Category: Year End Compliance
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Due to new laws and regulations, there are additional requirements to obtain the most favorable tax treatment for rental property. Since the passage of the 2017 Tax Act, a rental property must rise to the level of being a trade or a business to be eligible for the tax benefit of Qualified Business Income (QBI). The QBI rules allow a deduction from taxable income of up to 20% of the net income of the rental property. Because neither the IRS Code nor Regulations define a trade or a business, the IRS has provided for two methods to help determine the rental property’s trade or business status. These methods are the Safe Harbor Method and the Alternative Facts and Circumstances Method. Although the requirements to meet trade or business status under the Safe Harbor Method are stringent and may be difficult to meet, the IRS does not specifically mention filing Forms 1099-NEC or 1099-Misc. The form and function of the Alternative Facts and Circumstances Method are important to demonstrate that the rental is being operated as a trade or business. This includes filing all tax information forms, such as Forms 1099-NEC and 1099-Misc.
The Safe Harbor Method for rental real estate to be treated as a trade or business
The IRS issued guidance in 2019, which offers a safe harbor (determined annually) for rental real estate to be treated as a trade or business for purposes of the 20% QBI deduction. Although the requirements to meet the safe harbor may be difficult to follow, they do not specifically require the filing of Forms 1099-NEC or 1099-MISC. However, the following requirements must be met.
Qualifying Rental Services do count towards the 250-hour requirement. Such services may be performed by owners, employees, independent contractors, or agents, and include but are not limited to: advertising to rent the real estate; negotiating and executing leases; verifying tenant applications; collecting rent; operating, maintaining, and repairing the property; managing the real estate; purchasing materials; and supervising employees or independent contractors.
Non-Qualifying Rental Services do not count towards the 250-hour requirement. Non-qualified services include: arranging financing; procuring property, reviewing financial statements or operational reports; planning, managing, or constructing long-term improvements; or hours spent traveling to and from the real estate. There are certain other limitations, as well.
The Alternative Facts and Circumstances Method for rental real estate to be treated as a trade or business
You may not be able or willing to do everything necessary to qualify for the Safe Harbor Method. This means that rental real estate would have to qualify for trade or business status based on the Alternative Facts and Circumstances Method. This method is difficult because of its vagueness due to the fact there is virtually no IRS guidance on what qualifies as facts and circumstances. However, the IRS has indicated one factor they will consider. In its final regulations on the 20% QBI deduction, the IRS said, “taxpayers should consider the appropriateness of treating a rental activity as a trade or business…where the taxpayer does not comply with the information return filing requirements.” In other words, if you plan to claim the real estate rental as a trade or business, all required Forms 1099 (information returns) should be filed. Form 1099-NEC and 1099-Misc are two of the Forms in the 1099 information group.