Understanding Whether Real Estate Qualifies as a Trade or Business

Establishing whether real estate activities qualify as trade or businesses is of critical importance when filing taxes under the Tax Cuts and Jobs Act (TCJA), particularly regarding its Qualified Business Income deduction (QBI). In this article we investigate what criteria exist that qualify real estate as being classified as qualified trades or businesses.

Definition of Qualified Trade or Business Under the Tax Cuts and Job Act (TCJA), Section 199A of the Internal Revenue Code (IRC) allows a 20% deduction on qualified business income (QBI) earned domestically through sole proprietorship, partnership, S corporation trusts or estates operating domestic businesses in any form; to qualify real estate must meet Section 162's definition as well.

Section 162 defines "trade or business" as any activity conducted continuously and regularly with the intent to generate income or profit for its principal goal, with this definition including many real estate activities that qualify, provided they are substantial, continuous and regular in nature. This definition could potentially encompass most activities conducted related to property management as a trade or business activity.

Criteria for Real Estate Activities

In determining whether real estate activities constitute trade or business activities, several criteria are taken into consideration to ascertain whether real estate activities qualify. These factors are as follows:

Constancy and Regularity: Your rental/real estate management activity must remain continuous over time and regularity should be involved. Engaging regularly in rental management or real estate activities must become your core activity.

Goal of Generating Income or Profit: The primary aim of any activity should be to generate revenue or profit; any activities engaging in hobbies should not count.

Material Participation: Active involvement in managing, operating and administering your rental property is of utmost importance - such as advertising the rental home to tenants or keeping up the property itself. This could involve advertising costs for advertising campaigns as well as maintaining it and engaging in conversations with them directly.

IRS Safe Harbor for Rental Real Estate

In order to provide greater clarity, the Internal Revenue Service released Revenue Procedure 2019–38 outlining a safe harbor under which rental real estate enterprises could qualify as trade or businesses under Section 199A. In order to be considered under this safe harbor, certain criteria must be fulfilled to qualify. These conditions must include:

Maintain Separate Books and Records: Create separate records to accurately account for income and expenses associated with each rental real estate venture.

250-Hour Requirement: Rental real estate enterprises that have been operating for less than four years must perform at least 250 hours of rental services annually; those operating for at least four years should perform this amount across any three consecutive tax years ending with this year's tax year.

Cotemporaneous Records: Keep contemporaneous records such as time reports, logs or similar documents which outline all services performed including hours worked per service performed; description; dates performed on; who conducted these services and their providers; etc.

Safe Harbor Statement: For tax returns that claim the QBI deduction, attaching a statement confirming compliance with all safe harbor requirements will assist the Internal Revenue Service in processing.

Activities That Will Qualify for Property Management: Actively managing rental properties, from tenant acquisition and property upkeep, typically qualify.

Development and Construction: Real estate development and construction activities typically qualify as trades or businesses due to their on-going nature.

Real Estate Brokerage Services: Real estate brokerage services often meet criteria due to their active involvement and continuity requirements.

Triple Net Leases: Rental activities that utilize triple net leases - where tenants pay taxes, insurance and maintenance directly - typically do not meet this definition because of the limited activity level by landlords in this form of renting property.

Self-Rental: Rental properties that are rented to businesses wherein their owner materially participates can qualify as trade or businesses if active involvement by that owner in operations can be proven.

Conclusion

Is real estate a qualified trade or business? Real estate can qualify as an approved trade or business under IRS safe harbor provisions if it meets all three of its criteria - continuity, regularity and profit motive; as well as adhering to any regulations regarding tax matters or safe harbor provisions that might exist. Business owners should maintain detailed records to prove this qualification while consulting tax professionals to stay compliant.

Referring to IRS guidelines and consulting a qualified tax advisor can give more detailed guidance for real estate professionals looking for further guidance. By understanding and meeting these criteria, they can maximize the benefits of QBI deduction to optimize their tax positions and take full advantage of it.

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