The Blue Book released by the Joint Committee on Taxation contains an example on page 24 that is meant to illustrate what constitutes a trade or business for purposes of §199A using a rental as the basis for the example.  Given that one of the major concerns expressed about the application of §199A is when a rental qualifies for the deduction, the insertion of this example initially appears to be welcome news.

However, at least for now, it is not clear if the example found in the Blue Book clarifies matters or simply creates additional questions.

Here is the example as taken from the Blue Book:

An activity that is treated as a trade or business for all relevant Federal income tax purposes (and that keeps a complete and separable set of books and records) may be treated as a qualified trade or business. For example, assume that an individual owns a rental building in which the ground floor space is rented to three unrelated commercial establishments (a coffee shop, a drycleaner, and a newsstand) and the upper floors hold apartments rented to residential tenants. For Federal tax purposes, the individual accounts for the rental activities with respect to the entire building using a single set of books and records. Assume further that the individual materially participates in the rental activity, cost recovery deductions under section 168 are allowable with respect to the building, and deductions for expenses with respect to operating and maintaining the building are allowable under section 162. Because a complete and separable set of books and records is kept with respect to the entire building (including the [sic] both the commercial and residential rentals), and because deductions under section 162 are allowable, the real estate rental trade or business is a qualified trade or business for purposes of section 199A.

The first sentence is interesting to look at.  It suggests that the parenthetical comment about keeping a complete and separate set of book and records is key to being treated as a trade or business.  If that were the case, it would appear that thoughts that a taxpayer who had an entity where 25% of its revenue came from a specified service trade or business and 75% of revenue came from other sources would not be able to treat itself as two trades or businesses without keeping separate books.

The Blue Book goes on to posit an example of a rental that consists of a set of commercial tenants on the lower floor and residential rentals on the upper floors, all of which are accounted for in a single set of books.  As well, depreciation is allowed on the building under §168.

But the other two assumptions mentioned for this rental raise questions.  First, the example tells us the expenses of the rental are allowed as a deduction under §162.  The proposed regulations told us that the key test for a qualified trade or business under §199A was whether we had a §162 trade or business.  For a rental, the deductions could be allowed under §212 rather than §162, since IRC §62(a)(4) allows deductions related to a rental under either section to be deducted in computing adjusted gross income.  So it would seem the example doesn’t really answer anything, since it contains an assumption that is, under the proposed regulation, the key item that must be determined based on the facts presented to decide if the rental qualifies for the §199A deduction.  That is, does it rise to the level of a trade or business?

But perhaps we can read the example to be implicitly stating that what has been described otherwise for this rental does qualify it as a §162 trade or business.  The propriety of that reading is not clear from the example, and certainly it is, at best, poorly worded if that is how it is intended to be read. But even if that is the case, the other assumption raises its own issues.

We are told that our taxpayer materially participates in the rental.  While the example doesn’t explicitly mention that this is a reference to the material participation standard under IRC §469, certainly we’d expect the author to recognize that the term has a very specific technical meaning under the IRC that experienced readers would expect to be what is being referenced.

But that raises its own issues.  Under IRC §469(c)(2) a rental activity is automatically passive unless the taxpayer is a real estate professional as defined at IRC §469(c)(7).  Only for a real estate professional normally would “material participation” be relevant for a rental.

That leads to two possible interpretations.  First, only a real estate professional could have a rental trade or business since, it might be argued, only a real professional is able to apply the material participation test under §469 to rental activities.  Other taxpayers aren’t allowed to be treated as materially participating in a rental activity under this view.

But it could also be read to suggest that, even though it would not matter for purposes of treating an activity as not passive for non-professionals, all taxpayers must apply the material participation standards under IRC §469(h) and Regulations §§1.469-1 and 1T in order to claim the rental business is a qualified trade or business under §199A.  If that were to be the proper reading, then only a very limited number of rentals would likely meet the standards.

As well, nothing in the proposed regulations suggests that being “not passive” is important to be able to claim a deduction under §199A.  So that would then raise the question of whether the Blue Book is taking the position that, in fact, material participation is generally required for a §199A deduction to be claimed for any activity to rise to the level of a qualified trade or business.

But then the last sentence suggests that only two factors are key to being a qualified trade or business:

• A separate set of books and records are kept; and

• Deductions are allowed under §162

The first requirement was not mentioned in the proposed regulations, though those regulations don’t deal with determining how to determine what is a single trade or business vs. being multiple trades and businesses.  

The second requirement simply parrots what the proposed regulations provide--and mean that this rental example gives us no real additional information.  After all, the key problem most advisers have with the proposed regulations is determining when a rental rises to a §162 trade or business.

It seems likely that the authors of the Blue Book were aware that Treasury was in the process of finalizing regulations under §199A when the Blue Book was published and had been in communication with those finalizing the regulations.  Possibly this example draws from the not yet published final regulations that are now at OIRA for review and, once read with those regulations, this example will no longer be as difficult to interpret as is true now.

But at the moment this example does not appear to do much to help advisers who are trying to help clients make decisions before the end of 2018.