Section 199A—IRS Safe Harbor and Your Rental Property, What You Need to Know
Background: The Tax Cut and Jobs Act allows a deduction to a non-corporate taxpayer for up to 20% of Qualified Business Income (“QBI”). Click here for a more detailed discussion of the deduction. The starting point for QBI is income from a “trade or business”. There has been quite a bit of discussion of when a rental real estate activity rises to the level of a trade or business. Many tax practitioners and others asked the IRS to establish a bright-line test for this purpose. Instead on January 18 the IRS released Notice 2019-07 which establishes a safe harbor that taxpayers may use to determine when a rental real estate enterprise may be treated as a trade or business solely for purposes of Section 199A until further guidance is issued.
The safe harbor is available for tax years beginning after December 31, 2017 but adds a contemporaneous recordkeeping requirement described below beginning in 2019. Taxpayers have the choice of treating each property held for the production of rents as a separate enterprise treating all similar properties as a single enterprise. Commercial and residential properties are not similar and cannot be part of the same enterprise.
Taxpayers who want to use the safe harbor should begin keeping contemporaneous records as soon as possible for 2019 (Note: this record requirement is not applicable to taxable years beginning prior to January 1, 2019). These records must include reports, logs, and/or similar documents regarding the following:
- hours of all services performed;
- descriptions of all services performed;
- dates on which such services were performed; and
- who performed the services.
After a taxpayer meets the IRS’s 250 hour safe harbor threshold in a given taxable year, the rental enterprise may be treated as a trade or business for 199A purposes (i.e. the income qualifies for the up to 20% deduction). These records should be maintained for (up to) 8 years after the return if filed and are to be made available for inspection at the request of the IRS. The services that count toward this safe harbor can be performed by owners, employees, agents, and/or independent contractors. Specifically, a general list of services that qualify and do not qualify is provide below:
|Does Not Qualify
|Advertising to rent or lease the real estate
|Negotiating and executing leases
|Verifying information contained in prospective tenant applications
|Studying and reviewing financial statements or reports on operations
|Collection of rent
|Planning, managing, or constructing long-term capital improvements
|Daily operation, maintenance, and repair of the property
|Time spent traveling to and from the real estate
|Management of the real estate
|Other financial or investment management activities
|Purchase of materials
|Supervision of employees and independent contractors
- The safe harbor cannot be used for:
- Property used by the taxpayer as a residence (including a vacation residence) for any part of the year
- Real Estate rented or leased under a triple net lease.
- The taxpayer must attach a statement to the return reporting the income, signed under penalties of perjury, that the safe harbor requirements were met.
Failure to meet the safe harbor requirements does not preclude the taxpayer from otherwise establishing that the enterprise is a trade or business under IRC §162 and claiming the deduction.