Section 199A, as discussed in my prior blog post Section 199A Pass-Through Deduction and the Magic Number, provides for a deduction generally equal to the applicable pass-through entity’s qualified business income. However, the deduction is available only for a qualified trade or business, which Section 199A(d)(1) defines as any trade or business other than certain excluded ones. The regulations under Section 199A define trade or business by reference to Section 162, which applies a facts and circumstances approach to determining whether a trade or business exists, including whether the taxpayer is regularly or actively involved in the activity and whether the taxpayer has a profit motive. See Reg. § 1.199A-1(b)(14).

Reg. § 1.199A-1(b)(14) provides a rental business (including renting of real estate) that does not rise to the level of a Section 162 trade or business is nevertheless treated as a trade or business for the purposes of Section 199A if the property is rented to a trade or business conducted by the individual or relevant pass-through entity (an “RPE”) commonly controlled within the meaning of Reg. § 1.199A-1(b)(1)(i). Treas. Reg. § 1.199A-1(b)(10) defines RPE as a partnership or S corporation that is owned directly or indirectly by at least one individual, estate or trust. Accordingly, a passive real estate rental activity operated by a partnership or S corporation that rents the property to another trade or business under common control with such partnership or S corporation may be eligible for the 199A deduction.

Even if the RPE exception under Reg. § 1.199A-1(b)(14) does not apply, a rental real estate business may be able to qualify under Section 199A. Rev. Proc. 2019-38 provides a safe harbor for an activity’s being a rental real estate enterprise and therefore being an eligible trade or business for purposes of Section 199A. Failure to meet the safe harbor does not mean the rental real estate activity is not a trade or business, but qualifying for the safe harbor provides the taxpayer with comfort.

Rev. Proc. 2019-38 defines a rental real estate enterprise as “an interest in real property held for the production of rents.” A rental real estate enterprise may be an interest in a single property or multiple properties, but the taxpayer or RPE must hold each interest in real property directly or through a disregarded entity. Rev. Proc. 2019-38, § 3.02. A taxpayer, therefore, cannot combine interests in real estate held through different regarded entities into one rental real estate enterprise.

Importantly, the safe harbor does not apply to any business that leases or rents real estate under a triple net lease, “which includes an arrangement that requires the tenant or lessee to pay taxes, fees, and insurance, and to pay for maintenance activities for the property in addition to rent and utilities.”

John G. Hodnette is a partner with Fox Rothschild, LLP in Charlotte.

March 5, 2026/by TAX