Rentals & Section 199A Qualified Business Income Deduction – Unanswered Questions?

Posted by Lee Reams Sr. on

Neither the statute nor the committee reports directly addresses whether a rental is trade or business in the context of Section 199A.

Whether or not rental real estate constitutes a trade or business for other provisions of the Code has been the subject of much judicial concern. The significant majority of these decisions ruled in favor of trade of business.

As early as 1946 the tax court ruled that even one single family residential rental was a trade or business (Hazard v. Comm.’r, 7 T.C. 372 (1946)), with the IRS acquiescing to the decision in 1946-2 CB 3, an acquiescence which still stands. See GCM 38779 (7/27/81) in which Chief Counsels Office refused to revoke its acquiescence to Hazard. Hazard remains the authority for the Tax Court in every area of the country except in the 2nd Circuit where the court of appeals in Grier v. U.S., 218 F.2d 603 (2nd Cir. 1955) which held, contrary to Hazard that more “activity” (“broader activity”) was needed for a rental to constitute a trade or business.

With Treasury and the IRS writing regulations under section 199A it seems reasonable to expect that the IRS would have to follow Hazard and Chief Counsel’s clear position. To exclude rental real estate form section 199A would seem to require a technical correction or clarification.

Even more support for including rental real estate in section 199A can be harvested from the Committee Reports and the content of section 199A itself:

  • Qualified Property Limitation – Congress, at the last minute, added the 2.5% of unadjusted basis limitation to the 199A calculation, which appears to have been added to apply primarily rental income since landlords would be to chief beneficiary of this limitation.  
  • Material Participation – Some professionals take the position that rentals rise to the level of a trade or business if the landlord meets the material participation rules. While this is true for section 469 passive loss rules there is no compelling reason to invoke a passive/active criteria under section 199A.   
  • REIT’s & Publically Traded Partnerships – Both REITs and publically traded partnerships deal with real estate rentals and they qualify for the Sec 199A deduction. So why would Congress allow rental real estate to be included if held as a REIT of by a Publically traded partnership if they were not to be included if the property was vested in the individual taxpayer.  

Therefore the preponderance of evidence leans heavily in favor or Schedule E rental activities qualifying for the Sec 199B deduction. If rental income is QBI then here are some issues to consider:

Example – Taxpayer has two rentals.  Rental A shows a profit of $10,000 and rental B shows a loss of $4,000.  The QBI for these rentals would be $6,000 ($10,000 less the $4,000 loss).

Example – Same as above, but the taxpayer has a passive loss carryover of $20,000. The $6,000 combined profit from the two rentals would trigger $6,000 of passive loss carryover to offset the $6,000 and the QBI in this scenario would be zero.