Qualified Business Income Deduction - 2019 Update
Qualified Business Income Deduction
If you are a sole proprietor or have an interest in a pass-through entity such as a partnership, limited liability company, or S corporation, you may be eligible for a deduction of up to 20% of qualified business income. This deduction is a personal deduction, not a business deduction, and can be claimed whether you itemize or take the standard deduction.
The rules are complicated but here are some highlights. If your taxable income in 2019 does not exceed $321,400 for joint filers or $160,700 for other filers, the deduction is 20% of QBI. If your taxable income in 2019 is more than the taxable income limit above, special limitations to the 20% deduction apply. In 2020, the threshold increases to $326,600 for joint filers and $163,300 for others.
Your qualified business income (QBI) is the net amount of items of income, gain, deduction, or loss from your business. It does not include any capital gain (including Section 1231 gain) or loss, dividends, or interest income (other than interest properly allocable to your business). It does not include any net operating loss carryovers (other than those attributable to excess business losses of noncorporate taxpayers).
You must reduce QBI by the following deductions claimed as adjustments to income on Schedule 1 (Form 1040 or 1040-SR): (1) the deductible part of self-employment tax, (2) the self-employed health insurance deduction, and (3) deductible contributions to self-employed retirement plans.
Some professions are subject to additional limitations. Doctors, lawyers, accountants, consultants, financial advisors, actuaries, athletes, and performing artists, as well as owners of other businesses where the reputation or skill of the employee is “the principal asset of the business,” cannot claim any deduction once 2019 taxable income reaches $421,400 on a joint return, $210,700 for others. The deduction phases out over the first $100,000 of taxable income above the threshold for joint filers, or over the first $50,000 exceeding the threshold for others ($321,400 for joint filers, $160,700 for others).
Qualified Business Income Deduction for Rental Activities Clarified
During the 2019 filing season there was confusion as to whether rental real estate activities qualified for the QBI as a trade or business. Consequently, the IRS created a safe harbor for real estate rentals. If the safe harbor requirements are met, the rental property is treated as a business for purposes of the QBI. The safe harbor requirements are as follows:
You maintain separate books and records to reflect income and expenses for each rental real estate enterprise;
You perform 250 or more hours of rental services per year with respect to the rental real estate enterprise. For rental real estate enterprises in existence for at least 4 years, the hours of rental services requirement can be met by performing 250 or more hours of rental services in at least 3 of the 5 consecutive taxable years that end with the current taxable year. The services must be performed by you, or by your employees, agents, and/or independent contractors. Time spent on investor-type activities does not count.
For 2020 and later years, you maintain contemporaneous records, including time reports, logs, or similar documents, regarding the following: (i) hours of all services performed; (ii) description of all services performed; (iii) dates on which such services were performed; and (iv) who performed the services. Such records are to be made available for inspection at the request of the IRS. For taxable years beginning before 2020, the contemporaneous records requirement does not apply, but you must be prepared to prove that you are entitled to any QBI deduction claimed.
You must attach a statement to your return for each year that you are relying on the safe harbor. The statement must describe all properties being treated as a rental real estate enterprise and any rental real estate properties acquired or disposed of during the year. It also must state that you have satisfied the safe harbor requirements of Revenue Procedure 2019-38.
If you have interests in multiple rent-producing properties, each is a separate enterprise, but you may treat (aggregate) all similar properties as a single enterprise. However, commercial and residential real estate cannot be combined in the same enterprise.
Certain rental real estate interests are not eligible for the safe harbor. Property that you use as a residence (under the 14-day/10% personal use test in 9.7) is not eligible for the safe harbor. In addition, real estate rented or leased under a “triple net lease” is not eligible. A triple net lease refers to an agreement that requires the tenant or lessee to pay taxes, fees, and insurance, and to pay for maintenance activities of the property in addition to rent and utilities.