How should IRS regulate Section 199A for rentals?

Since we have nothing more so far than a "facts and circumstances" test for trade or business, how would you fix it, if you wanted to support effective tax administration while still carrying out some faint semblance of the intention of Congress when creating the QBI deduction under the TCJA law?

I suppose somewhere there might be comments on IRS proposed regs? AICPA requests? Anything new or fresh?

I would regulate as follows: (basically, a safe harbor, to drastically reduce the number of possible audits).

Case A: If your net gain from a Schedule E rental activity is $25K or less (or, if a loss, your net loss is $25K or less), then by default it will be considered QBI (income/loss).

Case B: If not, then a facts and circumstances test applies, and I might want to implement a due diligence form of some kind (even if just a few Yes/No questions, like the many we already deal with for business entities).

If desired, a taxpayer can make an election to be exempted from Case A, and apply Case B instead. Such election to be made within six months after due date of return excluding extensions. Such election only revocable by consent of commissioner.

May be IRS needs to issue regulations to define what is a "trade or business" for purposes of Sch E rental.

For example to claim QBI, the landlord must issue 1099-Misc for payments that meet the threshold to non corporate vendors. Must charge the market rent and follow all state/local rental laws. For example here we have landlords renting a one family home to two or more families by dividing up the area with partitions. I know that because my son lives in one of those apartments. If you look at the property records, it shows one family home not a multi-family house.

Could we perhaps start with a few examples of folks renting property for profit (vs renting cheap to a family member etc) but, in the opinion of tax pros here, would not qualify. I simply can't imagine not applying for QBID and in effect, causing my landlord/client additional tax in spite of the spirit of this new income deduction. When is a rental for profit NOT a "trade or business" .... anyone?

Bob A, can you brainstorm an approach that would make it easy for everyone to properly fill out the tax return showing QBI, and yet not completely throw the door wide open to anything and everything a taxpayer can conceive of? I was inspired by the OIH safe harbor, which certainly makes things much easier both for the taxpayer and the IRS, yet still allows for outliers to be handled case by case.

My first attempt, above, has the feature that you have to take the income and the loss into account, you can't just cherry pick the income only. As courts have determined, (I could find the cite somewhere else on this forum), a rental with annual losses due primarily to non-cash expenses such as depreciation can still be for profit, due to expected appreciation of the property.

May be IRS needs to issue regulations to define what is a "trade or business" for purposes of Sch E rental.

For example to claim QBI, the landlord must issue 1099-Misc for payments that meet the threshold to non corporate vendors. Must charge the market rent and follow all state/local rental laws.

I was assuming that a working definition of trade/business would not be forthcoming any time soon.

The 1099-MISC test is a good one, except there still may be a lot of rentals that don't need to issue them (for example, renting a condo that is part of an HOA, so that few direct payments to 1099 vendors are made). But what about having a local business license? That is a requirement for businesses in many towns and cities.

My thought about including some Yes/No questions on the return is to make it easier for IRS computer to flag questionable cases. So, for example, there could be a yes/no question about local business license.

It would be nice to look at the history somehow -- did someone suddenly decide they have a trade/business solely because of the new law, and not because of any true, consistent approach? But that would be harder to enforce. But you could at least check the history of business licenses.

Long ago, there was some discussion of the role that the six-digit business code on Schedule C plays in QBI determination. Could the code be extended to Schedule E somehow and be used as a way to get the taxpayer to commit (by not allowing the code to change arbitrarily from year to year).

I accept renting to a family member for less than fair market rent as NOT a "trade or business."
I accept "hobby" as NOT a "trade or business."

I will use one single family home, with the owner as landlord for QBID.
I will use one side of a duplex, with owner as landlord for QBID.
I will use a property with a property manager for QBID.
Previously, I discussed right here my landlord with commercial properties inside an S Corp, he admits to not being involved, uses a manager but since he does NOT take payroll, given he's operating as an S, he and I have concluded no QBID ... because he does not actively work/take payroll within an S NOT for any other reason.
I will use a tp who purchased a new residence, rents his former residence, for QBID.

follow all state/local rental laws. For example here we have landlords renting a one family home to two or more families by dividing up the area with partitions. I know that because my son lives in one of those apartments. If you look at the property records, it shows one family home not a multi-family house.

That seems like a scary hole to go down. First, few tax practitioners are attorneys and thus qualified to opine on legal questions outside of the scope of tax law. And then, those attorneys might themselves not be proficient enough in state and local law to make such determinations. And if a client has rental property in a different state (perhaps they moved from one state to another and decided to keep the old home as a rental instead of selling it) even a proficient state/local attorney in one state might not be proficient in the other state.

Secondly, most businesses (and individuals) fail to follow laws. Uber and Wells Fargo come to mind. It's a smaller scale with our clients for sure, but the law is the law.

Case A: If your net gain from a Schedule E rental activity is $25K or less (or, if a loss, your net loss is $25K or less), then by default it will be considered QBI (income/loss).

Honestly, wouldn't the opposite be more in line with reality? That a rental with net income under $25k would be by default not a trade or business, but a rental making $25k would be assumed to be a business?

Case A: If your net gain from a Schedule E rental activity is $25K or less (or, if a loss, your net loss is $25K or less), then by default it will be considered QBI (income/loss).

