199A Rental Real Estate Trade or Business Safe Harbor
On December 22, 2017, tax reform legislation was passed under the Tax Cuts and Jobs Act of 2017. As part of the new law, a deduction was added for non-corporate taxpayers – the Qualified Business Income (QBI) deduction (section 199A). In general, this deduction is up to 20% of the qualified income from a trade or business directly operated by the taxpayer or a pass-through entity. Since this law was enacted, there has been much uncertainty as to whether rental real estate activity qualifies for this deduction as a trade or business.
The IRS issued proposed regulations regarding 199A on August 8, 2018. Final regulations were issued January 18, 2019. Along with the final regulations, the IRS issued Notice 2019-07. This notice provides a safe harbor under which a rental real estate activity will be treated as a trade or business specifically as it applies to this QBI deduction. If the taxpayer or pass-through entity’s rental activity meets certain criteria listed below, the activity will quality as a trade or business under the safe harbor. Please note that if a rental activity does not meet the requirements to qualify under the safe harbor, the activity is not precluded from eligibility for the deduction if it otherwise meets the definition of trade or business.
Safe Harbor Rules of Application
For the purposes of the safe harbor, a rental real estate enterprise is defined in the IRS notice as an interest in real property held for the production of rents and may consist of an interest in multiple properties. If there are multiple properties, the activities can be treated separately or if they are all similar, they can be grouped and treated as a single enterprise. The properties must be similar – commercial and residential rentals cannot be combined into the same enterprise. The following three requirements must be met for each enterprise
- Separate books and records must kept for each rental real estate enterprise.
- 250 hours of rental services must be performed annually with respect to the enterprise.
- The taxpayer must document the 250 hours regarding the following four categories:
a. Total hours of service performed
b. Description of services performed
c. Dates of service
d. Who performed the service
If a taxpayer holds both a residential rental enterprise and a commercial rental enterprise, the three tests above must be met for each separately.
Various services qualify for the 250-hour rule. Some examples included by the IRS include advertising to rent or lease, negotiating leases, reviewing tenant applications, collecting rent, operating and maintaining the property, managing the real estate, purchasing supplies or materials, and supervising employees or subcontractors. The taxpayer is not required to personally perform these services, rather they may be performed by owners, employees, agents, or subcontractors. Examples of services that do not qualify to meet the 250-hour test are financial or investment management such as securing financing, procuring property, studying financial statements, planning, managing capital improvement, or hours traveling to and from the real estate property.
Exclusions from the Safe Harbor Provision
There are two activities that are expressly disallowed from applying the safe harbor provision:
1. Real estate used for any part of the year as a residence (either primary or vacation)
2. Triple Net Leases
Required Statement to Be Signed and Attached to Return
If a rental activity meets the criteria listed above, the taxpayer must attach the following signed statement to the tax return on which the QBI deduction is claimed:
NAME OF ENTITY: EIN:
The requirements of section 3.03 of IRS Notice 2019-07 have been satisfied.
“Under penalties of perjury, I (we) declare that I (we) have examined the statement, and, to the best
of my (our) knowledge and belief, the statement contains all the relevant facts relating to the
revenue procedures, and such facts are true, correct, and complete.”
We will have to review our clients’ real estate operations in detail on a case by case basis to determine applicability under the proposed and final regulations of 199A and under the IRS Notice 2019-07. We will review to determine if they meet the safe harbor and if the statement attached to the return is required. Please call us with any questions that you have.