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Do any of you have a reference for deducting 20% rental income as qualified business income ? I have a few clients having a number of rental properties but in reviewing the rules for them to deduct 20% of their rental income on the Form 1040 it looked to me as if the rules were strictly drawn but feel I ought to review them and see what if any modifications may have been made which might allow them this deduction.

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There's the safe harbor: if it works for your client, then he's presumed to be conducting a trade or business for his rental(s). Otherwise, does it rise to the level of a trade or business/does he treat it like a trade or business? Someone will have cites on the tip of their tongue (I'm in a webinar now).

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With respect to rentals being a trade or business there is no one specific cite.

There are some court cases, probably one of the most important going back to the early 1940s.

You need to do some online searches, there are a number of in depth analyses by various tax experts.

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Separate books and records must be maintained to reflect income and expenses for each rental real estate enterprise.

At least 250 or more hours of rental services must be performed by the taxpayer or other individuals (i.e., plumbers, landscapers, contractors, property managers) per year with respect to the rental enterprise. The activities that count towards the 250-hour requirement include landlord-related duties such as repairs and
maintenance, collecting rent, reviewing tenant applications, spending time with tenants, etc.

The taxpayer must maintain contemporaneous records of relevant items, including time reports, logs, or similar documents. This requirement applies to tax years beginning after December 31, 2018. Relevant items for recordkeeping include hours of all services performed, description of all services performed, dates on which such services were performed, and who performed the services.

This will basically disqualify the two guys I have in mind as they would never maintain these records. This is pretty much what I had expected. The record keeping requirements would likely kill their deduction as they would never comply.

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8 hours ago, Lion EA said:

There's the safe harbor: if it works for your client, then he's presumed to be conducting a trade or business for his rental(s). Otherwise, does it rise to the level of a trade or business/does he treat it like a trade or business? Someone will have cites on the tip of their tongue (I'm in a webinar now).

There are two safe harbors; the one being discussed and the De Minimus Safe Harbor, Sec 1-263a -1(f) election which allows a $2500 item that would normally be capitalized to be expensed.  As long as the object of the rental is to make a profit, it is considered a business.  

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One of the clients has four rentals the other eleven. Do they spend some 250 hrs. per year on these I have no idea and I am sure other than bills presented by repairmen and the like they do not keep what looks to me to be a formidable record keeping requirement. I simply have no wish to have one of them get an audit and be on the wrong end of understanding the requirement. I know a few real estate owners who take this deduction and feel sure they are unaware of the logging requirements. They are likely going out on a limb but it really comes down to how strictly the Service is able to enforce the above requirements. 

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7 hours ago, Max W said:

. . . . . .  As long as the object of the rental is to make a profit, it is considered a business.  

IMHO, based on the CPE seminars that I have attended and the lengthy tax expert articles that I have read,  the level of facts & circumstances needed for the ownership of rental to be considered a "trade or business" is higher than just intending to make a profit.

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7 minutes ago, Christian said:

One of the clients has four rentals the other eleven. Do they spend some 250 hrs. per year on these I have no idea and I am sure other than bills presented by repairmen and the like they do not keep what looks to me to be a formidable record keeping requirement. I simply have no wish to have one of them get an audit and be on the wrong end of understanding the requirement. I know a few real estate owners who take this deduction and feel sure they are unaware of the logging requirements. They are likely going out on a limb but it really comes down to how strictly the Service is able to enforce the above requirements. 

I have a client who has 2 commercial rentals and 6 residential rentals. For the past 2 years I have used the "Safe Harbor Rules" for the residential rentals.

The "Safe Harbor Rules" are restrictive since you cannot group commercial rental and residential rentals together. Also this client meets the 250 hours for the residential rentals,

but not for the commercial rentals which is annoying because the majority of the profits come from the 2 commercial rentals. I am going to sit down with this client to review

whether the "Trade or Business" approach would be a better way to go instead continuing to use the "Safe Harbor Rules". Frankly, I am not seriously concerned about the risk of audit.

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Christian, the logging requirements are for the Safe Harbor only. Take a webinar or more on rentals. Soon. This could be a great niche for you.

Just like keeping a mileage log, we have to educate our clients into keeping "books" and tracking time. Some tradesmen are getting onboard with listing their hours on their invoices; they've been doing it all along when billing hourly labor charges. Otherwise, train your client to ask and have vendor write it in on the invoice. Or, make his own note "2.5 hours per Joe via tel" on the invoice.