Honestly, wouldn't the opposite be more in line with reality? That a rental with net income under $25k would be by default not a trade or business, but a rental making $25k would be assumed to be a business?[/quote]

That was my first thought too, Missingdonut. However, makbo's suggestion gets rid of the small potatoes and leaves the big stuff only as facts and circumstances.

Bradford Letter Identifies a few cases:

Hazard Case:
The Hazard case shows how easy it can be for you to qualify your rental as a business.2
In this precedent-setting case, Mr. Hazard moved to Pittsburgh for new employment and listed his former Kansas City residence for sale or rent. He rented the house for about three years, after which he sold the property at a loss.
The Tax Court determined that Mr. Hazard used the property in a trade or business even though the court record has no mention of management activities by the taxpayer.

Levy Case
In Levy,3 the court ruled that the trustees of this estate, by renting the real estate, were engaged in a trade or business. The court then went on to say this:
Courts have consistently held that the rental of real estate is a “trade or business” if the taxpayer-lessor engages in regular and continuous activity in relation to the property.
It has been held that a taxpayer who rents only a single parcel of real estate is engaged in the “trade or business” of renting real estate if his activities are regular and continuous. The fact that the trustees employed agents to manage the real property does not make any difference.

Elek Case
In Elek,4 also a precedent-setting case, the taxpayer purchased an apartment building in Hungary, appointed his father manager, left Hungary, came to the United States, and became a citizen. During this time, the Hungarian government by decree nationalized his property because Mr. Elek had defected from this communist country and had become a capitalist.
The Tax Court granted Mr. Elek a business loss on this rental because it considered his rental apartment activity a trade or business for which nationalization caused his net operating loss.

Cottle Case
In Cottle,5 the Tax Court ruled that Mr. Cottle bought three fourplexes in what was, for him, a new trade or business of renting apartments.

Jephson Case
In Jephson,6 the court ruled that Mr. Jephson had a business when he bought a house to rent, listed it for rent, and showed it to prospective tenants but never rented it.

Key Point
If you have regular and continuous involvement with your rental activities, then you’ll meet the Section 162 trade or business test and qualify for the 20 percent Section 199A deduction on the rental activity.
Your non-recurring and/or non-devotion ventures likely don’t qualify as a trade or business

That was my first thought too, Missingdonut. However, makbo's suggestion gets rid of the small potatoes and leaves the big stuff only as facts and circumstances.

But the law implies that small potatoes are the ones who don't qualify in the first place! It also seems relatively unlikely that a rental or series of rentals totaling $25+k in profit would not rise to the level of a trade or business -- doubly so because related party rentals are treated as a part of the business rented to for the purposes of §199A.

So at that point the IRS might as well put out a regulation that states that any rental not subject to §183 qualifies for §199A and be done with it.

Agree with everything thing in post #9 so any safe harbor should meet the SCOTUS test of "continuity and regularity" which suggest an annual hours test( 500 hrs suggested in another thread based on IRC 1411 NIIT).

Key Point
If you have regular and continuous involvement with your rental activities, then you’ll meet the Section 162 trade or business test and qualify for the 20 percent Section 199A deduction on the rental activity.
Your non-recurring and/or non-devotion ventures likely don’t qualify as a trade or business

I don't see those requirements in the court cases you cite or how those cases support your Key Point. Regular and continuous is soooooooo nebulous.

Simple fix. Report a RE business on schedule C. QBI and SE tax. Report a RE investment on schedule E. No QBI, No SE tax.

But I thought there was a statute that excludes *rental* real estate activities income from self-employment tax, whether they're considered even if it's from "trade or business" activities or not...

IRC Section 1402(a)(1): https://www.law.cornell.edu/uscode/text/26/1402 "...except that…there shall be excluded...."

You mean we'd have to change the tax laws? Again? Didn't work the last time.

"Didn't work the last time" certainly relieves any pressure on us to determine what it was intended to do "last time" eh?

Since we have nothing more so far than a "facts and circumstances" test for trade or business, how would you fix it, if you wanted to support effective tax administration while still carrying out some faint semblance of the intention of Congress when creating the QBI deduction under the TCJA law?

I'd use the Small Business Jobs Act of 2010 as a template. That was the legislation that imposed 1099 reporting requirements on owners of rental property but was repealed a year later. In the relevant section (2101), it said "Solely for purposes of subsection (xx) and except as provided in in paragraph (nn), a person receiving rental income from real estate shall be considered to be engaged in a trade or business of renting property.."

Of course, in paragraph (nn) I could go to town with a long list.

If we're going with simplicity, I like HowardS' opinion in post 13, except that I'd amend that to say that anyone that qualifies as a real estate tax professional and reports that income on Schedule E would qualify for QBI as well. That would be pretty cut and dry.

Personally, I think that any property that is rented out with the intention of making a profit in which the taxpayer meets the material participation qualifications should be considered a "trade or business" for purposes of qualifying for the QBI deduction. I guess that would be too easy though.

For us to have gotten to a point in this topic where applying a "material participation" test might be considered *too easy* is a clear indication that we've lost our way in the forest...

Draft 2018 Publication 535

The ownership and rental of real property doesn’t, as a matter of law, constitute a trade or business, and the issue is ultimately one of fact in which the scope of your activities in connection with the property must be so extensive as to give rise to the stature of a trade or business.