The IRS and Treasury Department issued the final QBI deduction regs (regulations) on Jan. 18, 2019. This is the first tax year that taxpayers can claim this deduction because it was created with the Tax Cuts and Jobs Act (TCJA).
Many eligible taxpayers and tax professionals were waiting for the IRS to clarify some lingering questions. Here are key points in the final QBI deduction regs that either supported, updated, or changed items in the proposed regulations.
Pay attention. These might impact your deduction.
Real estate & safe harbor
A key part of the QBI deduction – or Section 199A deduction – is the definition of a qualified trade or business. This classification impacts whether you’re able to claim the deduction and your deduction limit.
Many people questioned whether rental real estate activities qualified as a trade or business. In the final regulations, the IRS didn’t provide direct rules on how to determine if your rental real estate is a qualified trade or business.
However, they did say it’s up to you and your tax practitioner to make this decision based on facts and circumstances.
The IRS did establish a safe harbor which may help rental real estate businesses determine if they’re eligible for the deduction.
If your rental meets the requirements of the safe harbor, it’s treated as a trade or business for this deduction. If you don’t meet the conditions of this safe harbor, it doesn’t necessarily mean that you can’t claim the QBI deduction.
Keep in mind, you or disregarded LLCs must own the rental properties in order to meet these safe harbor requirements.
Here are the three requirements:
1. At least 250 hours of services are performed each taxable year with respect to the enterprise
- Services include services performed by owners, employees, and independent contractors. It also includes time spent on maintenance, repairs, collecting rent, paying expenses, providing services to tenants, and efforts to rent the property.
- Any hours spent by someone acting as an investor or doing investment-related activities don’t count toward the 250 hours.
2. You must maintain separate books, records, and bank accounts for the rental real estate enterprise(s).
3. If you lease property under a triple net lease or use the property as your own residence for any part of the year, it isn’t eligible for the safe harbor.
- A triple net lease is a lease agreement where the tenant is responsible for the property’s expenses. Expenses can be property taxes, insurance, and maintenance.
The IRS decided that architecture and engineering services aren’t consulting services.
If you provide these services and they meet the definition of consulting services, it isn’t a specified service trade or business (SSTB).
It’s a qualified trade or business which influences your final deduction amount, ability to aggregate, and more.
If you want to aggregate – or combine – your businesses for this deduction, you must meet two of three factors. These factors are:
1. The businesses provide products and services that are the same or are usually provided together
Examples: Restaurant & food truck or gas station & car wash
2. The businesses share facilities or significant centralized business elements
Examples: Common personnel, accounting, legal, manufacturing, purchasing, human resources, or IT resources
3. The businesses are operated in coordination with each other or rely on other businesses in the aggregated group
Example: Supply chain
Aggregating is optional. Choosing to aggregate some, all, or none of your businesses doesn’t prevent you from claiming this deduction on any businesses that qualify for the deduction overall.
There are a couple of additional items to note if you pursue aggregating.
You can’t aggregate a SSTB.
The same person or group of people – directly or by attribution – must own 50% or more of each trade or business. You have to maintain at least 50% of ownership for the majority of the taxable year.
This includes the last day of the taxable year. A C corporation can be part of this group.
For the 2018 tax year, you can make your initial aggregations on amended returns. You can only do this for the 2018 tax year.
In addition, the IRS requires you to report all items that can be attributed to each of the aggregated trades or businesses on returns for the same taxable year. This is especially helpful when you apply the W-2 wage and UBIA of qualified property limitations.
If you aggregate, you must consistently report it. If you don’t aggregate right away, you can still do it in future years. But, you can’t amend returns in past years when you didn’t aggregate.
You must continue to aggregate for each taxable year. Unless you experience a material change in circumstances that would trigger a change to your aggregation.
Does your business fall into the rental real estate category? Review the IRS’ rulings above to help you decide if you can aggregate your businesses.
The IRS also allows a relevant pass-through entity (RPE) to aggregate trades or businesses that it operates directly, or through lower-tier RPEs. Then, the RPE and all its owners must report the final aggregation.
Also, an individual or upper-tier RPE can’t separate a lower-tier RPE’s aggregation. It must maintain its aggregation.
If you lease or license an associated rental or intangible property, you can aggregate if the law is met. You must rent or license the property to a trade or business that’s conducted by an individual or RPE and is commonly controlled.
And, the property must be treated as a trade or business for this deduction. This applies mostly to self-rentals.
Exchanges & UBIA
Part of the QBI deduction involves calculating your qualified property limitation. When property is exchanged, you need to know the value to correctly calculate your limitation.
Your unadjusted basis immediately after acquisition (UBIA) starts with the original acquisition cost of the exchanged property. Then you add the cash you paid for the property or subtract the cash you received in the exchange.
Generally, Section 743(b) states that you shouldn’t adjust the basis of partnership property as a result of a partnership interest transfer.
In the framework of the QBI deduction, partner-to-partner adjustments are treated as qualified property. Therefore, you should include them when calculating your deduction limitations.
Now, they’re only considered property to the extent that the basis adjustment reflects an increase in the fair market value of the underlying qualified property. Any Section 734(b) adjustments still don’t qualify for UBIA.
Again, these are key items to know for your 2018 return. Maybe you’d like to extend your tax returns to give yourself time to figure out how to maximize this deduction. Or to decide if it’s beneficial to aggregate your businesses.
This is an intricate element of the TCJA. Make sure you have the support and resources you need to make this deduction work for you.
Have questions about the QBI deduction regs? Let’s talk!