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August 28, 2018 | Posted in:

Self-Rental and the New QBI Deduction

What is Self-Rental?

Self-Rental is a term that describes the activity when a taxpayer rents property to his or her own business.  This is a very common practice.  For instance, a group of doctors may organize as a partnership and purchase an office suite.  This real estate partnership becomes the landlord, and the tenant is the doctors’ medical practice, a separate legal entity.

Why is Self-Rental Different from Other Business Activity?

Because owning and renting out real estate is typically a passive activity, taxpayers who have other sources of passive loss may try to artificially inflate the income of the self-rental in order to use the unrelated losses.  Without any passive income, passive losses are suspended until there is income or until the entity producing the losses is sold.  Since a taxpayer engaging in self-rental has control over the amount of the rent he charges, he could have his business pay very high rent in order to make the real estate entity profitable.  The possibility of this manipulation gave rise to special rules that say self-rental is treated as passive if there is a loss, but it is treated as active if there is a gain.

How Does the New QBI Deduction Work for Self-Rental?

The new Qualified Business Income (QBI) deduction created by the Tax Cuts and Jobs Act allows the owner of a business to deduct 20% of the qualified income from his taxable income as long as the business is not a C corporation.  There are many limitations and rules, of course.  One of the most important limitations is on total taxable income.  If a taxpayer’s taxable income is below the lower threshold (which is $315,000 for a married taxpayer filing a joint return), he is eligible for the deduction with a few exceptions.  One common question is whether or not a rental real estate activity qualifies as a trade or business.  The proposed regulations, which the IRS just released, clarify this.  If a rental activity rents or licenses tangible or intangible property to a commonly controlled business, then it qualifies as a trade or business for purposes of the QBI deduction.  Businesses are commonly controlled if the same person or group of people owns at least 50% of each entity.

What About Self-Rental if the Operating Business is a Service Business?

One of the limitations for the QBI deduction is for specified service businesses.  These are business in fields like health, law, consulting, and financial services.  Owners of these types of businesses are eligible for the QBI deduction if their taxable income is below the lower threshold ($315,000 for joint returns), but they don’t get a deduction at all if their income is above the upper threshold ($415,000 for joint returns).  The deduction is phased out if the taxable income is between the lower and upper thresholds.  The new regulations stipulate that if 80% or more of any businesses’ property or services are provided to a specified service business, then that business is part of the specified service business.  If we go back to our original example, the doctors will NOT be eligible for a QBI deduction for the rental income since it is deemed to be a part of the medical practice unless their taxable income is below the upper threshold.

 

The new tax law, and particularly the QBI deduction, contains many complex rules and limitations.  If you think any of these provisions may apply to you, contact our office to discuss your particular situation.

Author:

Associate Partner
 
Julie has over 20 years of experience in public and private accounting, representing varied clientele including the medical, legal, and real estate industries and trusts.
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