Recently the Treasury Department released a punitive ruling against nursing home rental property owners. Starting in 2018, if a person has rental income, they do not have to pay tax on 20% of that income in most cases. The ruling says that nursing home operators who own and rent their building to their related operator do not get this tax benefit.
The new 20% deduction is not allowed to medical service providers. The Treasury classifies a skilled nursing facility (SNF) as a medical service provider. Therefore, the 20% deduction is not allowed for SNF operations income. Treasury went one step further and decided that if there is a related party rental, then the nursing home owner will manipulate income by moving income to the rental property to benefit from the 20% deduction on the inflated rental income. Therefore, the 20% deduction will not be allowed to the related party rental owner.
This position by Treasury completely ignores the reality that operating a SNF and owning the building are two separate things. Case in point, many SNF buildings are owned by REITs or other large property owners. Owning the real estate is not mandatory to conduct the business as can be seen by the many operators who lease their facilities from unrelated people.
Certainly a rule that rent in excess of fair rent does not qualify for the 20% deduction would have been much more equitable.
The rule applies to a related party rental. The rental is a related party rental if the same people own 50% or more of the operator and the real estate. Structuring the ownership so that the real estate is owned less than 50% by the operator owners would avoid the problem. Doing the ownership this way is already often done when there are outside investors.
The rule at this time is only a proposed rule – it remains to be seen if Treasury took public comments into account.
The denial of the 20% deduction extends beyond rental properties and will apply to all related companies – management, supplies, and other ancillaries. The following paragraphs discuss the details of the Treasury position.
The 20% Qualified Business Income deduction allows a taxpayer to deduct from taxable income the smaller of 20% of income from business and rentals or 20% of their taxable income. This could lower someone’s tax rate on business and rental income from 37% to 29.6% in a best case scenario.
The guidance released by the IRS denies the 20% QBI deduction to income from skilled nursing facilities (SNF). The 2017 Tax Act denies the deduction to professional service businesses such as lawyers, accountants, and medical providers. For companies doing under $25 million of revenue, the recent IRS guidance would classify an activity as medical care if more than 10% of the revenue is generated by doctors, nurses, and therapists. For companies doing over $25 million of revenue, the cut off is 5%.
In doing so, the IRS went one step further and denied the 20% QBI deduction to companies which provide services or property to related SNFs. The proposed regulation treats income from any trade or business with 50 percent or more common ownership (directly or indirectly) that provides 80 percent or more of its property or services to a skilled nursing facility as not qualifying for the 20% QBI deduction. The companies would be viewed as “integrated.”
The extension to related companies will deny the 20% QBI deduction to related party rentals, management companies, service companies, and suppliers if there is 50% or more common ownership and more than 80% of the revenue is earned by doing business with a related company.
The regulation is unclear in whether the 80% test is for related parties only or whether it looks at the entire revenue sources. The best reading of the language when looking at the entire regulation is that it only applies if more than 80% is earned from related skilled care facilities.
Furthermore, if there is 50% or more common ownership, and less than 80% of the revenue comes from the related party skilled care facility, then the portion of the income generated from the related SNF will not qualify for the 20% QBI deduction. For instance, if a related supply company is owned more than 50% by the owners of a SNF and the supply company generates 60% of its sales from the related party SNF, then 60% of the income will not qualify for the 20% QBI deduction.
Kuno S. Bell, CPA, J.D. is the Director of Tax Pease & Associates LLC.