So far we’ve filled 5 parts of this series and reached no definitive conclusion. One can make educated guesses, and one can use the NIIT regs to say “only” real estate professionals have a trade or business.
In closing, I want to discuss why there isn’t better guidance out there on this. It would be a lot easier if the IRS simply said “use the traditional definition of trade or business with rentals,” or if they said “use the NIIT definition.” Either way, at least we’d know for sure.
Here are a few of my thoughts on why there’s no clear guidance. Really it boils down to this — historically, the distinction between a rental property being a trade or business, or investment property, has usually been a moot point:
- With the exception of the home-office deduction, the same rental deductions are allowed under EITHER Section 162 (trade or business) or Section 212 (property held for production of income). Most people can’t legitimately claim a home office deduction for their rental, which means the net income or net loss from the property will be the same way either way.
- Section 469 passive activity rules apply the same in either case.
- The most-common time “trade or business” would come into play is if the property is sold for a loss and the taxpayer takes a Section 1231 loss deduction. Many rental properties are sold for a gain (see point 4, next).
- If the property is sold for a gain, which most long-held rental properties will be because of accumulated depreciation, the gain treatment is the same whether the property was a trade or business, or not.
- Another situation where trade or business would come into play is with net operating losses; ultimately these situations are probably quite rare.
- Penalties for not issuing 1099s are probably not large enough for the IRS to pursue this issue very much, and so it simply hasn’t come up often enough for it to be addressed with formal guidance.
This could become an issue going forward, because of the new Section 199A QBI Deduction.
I am speculating here but I could see the IRS trying to have it both ways with the QBI deduction and rentals.
If you have a profitable rental property and take a QBI deduction, I could see the IRS saying “this isn’t a trade or business.”
But if you have a property that shows a loss, and you have other business activity that generates a profit, and you decide the rental isn’t a trade or business, you avoid having the rental loss grind-down the amount of income you can use toward the QBI calculation. I could see the IRS saying “of course that’s a trade or business, so you have to take the loss into account when calculating QBI!” This is just my speculation on this, of course.
My best advice to tax pros (and landlords themselves) is to do your own research on this and make an informed decision. Right now my opinion is, most rental property is “probably” a trade or business in most cases, thus requiring 1099s to be issued if necessary, but also opening the door to Section 1231 losses and a QBI deduction if the property is profitable. But as I’ve said before, others disagree with this assessment and they, too, can find backing for that viewpoint in the NIIT regs.
Links to Other Parts in This Series
- Part 1 (Introduction)
- Part 2 (What is a Trade or Business?)
- Part 3 (Net Investment Income Tax Regs)
- Part 4 (Cautions About Relying on NIIT Regs for 1099 Purposes)
- Part 5 (Miscellaneous Discussion: What Was the ACA Really Changing; How to Proceed)