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Section 199A Trade or Business Safe Harbor: Rental Real Estate

Last week, the IRS issued a safe harbor that allows a taxpayer to treat a rental real estate enterprise as a trade or business solely for purposes of Section 199A, or the 20% deduction. To qualify as a trade or business under this safe harbor, the rental real estate enterprise must satisfy the requirements of the proposed revenue procedure. 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 section 199A if the enterprise otherwise meets the definition of trade or business under section 162. If the rental real estate qualifies as a trade or business, then it qualifies for the section 199A deduction.

Background:

Section 199A was newly enacted on December 22, 2017, as part of the Tax Cuts and Jobs Act. Congress enacted section 199A to provide a deduction to non-corporate taxpayers of up to 20 percent 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 percent of aggregate qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership income.

Notice 2019-07 Basics:

This safe harbor is available to taxpayers who seek to claim the deduction under section 199A with respect to a rental real estate enterprise. The safe harbor rules apply at the Individual level as well as the relevant passthrough entities (RPE).  RPE’s include partnerships and S corps with underlying real property rental investments.  In order for rental real estate activity to qualify for the section 199A deduction, that rental real estate activity must be a trade or business.

Definition of Rental Real Estate Enterprise:

Solely for purposes of this safe harbor, a rental real estate enterprise is defined as an interest in real property held for the production of rents and may consist of an interest in multiple properties.

Ownership of a Rental Real Estate Enterprise:

The individual or RPE must hold the interest directly or through an entity disregarded as an entity separate from its owner.

Determining the Trade or Business Enterprises:

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.  Therefore, taxpayers can combine all commercial rental real estate as an enterprise and treat all residential real estate properties as another enterprise.  Once the taxpayer determines how they would like to group their real estate enterprises, they may not vary this treatment from year-to-year unless there has been a significant change in facts and circumstances.

Once each enterprise has been identified, then each enterprise must meet the requirements under this safe harbor.

Qualifications Under the Safe Harbor:

Solely for the purposes of section 199A, a rental real estate enterprise will be treated as a trade or business if the following requirements are satisfied at the entity level during the taxable year with respect to the rental real estate enterprise:

  1. Separate books and records are maintained to reflect each enterprise’s income and expenses.
  2. For tax years before January 2023, 250 hours or more of rental services are performed per year with respect to the real estate enterprise; AND
  3. Taxpayer maintains contemporaneous records supporting time reports, logs or similar documents showing hours of all services performed, dates of when such services were performed and who performed the service.
  4. Note: requirement 3 doesn’t apply to the 2018 tax year.

What are Rental Services?

  1. Negotiation and executing leases
  2. Advertising to rent or lease the real estate
  3. Verifying tenant applications
  4. Daily operations, maintenance and repair of the property
  5. Collection of rent
  6. Management of the real estate
  7. Purchase of materials
  8. Supervision of employees and independent contractors.

It should be noted that the term rental services does not include hours spent to arrange financing, procuring property, studying and reviewing financials, planning, managing or constructing long-term capital improvements and hours spent traveling to and from the real estate.

Rental services may be performed by owners or by employees, agents, and/or independent contractors of the owners.

Certain Rental Real Estate Arrangements are Excluded as Part of the Safe Harbor:

  1. Real estate rented or leased under a triple net lease
  2. Vacation homes

Definition of 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. This includes a lease agreement that requires the tenant or lessee to pay a portion of the taxes, fees, and insurance, and to be responsible for maintenance activities allocable to the portion of the property rented by the tenant.

Procedural Requirements to Qualify Under this Safe Harbor:

A taxpayer or RPE must include a statement attached to the return on which it claims the section 199A deduction or passes through the 199A information. This statement must be signed by the taxpayer and the taxpayer must have personal knowledge of the facts and circumstances.

Sample Statement:

Statement under Revenue Procedure 2019-07

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.

_____________

Signed

Contact your Janover LLC representative for  any questions pertaining to this IRS Notice.

 

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