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How to Determine if Your Rental Property Qualifies for the Business Income Deduction

If you own a rental property an of your most important tax questions to answer is a rental property qualified business income. If it is qualify, you could qualify for a significant tax deduction, which can increase your profits. However, qualifying isn’t automatic–it is contingent upon meeting specific IRS criteria.

Let’s look at what the IRS looks for when determining whether rental activity is a business for the purposes of QBI.

Understanding QBI in a Rental Context

Qualified Business Income refers the income that is earned through a trade or business operated as a pass-through organization. Although rental properties are traditionally classified as passive income, the IRS permits certain rental activity to be considered qualified if they meet the standard of a trade or business.

The IRS Business Test: Are You Operating Like a Business?

In order to be eligible for the QBI deduction the rental activity must be carried out with consistency regularity, consistency, and a profit purpose. The IRS takes into consideration a number of aspects when determining if your rental qualifies as an enterprise:

Active Management

You should be involved in managing the property, making decisions on repair, interactions with tenants as well as lease compliance.

Recordkeeping

Keeping books and financial records, tracking expenses, and controlling income is a an active business.

Operational Structure

The presence of systems for business including regular maintenance programs, tenants onboarding, and use of service providers, supports business classification.

Use of the Safe Harbor Rule

The IRS has created a safe harbor rule to clarify the meaning of the term. If your rental enterprise:

Maintains separate records and books and

Provides 250 hours or more of rental services annually, and

Keeps track of dates, hours, and activities,

…then it is generally treated as an enterprise in the eyes of QBI reasons.

This safe harbor applies to every business individually or in a group if similar properties are put together.

What Activities Count as Rental Services?

Services for renting under the Safe Harbor rule comprise:

Advertising and tenant screening

Renewals and lease negotiation

Repairs and maintenance to the property

Rent collection and bookkeeping

Coordination with Service professionals

Even if you hire others to help, these hours are still counted. Just make sure that the services are related to the rental.

Common Situations That Qualify

Owning multiple properties and managing them actively

Short-term rentals that have regular turnover of the tenant

Long-term rental with ongoing improvements and management involvement

Conclusion

If the rental income you earn is eligible to be eligible for the QBI deduction is contingent upon how you run your operation. By knowing the IRS standards–and especially the safe harbor rules, you can set your rental business in a way that it meets the threshold for business. If you do it correctly it can result in substantial tax savings year after year.