One of the new tax laws that went into effect in tax year 2018 is that if you own a pass-through businss (i.e. anything but a C-corporation), you will receive a deduction of up to 20% on all “Qualified Business Income.”
The new tax laws were passed in a hurry and in a mess, and therefore we all were left wondering just what businesses and sources of income truly qualify. On January 18, 2019, the U.S. Treasury and the IRS published new regulations and guidance to hopefully let business people make it through tax season with their sanity intact.
The official IRS notice is published here. One of the pieces of good news is that if you own real estate that you rent out, you can classify your rental income as QBI if you meet certain conditions. This rule, according to the IRS, isn’t exactly final-final, but the government is giving you a safe harbor pending their permanent decision.
Tony Nitti has a very helpful article in Forbes that translates many of the new rules into plain English. As Nitti writes, “This safe harbor is great news for a number of rentals. But there are some activities that get shut out; first, a taxpayer can't use the safe harbor for the rental of any residence that the taxpayer uses as a personal residence for more than 14 days during the year. So if you rent your beach house out for three weeks a year but live in it for four weeks, the safe harbor is unavailable to you.”
It is important to note that income from triple net leases is excluded from QBI. Triple net leases are most commonly seen in commercial real estate rentals. In such a lease agreement, the tenant takes on all responsibility to insure the property, pay the real estate taxes, and do all the maintenance. As Nitti explains, “In those situations, because the building owner bears little of the responsibility of operating the building, the IRS has viewed the ownership of real estate rented on a triple-net basis as akin to holding stock,and it has treated the property as an investment rather than a Section 162 trade or business.”
Everyone will notice differences when doing their IRS returns for tax year 2018. The 1040 forms have changed their look; exemptions are gone; and standard deduction amounts have gone way up while many expenses that used to be deductible are no longer allowed. There is potential for a lot of confusion, but among the most confused will probably be business owners trying to determine whether or not their income is QBI. Had you asked an accountant prior to January 18, they would not have been able to tell you for sure either (if they were being honest). Fortunately, the federal government has managed to provide this new guidance, reasonably early in tax season, despite the hideous nature of the tax bill as it was passed and despite the horror of the recent government shutdown. Good luck!