1) The activity must be a “trade or business.” Unfortunately, there is no specific test of what qualifies as a trade or business. The basic definition established by the courts is that an activity must be carried on with the primary intent of making a profit, as well as with regularity and continuity. (More on this later.)

2) The activity must be US-based. If your business sells products or provides services in the United States, the profits (or losses) from this business are generally US-based. Goods sold abroad and services provided abroad will generally also count as US-based if they are delivered from a US base of operations to a country where the business has no base of operations.

3) The income must not be “wages.” For purpose of this test, wages generally includes all payments you receive as an official employee of a business (i.e. wages reported on a W-2). However, there are two special cases. If you’re a statutory employee (indicated by the “statutory employee” box on line 13 of your W-2 being checked), then the income from the statutory W-2 is not considered wages for QBI purposes. Also, in some cases payments you receive from a former employer may be treated as wages even if that employer no longer consider you an employee. If this business includes payments received from a company that employed you in the last three years, then those payments might be considered wages by the IRS.

How much “regularity and continuity” is necessary for an activity to be treated as a “trade or business?”
In some cases, this can be a tough question to answer.

Generally, if you’re providing services or selling products with the intent to make a profit, and you’re reporting this as “Business” or “Self-employment” income (Schedule C) or “Farm” income (Schedule F), this is going to be treated as a regular and continuous business eligible for the QBI deduction. If you receive payment for a “one off” or very occasional service, and you report this as “other income” rather than a self-employment or business activity, this would not be considered a qualified business.

However, if you are renting out property or receiving royalties from an investment that are reported on Schedule E (or in some cases related to farm rentals, Form 4835), the question of whether this is a “trade or business” is often not clearly answered by the IRS. There is one instance where this type of activity is definitely a trade or business. Rents or royalties that are paid to a trade or business that is also at least 50% owned by the same person (or people) who owns the property generating the rents or royalties are automatically defined as a trade or business.

Outside of that specific situation, here are some guidelines for what types of rental or royalty activities are considered a trade or business. If you are renting property that requires very infrequent interaction with the tenants and maintenance to the property, the courts have generally found this type of activity is not a “trade or business”. On the other hand, if you rent out property that requires frequent tenant interactions or maintenance services, this type of activity is generally classified as a “trade or business.” (See examples later of activities that would or would not typically be treated as trades or businesses.)

There is considerable uncertainty about whether a small-scale, long-term rental of a single property or small number of properties is a “trade or business.” This applies to the relatively common situation where a taxpayer owns a single rental home or two, and has relatively stable tenants that generally stay for a year at a time or more. Numerous court cases exist where situations meeting this description have been considered a “trade or business,” and others where similar situations have not been considered a “trade or business.”

Examples
1) You rent a piece of bare land you own to a long-term tenant. You don’t provide or maintain any improvements to the land. The tenant is responsible for any improvements. There is very little that needs to be done to collect income from this property besides depositing monthly checks. This type of activity is typically not classified as a trade or business. (Note that farm rentals reported on Form 4835 would commonly follow this fact pattern.)

2) You receive income from a net lease of a small office building you own in which the tenant is responsible for substantially all maintenance and upkeep of the property. As in the first example, about the only regular activity required from this activity is depositing rent checks. This type of activity is typically not classified as a trade or business.

3) The facts are the same as the second example, except in this case the tenant is your own S Corporation that you own 100%. The S Corporation uses the leased building as its office and is responsible for all maintenance and upkeep of the property. Even though the office wouldn’t normally be considered a trade or business because of the lack of regular activity, in this case the office lease IS a trade or business because you own both the office building and the business renting it.

4) You own a vacation home which is rented out most weeks year-round to new tenants who typically stay for a week or less. Because of the frequent interactions required with tenants, this type of activity would typically be classified as a trade or business.

5) You own a large building with many different units and tenants. At any given time, there is often a tenant moving out or space that’s open and needs a tenant to be found. Maintaining the building to the standards expected by the many tenants is an on-going task. You have hired a management company that handles all of these on-going tasks on your behalf. Because of this regular and continuous activity (even though some or all of it may be conducted by agents you’ve hired to act on your behalf), this type of activity would typically be classified as a trade or business.