TO KEEP YOU INFORMED
IRS ISSUES SAFE HARBOR RULES FOR 199A AND RENTAL REAL ESTATE
WHEN DOES A RENTAL REAL ESTATE ENTERPRISE QUALIFY AS A TRADE OR BUSINESS FOR THE SECTION 199A DEDUCTION
February 4, 2019
The IRS has issued a Proposed Revenue procedure that details a safe harbor for determining when a rental real estate enterprise will be treated as a trade or business for the new Section 199A deduction. This revenue procedure is welcome news indeed for tax practitioners and owners of rental real estate, as this was one of the murkier areas of the new tax law.
As you should recall, Section 199A was enacted under the Tax Cuts and Jobs Act, commonly known as tax reform, to provide non-corporate taxpayers with a deduction of up to 20% of the taxpayer’s qualified business income from qualified trades or businesses. This includes trades or businesses that are operated through passthrough entities such as partnerships, S corporations, and limited liability companies. What made this area murky is that rental real estate has typically not been a trade or business under existing tax law, yet the new tax law included wording that would seem to allow for this deduction for rental activities. Recent proposed regulations and draft publications created additional confusion as self-rental activities were qualifying activities, but other rental activities would only be included if the activity rose to the level of a trade or business. As you can imagine this left a lot of rental owners in the dark as to whether their income would be eligible for this valuable deduction.
So last week’s proposed revenue procedure is welcome news indeed. While a safe harbor does not cover all facts and circumstances, it does give us some guidance on what to plan for, how to structure activities, and what documentation to prepare in case of audit. If the activity fails to meet the safe harbor requirements, it may still be treated as a trade or business for purposes of Code Sec. 199A if the enterprise otherwise meets the definition of trade or business in Reg §1.199A-1(b)(14).
PROPOSED SAFE HARBOR
What is a Rental Real Estate Enterprise?:
Solely for the purposes of this safe harbor:
- a rental real estate enterprise is defined as an interest in real property held for the production of rents and may consist of an interest in multiple properties
- the individual or pass through entity MUST hold the interest directly or through a disregarded entity
- taxpayers must either treat each property as a separate enterprise or treat all similar properties held for the production of rents (other than rentals used by the taxpayer as a residence) 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 Rules:
A rental real estate enterprise will be treated as a trade or business under Sec 199A if the following requirements are satisfied during the tax year:
- separate books and records are maintained for each rental real estate enterprise that clearly reflect income and expenses
- For tax years beginning prior to January 1, 2023, 250 or more hours for rental services are performed per year with respect to the rental enterprise
- For tax years beginning after December 1, 2022, in any three of the five consecutive tax years that end with the tax year (or in each year, if the enterprise has been held less than five years), 250 or more hours for rental services are performed per year with respect to the rental enterprise
- The taxpayer 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; and
• who performed the services
Rental services for purposes of this revenue procedure include the following:
- 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.
It is interesting to note that obtaining financing, reviewing financial reports, activities related to long term capital improvement construction projects or hours spent travelling to or from the properties DOES NOT count as rental services.
Rental services may be performed by owners or by employees, agents and/or independent contractors of the owners.
Real estate used by the taxpayer as a residence for any part of the year, and real estate rented or leased under a triple net lease ARE NOTE eligible for this safe harbor.
What Should You Do?
This proposed revenue procedure is effective for tax years ending after December 1, 2017, and therefore is applicable to the 2018 tax returns. So now is the time to review your rental activities.
- Make sure that all properties are identified as triple net lease, self-rental, or used as a residence for any part of the year so that you can determine if a rental real estate enterprise exists and what properties comprise the enterprise
- Make sure that you have books and records for the enterprise
- Make sure that you have time records for the allowed activities that show the threshold has been reached.
If you have any questions about the benefit of determining if a rental real estate enterprise exists with your rental properties and if this election would give you a valuable deduction on your tax return, please give our office a call.
Nicola Neilon – CPA, SHAREHOLDER
I am a CPA and shareholder at Casey Neilon. In this role, I work with many small businesses and their owners. I love that this gives me the opportunity to go beyond just being a tax preparer or auditor. The long-term relationship that develops encompasses the roles of business advisor and trusted confidant. I have been serving clients in this capacity since 1997. My experiences have taught me that I am not Wonder Woman, nor do I have a crystal ball, but many people have no background in accounting and finance, and they need someone that they can trust to help them navigate a path to reach their goals.