The IRS recently issued a new notice providing a “Safe Harbor” for rental real estate businesses to qualify for the 20% qualified business income deduction under Section 199A.
The IRS published Notice 2019-07, which provides a “safe harbor” with respect to whether or not a rental real estate enterprise can qualify for the 20% qualified business income deduction under Section 199A of the Internal Revenue Code. Recall, Section 199A came into being as part of the tax law passed in December of 2017 and applies to certain “pass-through” entities, e.g. partnerships and S corporations.
While the IRS has continually referred to Section 162 of the Code for defining a trade or business, this standard has always remained unclear for those engaged in the rental business; because, in rental business situations, emphasis remained on a taxpayer’s specific facts and circumstances. As such, the Treasury Department and IRS were entirely aware of the uncertainly existing for many taxpayers in this area.
When Does The Safe Harbor Apply?
Under the new notice, a safe harbor applies where at least 250 hours are devoted to the rental business each year (including hours work by owners, employees, or contractors). Tasks qualifying include time spent on repairs, collecting rent, negotiating leases, and tenant services. It’s worth noting that time spent driving to and from various parcels of rental real estate are specifically excluded.
According to the notice, taxpayers may treat separate properties as separate enterprises or, alternatively, treat similar properties as a single enterprise. However, commercial and residential real estate may NOT be treated as part of the same enterprise. Further, real estate used by a taxpayer as a residence for any part of the year is not eligible. The same goes for any property subject to a “triple net” lease (e.g., a lease where the tenant is responsible for paying taxes, fees, maintenance, and insurance with respect to the property).
The notice provides very strict record keeping rules that must be complied with in order to be eligible for the deduction.
Lastly, the current safe harbor rules are subject to change, according to the IRS, who have indicated the current rules may be changed in the future. Even so, accounting professional are currently lobbying the IRS to lower the threshold to 100 hours per year; and the IRS is continuing to accept comments to this proposed revenue procedures addressing this issue.