Keeping all his vendor receipts is a great start. Have him hand out W-9s (mail them now for 2020 services already provided) and prepare the Forms 1099-MISC for him in January. I'm sure he knows his rental income and has the deposits to prove it and his notes in whatever form to track who's late.Give him a green ledger sheet for each rental for each year for tracking income and expenses.

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Remember, a set of "books and records" does not mean they have to have an accounting program.   An excel spreadsheet is books and records.   The only thing I would advise if they are not doing it is to have a separate bank account for the rental activity.   And reconciling it every month adda hours to the time spent on the rental activity.

Tom
Modesto, CA

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I want to thank each of you who have replied. In all probability I could simply go ahead and make the deduction for them. In reading Lion's advice I recall reading the Service wanting rental owners to prepare Form 1099-Misc for payments to contractors etc. I have real difficulty in getting them off their butts at usually the END of tax season to get their figures in to prepare the returns ! The idea that I am going to EDUCATE them to prepare forms which they despise and keep time logs and the like would be a mind boggling task. One came in this year moaning and groaning about the five hours he had to spend organizing his matters and having him account for some 250 hrs spread out over the entire year good Lord !! Some time back I told him I did not have the time to sift through coffee stained, ink deficient, and crumpled up receipts and if he was unable to bring me listed costs for each property SEPARATEDLY indicated to carry it to H & R. Folks here can't even manage mileage logs very well. No I simply do not have the time to coach clients. I'll see if there is an available online seminar or webinar I can take but unless it simply involves accepting the fact these guys want to make money with their rentals without all these paperwork requirements I am not going to fool with it and everything I've read indicates the Service expects just that and not they they simply handle the rentals in a businesslike manner. 

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21 hours ago, cbslee said:

The "Safe Harbor Rules" are restrictive since you cannot group commercial rental and residential rentals together. Also this client meets the 250 hours for the residential rentals,

I thought I read an IRS notice last year that this was allowed for '19 and beyond?

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On ‎5‎/‎28‎/‎2020 at 5:33 PM, Christian said:

Separate books and records must be maintained to reflect income and expenses for each rental real estate enterprise.

At least 250 or more hours of rental services must be performed by the taxpayer or other individuals (i.e., plumbers, landscapers, contractors, property managers) per year with respect to the rental enterprise. The activities that count towards the 250-hour requirement include landlord-related duties such as repairs and
maintenance, collecting rent, reviewing tenant applications, spending time with tenants, etc.

The taxpayer must maintain contemporaneous records of relevant items, including time reports, logs, or similar documents. This requirement applies to tax years beginning after December 31, 2018. Relevant items for recordkeeping include hours of all services performed, description of all services performed, dates on which such services were performed, and who performed the services.

This will basically disqualify the two guys I have in mind as they would never maintain these records. This is pretty much what I had expected. The record keeping requirements would likely kill their deduction as they would never comply.

The safe harbor is a way to qualify, but not meeting the safe harbor does not disqualify. 

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I have an IRS webinar scheduled to address this when time is available. I can always file an amended return for either of them. The operative question then is if they do not meet the requirements for the safe harbor rules what Rita WOULD qualify them to use the deduction ?

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11 minutes ago, Christian said:

The operative question then is if they do not meet the requirements for the safe harbor rules what Rita WOULD qualify them to use the deduction ?

They would then have to rise to the level of a trade or business per section 162 as determined by case law.

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I have been listening to an IRS webinar and done some additional reading. The simple reality it's basically a judgement call. There are not a few variables that can effect it as well and frankly it will take up far too much of my time to examine them to produce the correct QBI. The fact that these guys would seemingly qualify under Sec.162 doesn't entirely cut it and on and on. What would at first appear pretty simple falls into a quagmire of sorts. Needless to say I simply don't have the time do fool with it.😖    

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One thing that eliminates QBI for commercial property is a Triple Net Lease.

Another thing that also eliminates it for both biz and residential is renting below FMV.  I think that that is more of an issue with residential, with people renting to children , or other relatives at discounted prices.

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"However, hours spent in the owner’s capacity as an investor, such as arranging financing, procuring property, reviewing financial statements or reports on operations, and traveling to and from the real estate, will not be considered hours of service for the enterprise."

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At the top of the general forum, Judy has pinned the all QBI posts and discussions. There is a wealth of information that will help. Everyone here has given you excellent and expert responses. However, under the QBI tab you can find resources and code references you may need. I didn't read all replies in depth but your client has to make the safe harbor election if they qualify. Depending on which software you are using, you may need to include this yourself. Drake has an election that will go with the tax return when it is transmitted.

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