A significant question related to the new Sec. 199A 20% Qualified Business Income (QBI) deduction provisions is when a real estate rental will be eligible for the 20% deduction. On January 18, 2019, in an Notice that contains a proposed revenue procedure, IRS provided a safe harbor under which a rental real estate enterprise will be treated as a trade or business solely for the purposes of Code Sec. 199A, the QBI deduction.
Background. Congress enacted Code Sec. 199A to provide 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 qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership income.
Code Sec. 199A(d) defines a qualified trade or business as any trade or business other than a specified service trade or business (SSTB) or the trade or business of performing services as an employee. Reg § 1.199A-1(b)(14) defines trade or business, in relevant part, as a trade or business under Code Sec. 162 other than the trade or business of performing services as an employee.
Proposed revenue procedure safe harbor. The proposed revenue procedure provides a safe harbor for treating a rental real estate enterprise as a trade or business solely for purposes of the Code Sec. 199A deduction. If an enterprise fails to satisfy these requirements, the rental real estate enterprise 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). Relevant pass-through entities (RPEs), as defined in Reg. §1.199A-1(b)(10), may use the safe harbor in order to determine whether a rental real estate enterprise is a trade or business.
Safe harbor. Solely for the purposes of Code Sec. 199A, a rental real estate enterprise will be treated as a trade or business if the following requirements are satisfied during the tax 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 tax years beginning prior to Jan. 1, 2023, 250 or more hours of rental services are performed (as described below) per year with respect to the rental enterprise. For tax years beginning after Dec. 1, 2022, in any three of the five consecutive tax years that end with the tax 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 below) per year with respect to the rental real estate enterprise; and
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. Such records are to be made available for inspection at the request of the IRS.
The contemporaneous records requirement will not apply to tax years beginning prior to Jan. 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/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; planning, managing, or constructing long-term capital improvements; or hours spent traveling to and from the real estate.
Real estate used by the taxpayer (including an owner or beneficiary of an RPE relying on this safe harbor) as a residence for any part of the year under Code Sec. 280A is not eligible for this safe harbor. Real estate rented or leased under a triple net lease is also not eligible for this safe harbor. For purposes of the revenue procedure, a triple net lease includes a lease agreement that requires the tenant or lessee to pay taxes, fees, and insurance, and to be responsible for maintenance activities for a property in addition to rent and utilities.
Effective date/reliance. The proposed revenue procedure is proposed to apply to tax years ending after Dec. 1, 2017.
Until such time that the proposed revenue procedure is published in final form, taxpayers may use the safe harbor described in the proposed revenue procedure for purposes of determining when a rental real estate enterprise may be treated as a trade or business solely for purposes of Code Sec. 199A.
If you would like more information on this topic or another tax topic of interest to you, please contact our office.
—McAvoy + Co, CPA