20% QBI Deduction: Some Landlords Must Revise Lease Under New Tax Law
The 20 percent qualified business income (QBI) deduction is a huge boon to qualifying taxpayers. Essentially, a qualified business with $100,000 in profit can use the QBI deduction to reduce taxable income to $80,000.
Under the guidelines the IRS introduced less than a month ago, in order for landlords to qualify, they must actively manage rental property. To be considered an “active trade or business” a landlord must log 250 hours per year toward management of the rental property. Time reports should include a description of services performed, date services are performed, time spent, and who performed the services. 250 hours per year is a lot of time, so I’m sure taxpayers will be padding their hours to qualify for the QBI deduction.
If you lease commercial property under a triple net (NNN) lease, you are going to have a hard time proving that you spend 250 hours per year managing your property. Triple net leases shift many of the key landlord responsibilities to commercial tenants. The tenant is responsible for procuring and paying real property taxes, building insurance, and maintenance. A landlord cannot reasonably argue that they have continuous and regular involvement in the leasing activity when most of the on-site responsibilities are handled by the tenant. You may be saying to yourself, “I’m perfectly fine without the QBI deduction – I don’t have time to actively manage my rental property.” However, the active management services can be performed by employees or independent contractors of the owner. The tax-savings of the QBI deduction, along with any increased rent you can negotiate by taking over responsibilities, should outweigh property management fees (which are deductible).
A commercial landlord that leases property under a triple net lease may want to consider entering into a new lease with their tenant. One that shifts active management responsibilities back to the landlord. But first, make sure you qualify for the QBI deduction. The deduction is generally limited to individuals earning less than $157,500 per year and couples earning less than $315,000 per year.
The QBI deduction is the most perplexing change brought about by the new tax law. Since the tax rate for corporations was reduced to 21%, the QBI deduction was intended to provide comparative relief for businesses that pass through taxes to owners, such as limited liability companies, subchapter S corporations, and sole proprietors. It is disappointing and hard to imagine why a triple net landlord should be treated differently from a landlord that actively manages real property. The QBI deduction is available for trades or businesses except those classified as a “specified service trade or business” (SSTB). An SSTB is a business that provides services in any one of the following business types: health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any business where the principal asset is the reputation or skill of one or more employees or owners.
The SSTB are all of the type that require active management and participation. I cannot find the logic in rewarding active landlords while punishing active professionals. To boot, engineering and architecture services are specifically excluded from the definition of an SSTB and are considered qualified businesses. Maybe this section of the new tax law will be deemed discriminatory… until then, consider revising your triple net lease.