Whether a rental real estate enterprise is a trade or business for purposes of the section 199A qualified business income deduction (QBID) has been a subject of uncertainty for many taxpayers. Thankfully, the IRS has issued guidance to help clarify the situation.
Notice 2019-07, released on January 19, 2019, provides a safe harbor for treating a rental real estate enterprise as a trade or business solely for purposes of the section 199A deduction.
Solely for 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. Additional items of note with this definition:
- The individual or RPE (relevant pass-through entity) relying on the revenue procedure must hold the interest directly or through an entity disregarded as an entity separate from its owner.
- 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.
- Real estate used by a taxpayer as a residence for any part of the year or real estate rented under a triple net lease is specifically excluded from eligibility under this safe harbor.
- 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.
If the following safe harbor requirements are met, the real estate enterprise will be treated as a trade or business for purposes of applying the regulations under section 199A. The safe harbor applies to individuals and relevant pass-through entities (RPEs) which includes qualifying partnerships, LLCs and S corporations.
Safe Harbor Requirements
Per the IRS, a rental real estate enterprise will be treated as a trade or business if the following requirements are satisfied during the taxable year with respect to the rental real estate enterprise:
(A) Separate books and records are maintained to reflect income and expenses for each rental real estate enterprise;
(B) 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 (or in each year for an enterprise held for less than five years), 250 or more hours of rental services are performed (as described in this revenue procedure) per year with respect to the rental real estate enterprise; and
(C) 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.
Rental services for purpose of the proposed revenue procedure 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.
Rental services may be performed by owners or by employees, agents and independent contractors of the owners. The term rental services does not include financial or investment management activities, such as arranging financing; procuring property; studying and reviewing financial statements or reports on operations; planning, managing, or constructing long-term capital improvements; or hours spent traveling to and from the real estate.
It’s important to note that failure to satisfy the requirements of this safe harbor does not preclude a taxpayer from otherwise establishing that a rental real estate enterprise is a trade or business for purposes of section 199A under other provisions. However, this IRS guidance should go a long way in easing uncertainty for those with real estate holdings.
Real estate CPAs are well versed in safe harbor requirements and guidelines for other tax advantages available to you. Contact James Moore for help in navigating these opportunities so you can get the most out of your return.
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