IRS Provides a Trade or Business Safe Harbor under 199A for Rental Property
On January 18, 2019, the IRS issued long-awaited final IRC §199A regulations. In conjunction with these regulations, a proposed revenue procedure, Notice 2019-07, was also released to provide a safe harbor under which a rental real estate enterprise will be treated as a trade or business solely for purposes of IRC § 199A.
Trade of Business Requirement
The new IRC § 199A 20 percent deduction is available for “qualified business income” arising from a “qualified trade or business”. Since the issuance of the initial guidance on the deduction, taxpayers and practitioners alike were looking for guidance on when a taxpayer’s rental real estate activity is enough to meet the “qualified trade or business” standard.
New Safe Harbor for Real Estate Trade or Business
In response to the requests for more certainty, Notice 2019-07 was released and includes a proposed safe harbor under which a rental real estate enterprise may be treated as a trade or business solely for the purposes of IRC § 199A.
Under the guidance, taxpayers must either treat each property held for the production of rents as a separate enterprise or treat all similar properties held for the production of rents as a single enterprise. Commercial and residential real estate may not be part of the same enterprise. Taxpayers may not vary this treatment from year-to-year unless there has been a significant change in facts and circumstances.
Safe Harbor Requirements
To meet the safe harbor requirements, the taxpayer must satisfy the following factors during the taxable year:
- Maintains separate books and records to reflect income and expenses for each rental real estate enterprise
- For taxable years beginning prior to January 1, 2023, perform 250 or more hours of rental services per year with respect to each rental real estate enterprise
- For taxable years beginning after December 31, 2022, in any three of the five consecutive taxable years that end with the taxable year (or in each year for an enterprise held for less than five years), perform 250 or more hours of rental services per year with respect to the rental real estate enterprise
- Maintains contemporaneous records – including time reports, logs, or similar documents – regarding the following:
- Hours of all services performed
- Description of all services performed
- Dates on which such services were performed
- Record of who performed the services
These 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, 2019.
What rental services qualify?
Rental services, for purposes of the revenue procedure, include the following:
- Advertising to rent or lease the real estate
- Negotiating and executing leases
- Verifying information contained in the prospective tenant applications
- Collection of rent
- Daily operation, maintenance, and repair of the property
- Management of the real estate
- Purchase of materials
- Supervision of employees and independent contractors
These activities may be performed by owners, employees, agents, or independent contractors of the owners.
What activities do not count?
Time devoted to the following financial or investment management activities will not constitute rental activities and cannot be counted toward the 250-hour requirement:
- Arranging financing
- Procuring property
- Studying and reviewing financial statements or reports on operations
- Planning, managing, or constructing long-term capital improvements
- Hours spent traveling to and from the real estate
Excluded from the Safe Harbor
The proposed revenue procedure excludes two types of rental arrangements from the protection of the safe harbor. These include:
- Real estate used by the taxpayer (or owner or beneficiary of a pass-through entity) as a residence for any part of the year
- Real estate rented or leased under a triple net lease
A taxpayer using the safe harbor must include a statement attached to their income tax return specifying that the requirements of the revenue procedure have been satisfied. The statement must be signed by the taxpayer or an authorized representative of an eligible taxpayer, and it must say, “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 procedure, and such facts are true, correct, and complete”. The individual or individuals who sign must have personal knowledge of the facts and circumstances related to the statement.
The proposed revenue procedure may be applied generally to taxpayers with taxable years ending after December 31, 2017. Taxpayers may rely on it until final guidance is issued.
Self-Rental Rule Tweaked
It should also be noted that the final regulations continue to provide that rental activity that does not rise to the level of an IRC § 162 trade or business is nevertheless treated as a trade or business for purposes of IRC § 199A if the property is rented to a commonly controlled trade or business. In other words, self-rental activities do not have to rise to the level of a trade or business for the rental income to qualify as QBI. Common control under the final regulations means that the same person or group of persons, directly or by attribution under IRC §§ 267(b) or 707(b), owns 50 percent or more of each trade or business. Notably, the final rule was written to exclude self-rental income received by a C corporation from this special treatment.