have HOA assessments, are we allowed to drill down to the HOA dues and carve out wages, time, and assets that are utilized by the HOA managers on the landlord's behalf?  With no bright line test, only facts and circumstances if not meeting the safe harbor 250 hours, do we have any guidance for the mom and pop landlords?

[G4Trax]

The safe harbor election is just one of the multitude of items that goes into determining whether being a landlord qualifies for 199A. Your description would seem to indicate a leaning toward claiming the deduction. Does the taxpayer issue 1099's to the repairmen? Just one more notch in the measuring stick to see if they qualify. 

[G4Trax]

Nothing specific for the Mom & Pop. I think you state good points, but drilling down to ferret out assets and hours - is that really going to be productive and I really doubt that ownership exists for the common area and neither mom or pop filed a payroll return, so I think that is WAY TO BIG A STRETCH. We can only wait for guidance to see if you are right. 

[itonewbie]

To me, it's hard to imagine how these rental properties would rise to the level of §162 trade or business if your client cannot even clock in 250 hours of rental services collectively for three properties, even when these include services provided by various third parties.

You may, therefore, like to re-examine the facts and determine whether your client may qualify under the safe harbor going forward.

[taxed2max]

Thanks George for the thoughts.  Do not know how productive this drilling down would be, but condos have deeded interests in common areas and the HOA is usually hired by the board which is elected/controlled by the owners.  And usually one of the biggest expense items in their budgets is for reserves to replace all the expensive fixed assets.  But I don't know how available this info might be... just stretching here.

[Intuit_Devin]

Every tax preparer wishes there was a clear answer to this, but unfortunately there just isn't.

The 250 hour safe harbor is a bar that means an activity is automatically a trade or business, but failing to meet this safe harbor doesn't mean this is NOT a t/b. Case law has numerous well known cases where very low level rental activity was held to be a t/b. (E.g. Hazard v Commissioner, 7 TC 372 (1946), or Lagriede v Comm’r, 23 TC 508 (1954)). Ultimately you have to use your judgment as a preparer and look at the facts and circumstances of your case compared to settled case law.

That said, one excellent bright line test is whether these activities have made a practice of issuing Form 1099-MISC forms to any service providers. The IRS requires consistency in treatment of an activity as a business for all relevant portions of the tax code. If they've been issuing Form 1099-MISC, then that's indicative of a business, and it would seem consistent to continue to treat such an activity as a business for purposes of the QBI deduction. If these activities haven't been issuing Form 1099-MISC, then that would suggest that up to this point that the owner has not viewed them as business activities subject to the Form 1099-MISC requirement for businesses. To suddenly change positions now that there's a benefit to being a business would certainly seem like a weak position to take.

[NinjaCPA]

The 250 hour safe harbor test is for 199A?

If the operation is a business, would the net earnings be subject to self-employment tax?

[TaxMonkey]

Rental income from real property is specifically exclude for SE tax under IRC 1402.

[itonewbie]

Rental income is inherently passive from a trade or business with or without the safe harbor, except it does not automatically rise to the level of §162 trade or business unless it meets the common law facts and circumstances tests.  If a taxpayer elects to use safe harbor, it "will be treated as a trade or business solely for purposes of section 199A and its regulations."  It does not make the rental enterprise a §162 trade or business.

The issuance of 1099-MISC is not a bright-line test although it might demonstrate a taxpayer's intention to manage the activity as a trade or business.  If other facts and circumstances are not supportive of the claim the activity rose to the level of §162 trade or business, it may still be deemed form over substantance.

[Intuit_Devin]

To clarify what I meant by bright-line test. I used the term "bright-line" test to mean it's a test for which either a taxpayer clearly meets a requirement, or they do not. In the case of issuing Form 1099-MISC, either a taxpayer has issued Form 1099-MISC, or they have not. There's not really a middle ground. (I suppose if they issue 1099s some years but not others...but at least on a year by year basis, either they've issued them or they didn't.) This is distinct from a test like "carried on with regularity", for which there is considerable ambiguity. So in the sense I intended it, the test of whether or not an activity issued 1099s is a bright line test.

I did not intend to say that issuing 1099s in and of itself is determinative in whether or not an activity is a trade or business.

Just wanted to clarify since it sounds like at least one person misunderstood my use of the term "bright line test".

[Stephen L Nelson CPA]

I disagree with this.

Look at Revenue Ruling 77-356, for example. IRS said a member of Congress who earned $1500 by making ten speeches over a year runs a trade or business.

How could a small landlord not in many situations show similar continuity, regularity and then the profit motive thing should easy.

[Stephen L Nelson CPA · Accepted solution]

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@Intuit_Devin wrote:

Case law has numerous well known cases where very low level rental activity was held to be a t/b. (E.g. Hazard v Commissioner, 7 TC 372 (1946), or Lagriede v Comm’r, 23 TC 508 (1954)). Ultimately you have to use your judgment as a preparer and look at the facts and circumstances of your case compared to settled case law.

Exactly!

I tried to summarize some key cases in blog post below... and then reframe those cases as "real estate" businesses.

https://evergreensmallbusiness.com/section-199a-rental-property-trade-or-business-definition/

BTW, it's also going to be true in many cases that someone makes money in real estate and they aren't rising to level of Section 162.

P.S. Agree with others on the 1099 thing. If you're in a trade or business, you're issuing 1099s...