In January 2019, the IRS issued Notice 2019-07 which contains a proposed revenue procedure safe harbor under which a rental real estate enterprise will be treated as a trade or business solely for purposes of IRC section 199A. The IRS recently issued Revenue Procedure 2019-38 which contains the final rules for this safe harbor.
IRC section 199A provides for a deduction to non-corporate taxpayers of up to 20% of the taxpayer’s qualified business income from each of the taxpayer’s qualified trades or businesses, including those operated through a partnership, S corporation, or sole proprietorship, as well as a deduction of up to 20% of aggregate real estate investment trust dividends and qualified publicly traded partnership income. The regulations for IRC section 199A state that a trade or business for purposes of the deduction is generally a trade or business under IRC section 162 other than the trade or business of performing services as an employee. In addition, the regulations state that rental or licensing of tangible or intangible property (rental activity) that does not rise to the level of a section 162 trade or business is nevertheless treated as a trade or business for purposes of IRC section 199A, if the property is rented or licensed to a trade or business conducted by the individual or a relevant pass-through entity which is commonly controlled.
In other words, an individual does not have to report the rental activity on a Schedule C as a sole proprietorship to claim the deduction. Rental real estate activities reported on a Schedule E may also qualify as a trade or business for purposes of the deduction, but only if there is a certain level of services provided in relation to the Schedule E rental activity.
To help mitigate the uncertainty of whether or not a rental real estate activity rises to the level of a trade or business for purposes of IRC section 199A, Revenue Procedure 2019-38 provides the final rules for the safe harbor that was originally proposed in Notice 2019-07. If the safe harbor requirements are met, the rental real estate enterprise will be treated as a single trade or business for purposes of applying the regulations under IRC section 199A, including the application of the aggregation rules. Partnerships and S corporations may also use this safe harbor. Failure to satisfy all of the requirements of the safe harbor does not preclude a taxpayer or the IRS from otherwise establishing that the rental real estate activity is a trade or business for purposes of IRC section 199A.
Safe harbor. The determination to use this safe harbor must be made annually. Each rental real estate enterprise will be treated as a single trade or business if all of the following requirements are satisfied during the tax year:
A) Separate books and records are maintained to reflect income and expenses for each rental real estate enterprise. If a rental real estate enterprise contains more than one property, income and expense information statements for each property must be maintained and then consolidated.
B) For rental real estate enterprises that have been in existence less than four years, 250 or more hours of rental services are performed per year with respect to the rental real estate enterprise. For rental real estate enterprises that have been in existence for at least four years, in any three of the five consecutive tax years that ends with the current tax year, 250 or more hours of rental services are performed per year with respect to the rental real estate enterprise.
C) 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.
If services with respect to the rental real estate enterprise are performed by employees or independent contractors, the taxpayer may provide a description of the rental services performed by such employee or independent contractor, the amount of time such employee or independent contractor generally spends performing such services for the enterprise, and time, wage, or payment records for such employee or independent contractor
D) A statement is attached to a timely filed original return (or an amended return for the 2018 tax year only) for each tax year in which the taxpayer relies on this safe harbor. A single statement may be submitted, but the statement must list the required information separately for each rental real estate enterprise. The statement must include the following information:
- A description (including the address and rental category) of all rental real estate properties that are included in each rental real estate enterprise,
- A description (including the address and rental category) of rental real estate properties acquired and disposed of during the tax year, and
- A representation that the requirements of this revenue procedure have been satisfied.
Multiple properties. Taxpayers may either treat each interest in real estate properties as separate rental real estate enterprises, or treat each interest in similar properties as a single rental real estate enterprise. Similar real estate properties for purposes of combining properties into a single rental real estate enterprise means they are either all residential or commercial. Thus, commercial real estate held for the production of rents may only be part of the same enterprise with other commercial real estate, and residential properties may only be part of the same enterprise with other residential properties. Once multiple properties are combined into one enterprise, the taxpayer must continue to treat each property as a single rental real estate enterprise when using this safe harbor. However, if properties are each treated as separate enterprises for the current year, the taxpayer may choose to treat each similar property as a single rental real estate enterprise in a future year
Rental services. For purposes of the safe harbor, rental services include, but are not limited to:
- Advertising to rent or lease the real estate,
- Negotiating and executing leases,
- Verifying information contained in prospective tenant applications, iv) Collection of rent,
- Daily operation, maintenance, and repair of the property, including the purchase of materials and supplies,
- Management of the real estate,
- Supervision of employees and independent contractors
Rental services may be performed by owners, including owners of partnerships and S corporation, or by employees, agents, and/or 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, improving property, or hours spent traveling to and from the real estate.
Certain rental real estate arrangements excluded. The following types of property may not be included in a rental real estate enterprise for purposes of this safe harbor:
- Real estate used by the taxpayer as a personal residence,
- Real estate rented or leased under a triple net lease. A triple net lease includes a lease agreement that requires the tenant or lessee to pay taxes, fees, and insurance, and to pay for maintenance activities for property in addition to rent and utilities,
- Real estate rented to a trade or business conducted by a taxpayer (including a partnership or S corporation) which is commonly controlled under Regulation section 1.199A-4(b)(1)(i).
- The entire rental real estate interest if any portion of the interest is treated as a specified service trade or business (SSTB). See Regulation section 1.199A-5(c)(2) for special rules where property or services are provided to an SSTB.
Note: Article courtesy of Tax Materials, Inc, Minnetonka, MN