The Internal Revenue Service recently offered welcome news to some business owners still sorting out the impact of the Tax Cuts and Jobs Act.
One of the key provisions of the tax reform law passed more than a year ago is a 20% deduction of qualified business income from each of a taxpayer’s qualified trades or businesses when operated as a pass-through entity, like a partnership, S corporation or sole proprietorship. As exciting as the deduction sounds, it also produced plenty of questions that the IRS needed to answer to enable people to understand how it would be applied in practice.
One question the IRS recently addressed involved rental income. To qualify for the 20% deduction, income must be generated through a business activity, but rental income can fall into a gray space between business and investment activity.
Consider the difference, for example, between an individual who owns and rents out a single property compared to a large company that owns and operates a group of residential communities. The solo landlord may spend very little time managing that single property, but the business activity to support an entire building full of tenants or sprawling residential complexes can be significant. Commercial real estate enterprises will employ a staff of people to manage and market properties, collect rents, enforce lease agreements and perform necessary maintenance.
Given those extremes, it’s easy to see how the tax rules might say some rental income can be regarded as business income, but some not. Along the continuum, there are lots of facts and circumstances to consider to determine whether a specific rental operation meets the definition of a business for tax purposes.
Information in this article is based off content from Peter DeMarco's article in Crain's Cleveland Business.