Rentals as Trade or Business for the 199A Deduction

Posted by Lee Reams Sr., BSME, EA on

One of the most difficult tasks tax practitioners are facing this tax season is the determination of whether their clients’ rentals rise to the level of trade or business for purposes of the Sec 199A deduction. 

The final regulation (§1.199A-1(b)(14)) defines a trade or business as being the same as a trade or business under Code Sec. 162. However, Code Sec. 162 is based on a myriad of court cases and IRS rulings that require the tax preparer to make a subjective determination which can be challenged by the Service. The catch-22 here is that IRS can determine a rental is a trade or business under Sec 162 even if it did not meet the safe harbor of Notice 2019-07. (You’ll notice in the court cases we’ve cited that the IRS will sometimes argue that a rental is a trade or business, and in other cases will take the position that a rental is not a trade or business.) With regard to the Sec 199A deduction, a rental activity with a net profit benefits the taxpayer if it is a trade or business, but if the rental has a net loss it is a disadvantage since a net loss will offset any net profit from other business activities. You can’t arbitrarily make those decisions to help a client; the decisions have to be based on facts and circumstances.

We see two problems here facing tax practitioners:

  • Explaining this very difficult determination to their client so the client (a) understands the determination is subjective, and can be challenged by the IRS, and (b) joins in the decision. To that end we have developed a client letterwhich will automatically download in a Word format and can be used as is or modified. 

  • Understanding the numerous tax court cases and how they might tie into their client’s particular circumstances. For that we have developed a checklist of facts and circumstances that will help a practitioner determine if a rental is a trade or business under Sec 162 and have tied those facts and circumstance to particular court cases in a summary of court cases and other guidance that we have developed. The summary includes over 25 court cases related to rentals as trade or business.

Practitioners are free to download and use these materials in their practices. We hope they make tax season a little less stressful.