IRS Proposes Safe Harbor for Taxpayers Seeking the Section 199A Deduction for Rental Real Estate Activities
On January 18, 2019, the IRS released additional guidance on the much anticipated Section 199A deduction as many taxpayers eagerly await the opening of tax season. Among other issues, the guidance offers taxpayers a proposed safe harbor in determining when rental real estate activities can be treated as qualified trade or business for the purpose of taking the Section 199A deduction. This guidance is provided by the IRS in response to taxpayer uncertainty whether rental real estate activities qualify as a trade or business for the purpose of the Section 199A deduction.
As stated under IRS Notice 2019-7, solely for the purposes of Section 199A, a rental real estate enterprise will be treated as a trade of business if the following requirements are satisfied during the taxable year with respect to the rental real estate enterprise:
- Separate books and records are maintained to reflect income and expenses for each rental real estate enterprise.
- For taxable years beginning prior to January 1, 2023, 250 or more hours of rental services are performed per year with respect to the rental enterprise. For taxable years beginning after December 31, 2022, in any three of the five consecutive taxable years that end with the taxable year, 250 or more hours of rental services are performed per year with respect to the rental real estate enterprise.
- The taxpayer maintains contemporaneous records, 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, 2019.
Solely for purposes of this safe harbor, the IRS defines a real estate enterprise as an interest in real property held for the production of rents and may consist of multiple properties. The safe harbor applies to individual or relevant passthrough who hold the interest directly or through a disregarded entity. Taxpayers must either treat each property held for the production of rents as a separate enterprise or treat all similar properties held for production of rents as a single enterprise. Commercial and residential property may not be part of the same enterprise and the treatment of each real estate enterprise may not vary from year-to-year unless there has been a significant change in facts and circumstances.
Qualified Rental Services
For the purpose of this revenue procedure, rental services that qualify for the hourly requirement include services that are performed by owners, employees, agents and/or independent contractors and include services that generally lends to the operation of the real estate enterprise. Qualified rental services include routine repairs and maintenance of the property, advertising and other efforts to rent the property, negotiation and execution of lease agreements, verifying tenant applications and other provision of tenant services, collection of rent, management of the real estate, purchasing of materials and payment of expenses, and supervision of employees and/or independent contractors. Financial and investment management activities, such as procuring property, arranging financing, planning, managing, or constructing long-term capital improvements, reviewing financial statements, and traveling to and from the real estate do not qualify as rental services in respect to the hourly requirement.
Real Estate Rentals Not Eligible for the Safe Harbor
In the provided guidance, the IRS also defines properties that are not eligible for the safe harbor, including properties that are used by the taxpayer (including an owner or beneficiary of a relevant passhtrough entity) as a residence for any part of the year and real estate that is rented or leased under a triple net lease. For the purpose of determining the safe harbor, a triple net lease includes a lease agreement that requires the tenant or lessee to pay property taxes, property insurance, and maintenance costs.
If it is determined that you cannot meet the requirements for this safe harbor, your rentals can still be considered for treatment of a trade or business for the purpose of Section 199A if you can demonstrate that it meets the definition of a trade of business under Section 1.199A-1(b)(14).
Things to Keep in Mind
When considering how you define your real estate enterprise, keep in mind that your decision factors into the recordkeeping provision of the safe harbor rules. Comprehensive and accurate recordkeeping is key for taxpayers to substantiate the IRS requirements.
The proposed guidance on the Section 199A Trade or Business Safe Harbor for Rental Real Estate activities is issued on IRS Notice 2019-07. Until the proposed guidance is published in final form, taxpayers may use this guidance in determining whether a real estate enterprise may be treated as a trade or business solely for the purpose of the Section 199A deduction.
As always, our CPAs at Mason + Rich are ready to answer any additional questions. Feel free to call us at 603-224-2000.