The IRS has issued a proposed revenue procedure containing a safe harbor for treating a rental real estate enterprise as a trade or business for purposes of the 20% Qualified Business Deduction.
Congress enacted section 199A to provide a deduction to non-corporate taxpayers of up to 20 percent of the taxpayer’s qualified business income from each of the taxpayer’s qualified trades or businesses. The IRS is aware that whether an interest in rental real estate rises to the level of a trade or business for purposes of the deduction under section 199A is the subject of uncertainty for some taxpayers.
A rental real estate enterprise may consist of an interest in a single property or interests in multiple properties. Each enterprise must separately meet the requirements of the safe harbor to qualify as a trade or business for purposes of claiming the qualified business income deduction. Similar properties can be grouped if they are part of the same rental real estate category – residential or commercial. A mixed-use property may be treated as a single rental real estate enterprise or may be split into separate residential and commercial interests. However, if the property is treated as a single rental real estate enterprise, it may not be grouped with any other enterprise.
The safe harbor requirements issued in Rev. Proc 2019-38 are as follows:
- Separate books and records are maintained to reflect income and expenses for each rental real estate enterprise;
- For rental real estate enterprises that have been operating less than four years, 250 or more hours of rental services (defined later) are performed per year. For those enterprises that have been operating at least four years, in any three of the five consecutive taxable years that end with the taxable year, 250 or more hours of rental services are performed; and
- Contemporaneous records are maintained including time reports, logs, or similar documents, regarding the following: (i) hours of all services performed; (ii) description of all services performed; (iii) dates on which such services were performed; and (iv) who performed the services. Such records are to be made available for inspection at the request of the IRS. The contemporaneous records requirement will not apply to taxable years beginning prior to January 1, 2020.
Rental services under the safe harbor include advertising to rent or lease the real estate, negotiating and executing leases, verifying information contained in prospective tenant applications, collection of rent, daily operation, maintenance, and repair of the property, management of the real estate, purchase of materials, and supervision of employees and independent contractors.
The Revenue Procedure adds a requirement to attach a statement to the return for each taxable year in which the taxpayer relies on the safe harbor. The statement must identify the properties included in each rental real estate enterprise and must also contain a representation that the requirements of the safe harbor have been satisfied.
Certain rental real estate arrangements are not eligible for the safe harbor. These include real estate used as a residence by the taxpayer, real estate rented under a triple net lease, and a real estate interest if any portion of the interest is treated as a specified service trade or business under the 199A regulations. A triple net lease includes a lease agreement that requires the tenant to pay taxes, fees, and insurance, and to pay for maintenance activities for a property in addition to rent and utilities. However, it is important to note that just because a rental real estate enterprise fails to qualify for this safe harbor; that does not necessarily preclude taxpayers from taking the qualified business income deduction if the enterprise otherwise rises to the level of a trade or business depending on the facts and circumstances.
Please contact our office to discuss these safe harbor requirements for rental real estate businesses. We can review your current business operations and organization to see if your rental real estate business qualifies for the Code Sec. 199A deduction as well as determine if you are meeting the documentation requirements.