The IRS, in its new proposed Section 199A regulations, defines when a rental property qualifies for the 20 percent tax deduction under new tax code Section 199A.
One part of the good news on this clarification is that it does not require that we learn any new regulations or rules. Existing rules govern.
The existing rules require that you know when your rental is a tax law–defined rental business and when it is not. For the new 20 percent tax deduction under Section 199A, you want rentals that the tax law deems businesses.
You may find the idea of a rental property as a business strange because you report the rental on Schedule E of your Form 1040.
But you will be happy to know that Schedule E rentals are often businesses for purposes of not only the Section 199A tax deduction but also additional tax code sections, giving you even juicier tax benefits.
Under the proposed regulations, you have two ways for the IRS to treat your rental activity as a business for the Section 199A deduction:
the rental property qualifies as a trade or business under tax code Section 162, or
you rent the property to a “commonly controlled” trade or business.
Your rental qualifying as a Section 162 trade or business gets you other important tax benefits:
Tax-favored Section 1231 treatment
Business use of an office in your home (and, if it’s treated as a principal office, related business deductions for traveling to and from your rental properties)
Business (versus investment) treatment of meetings, seminars, and conventions
If your rental activity doesn’t qualify as a Section 162 trade or business, it will qualify for the 20 percent Section 199A tax deduction if you rent it to a commonly controlled trade or business.