The Tax Cuts and Jobs Act, passed in December 2017, enacted a new tax code section, IRC 199A, which gives certain businesses a 20% deduction against their qualified business income. To qualify for this deduction the taxpayer must be engaged in a trade or business (T-B). There has been confusion as to which rental real estate enterprises will qualify for this new deduction.
The preamble of the IRC section 199A regulations stated The Treasury Department and IRS recognize the difficulties taxpayers and practitioners may have in determining whether a taxpayer’s rental real estate activity is sufficiently regular, continuous, and considerable for the activity to constitute a section 162 trade or business. To help clarify this issue, the IRS issued guidance in Rev. Proc 2019-07 on 1/18/19.
Rev. Proc 2019-07 provides for a safe harbor under which a rental real estate enterprise will be treated as a T-B solely for purposes of IRC section 199A. This revenue procedure also applies to Relevant Passthrough entities, RPE’s (i.e. Partnerships, S corporations, and certain trusts).
This safe harbor will minimize disputes with the IRS and allow for defacto aggregation for multiple
properties. Though, failure to satisfy the safe harbor rules does not preclude a taxpayer from establishing a rental real estate enterprise is a T-B for section 199A. Rev. Proc 2019-07 is effective for tax years ending after December 31, 2017.
How to meet the safe harbor? The rental real estate enterprise (RRE) must:
- Maintain separate books and records for each RRE,
- For years beginning before 2023, 250 or more hours of rental services is performed per year for the RRE,
- Maintain contemporaneous records, including time reports, logs or similar documents. Recordkeeping requirement won’t apply to tax years before 1/1/19. After 1/1/19 it must include:
- Hours of all services performed
- Dates on which services were performed, and
- Who performed the services.
- For tax years after 2022 additional requirements are required.
Rental services include:
- Advertising to rent or lease
- Negotiating and executing leases
- Verifying information contained in the prospective tenant application
- Collection of rents
- Daily operation, maintenance, and repair of the property,
- Management of real estate
- Purchase of materials, and
- Supervision of employees, and independent contractors
Rental services do 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 real estate.
Rental services can be performed by owners or by employees, agents, and/or independent contractors of the owner.
The taxpayer must:
- Treat each property as a separate RRE, or,
- Treat all similar properties held for the production of rents as a single enterprise. (Defacto aggregation.)
- Commercial and residential real estate may not be part of the same enterprise.
- Rev. Proc. Does not apply to a partner’s partnership interest, but if eligible can be aggregated with others.
- Real Estate does not qualify if:
- Treated as a residence under section 280A
- Rented or leased under a triple net lease
- Taxpayer or RPE must include a statement attached to the return on which it claims the section 199A deduction (or passes through the section 199A information) that the requirements in Section 3.03 of this revenue procedure (Rev. Proc 2019-07) have been satisfied.
- The statement must be signed by the taxpayer or an authorized representative of an eligible taxpayer or RPE, under penalty of perjury.