In December of 2017, the Tax Cuts and Jobs Act was signed into law, which created IRS code section 199A, the Qualified Business Income Deduction. While the details of the code are inexhaustible, for our purpose it is only important to understand the basic nature of the 199A deduction. In a sentence, the 199A deduction is a potential 20% phantom deduction from your trade or business income. For example, if your business makes $100,000 in a year, the business may be entitled to a $20,000 phantom deduction and pay tax on only $80,000, provided the business meets certain limitations. This is a sizable tax break for owners of trades and businesses. However, the IRS generally does not consider a rental property to be a trade or business. Therefore, owners of residential or commercial rental properties would generally not qualify for this new deduction. But in January of 2019, the IRS released Notice 2019-07, which institutes a safe harbor for rental real estate owners who may otherwise not be able to take the 199A deduction. Notice 2019-07 applies to individuals, pass-through entities, and disregarded entities.
Before we discuss how to qualify under the safe harbor, let’s review a few types of rentals Notice 2019-07 does not cover. Triple-net leases are not eligible for this safe harbor. In a triple net lease, the tenant or lessee pays for taxes, fees, insurance, and is responsible for maintenance. The IRS argues that you cannot be active in such a scenario. Additionally, if you use a rental property as a personal residence for more than 14 days during the taxable year, you will not qualify for the safe harbor. Finally, if your rental property is leased by a company that you own, the safe harbor is not necessary to use because the rental activity is considered to be a part of the trade or business for purposes of section 199A. If none of these scenarios apply, you are likely eligible for the safe harbor, so long as the following three qualifications are met.