When it comes to Section 199A advantages under new tax reform, many taxpayers engaged in the real estate industry were left waiting to find out if they would qualify for the benefits. Notice 2019-07 provides additional guidance specific to rental real estate activities.
Section 199A was designed to help eligible taxpayers deduct up to 20 percent of their qualified business income. To qualify for the deduction, taxpayers must demonstrate they have “trade or business” income under Section 162, which is defined in the regulations 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.”
Rental Real Estate Enterprises
Under the safe harbor rule, a rental real estate enterprise (RREE) is deemed to be a Section 162 trade or business if it satisfies certain specific requirements. RREEs making the safe harbor election may claim the 199A deduction. If an enterprise fails to satisfy the requirements of this safe harbor, the rental real estate enterprise may still be treated as a trade or business for purposes of Section 199A if the enterprise otherwise meets the definition of a trade or business.
The regulations define a rental real estate enterprise, solely for the purpose of the 199A deduction, as “an interest in real property held for the production of rents and may consist of an interest in multiple properties…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. Commercial and residential real estate may not be part of the same enterprise.” The taxpayer or relevant pass-through entity (RPE) has to directly hold the interest or hold the interest through a disregarded entity. Taxpayers are prohibited from changing the treatment of properties after the initial filing.
Safe Harbor Rules
To qualify for the safe harbor election, all of the following requirements set forth in the regulations need to be met:
- Books and records need to be maintained separately for each rental real estate enterprise;
- For years beginning prior to January 1, 2023, a minimum of 250 hours has to be spent performing rental activities with respect to the rental enterprise in the given year. For years beginning after December 31, 2022, the 250-hour minimum performance requirement is no longer mandatory on an annual basis but needs to be met in any three of the five consecutive years; and
- Contemporaneous records must be maintained, including documentation of hours of services performed, description of services performed, dates services were performed, and who performed the services. This applies to tax years beginning after December 31, 2018.
The following services are included and considered rental activities with respect to the deduction:
- Any advertising and/or marketing used to rent or lease the property;
- Negotiating and executing leases;
- Verifying prospective tenant applications;
- Collecting rent payments;
- Assisting in the daily operations of the property including repairs and maintenance, along with management of the property, purchase of any materials and supervision of employee(s) and independent contractors.
These services can be performed by the owners themselves or their employees/independent contractors. Financial or investment activities are specifically excluded from this definition of qualifying services. This includes organizing financing, acquiring property, reviewing financial statements/reports on operations and time spent commuting to and from real estate.
If the taxpayer used any part of the rental property as a personal residence or if the property was leased under a triple net lease, the enterprise is ineligible for this safe harbor.
Taxpayers (individuals or RPEs) relying on the safe harbor must attach a statement confirming that the specified information satisfies the safe harbor rules. An example of such statement follows.
Election to Claim Section 199A under IRS Notice 2019-07 Safe Harbor
The taxpayer meets the following requirements to be treated as a trade or business for purposes for IRC § 199A:
- The taxpayer maintains separate books and records to reflect income and expenses for each rental real estate enterprise.
- The taxpayer performed 250 or more hours of rental services (as described in Revenue Procedure 2019-07) per year with respect to the rental real estate enterprise.
For tax years after 2018, the statement must also include a representation regarding contemporaneous records such as:
- The taxpayer maintained a contemporaneous record, including time reports, logs, or similar documents regarding (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.
The statement must be signed by the taxpayer or authorized representative of the RPE, and must include the following language:
“Under penalties of perjury, I (we) declare that I (we) have examined the statement, and, to the best of my (our) knowledge and belief, the statement contains all the relevant facts relating to the revenue procedure, and such facts are true, correct, and complete.”
Although not yet codified, this Notice can be relied upon for tax years ending after December 31, 2017.