Section 199A and the Trade-or-Business Hurdle: A Crucial Distinction for Real Estate Owners
By Cody C. Heimerdinger, CPA
Why This Matters
For real-estate owners, the trade-or-business distinction under Section 199A isn’t just a technical detail—it can directly shape the financial viability of an investment.
The Qualified Business Income (QBI) deduction allows up to a 20% deduction on qualified business income, reducing effective tax rates and boosting after-tax returns. But not every rental activity qualifies. The first hurdle? The activity must rise to the level of a trade or business under Section 162.
Fail that test, and the 20% deduction never gets out of the gate.
Defining a “Trade or Business” Under Section 162
Section 162 requires that an activity be conducted with continuity, regularity, and a profit motive. For real-estate owners, determining whether operations meet that standard is a nuanced, facts-and-circumstances analysis.
Certain common arrangements tend to fall short:
- Triple-net leases: Tenants handle taxes, insurance, and maintenance, leaving the owner with minimal activity.
- Single-property rentals: Limited services and oversight often mean the owner’s involvement doesn’t meet the trade-or-business threshold.
In both cases, rental income might be excluded from QBI eligibility, eliminating access to the 20% deduction.
Two Investments, Two Outcomes
The IRS allows several ways to calculate the value of personal use, but each comes with rules:
| Investment | Structure | Owner Involvement | Likelihood of “Trade or Business” | QBI Eligibility |
| A | Single-tenant commercial property (triple-net lease) | Minimal oversight, low activity | Low | Unlikely |
| B | Multifamily residential property | Active management: leasing, maintenance, capital planning | High | Likely |
While both investments can produce similar pre-tax cash flow, their after-tax results may diverge dramatically depending on whether they qualify as a trade or business.
The IRS Safe Harbor: A Shortcut to Certainty
To simplify this gray area, the IRS issued Revenue Procedure 2019-38, introducing an optional safe harbor for rental real-estate enterprises. Meeting the safe-harbor requirements automatically treats the activity as a trade or business for Section 199A purposes.
To qualify, you must:
- Maintain separate books and records for each rental real-estate enterprise.
- Perform at least 250 hours of rental services annually (or in 3 of the prior 5 years for established operations).
- Keep contemporaneous records of hours, services performed, dates, and service providers.
- Attach a signed statement to the tax return affirming reliance on the safe harbor.
Exclusions apply:
- Properties under triple-net leases are not eligible.
- Properties used as a residence under Section 280A (like vacation homes) are excluded.
Even without meeting the safe harbor, an activity may still qualify under the general Section 162 standard, so long as it passes the facts-and-circumstances test.
Strategic Takeaways for Real-Estate Investors
- Evaluate operations beyond ownership.
Merely collecting rent isn’t enough, qualifying as a trade or business hinges on regular, continuous, profit-motivated activity. - Group properties strategically.
Grouping similar assets can help meet safe-harbor thresholds and strengthen your overall Section 162 position. - Document every activity.
Hours, services, contractors, management tasks, detailed documentation provides the evidence the IRS expects. - Compare after-tax outcomes.
Run projections with and without the QBI deduction. The delta often justifies additional operational involvement or restructuring. - Review lease structures.
For triple-net leases, consider ways to introduce operational involvement, such as owner-provided maintenance or tenant-service oversight, to enhance qualification potential
The Bottom Line
Your eligibility for the Section 199A deduction depends not just on what you own, but how you operate it. A triple-net lease may be hands-off, but it could leave valuable deductions on the table. Conversely, an actively managed multifamily or commercial portfolio can deliver both operational control and meaningful tax advantages. The IRS safe harbor provides one clear path, but strong documentation and thoughtful structuring remain essential for all.
Need a QBI qualification review for your real-estate holdings?
Keystone CPAs’ can help assess your current operations, identify qualifying opportunities, and develop documentation systems that protect your deduction.