As part of the IRS’ continuing efforts to clarify the intricacies of the Qualified Business Income Deduction under IRC §199A, Rev. Proc. 2019-38 was issued on Tuesday, September 24, 2019. This Revenue Procedure provides information regarding the safe harbor that allows a rental activity to be treated as a trade or business for the purposes of §199A.
Taxpayers may rely on the safe harbor for the 2018 taxable year. Taxpayers have until January 1, 2020 to comply with the contemporaneous records rules set forth within the Revenue Procedure. This safe harbor is only necessary in the case that a taxpayer has determined that a rental activity does not rise to the level of a trade or business. For those rental activities that are already considered a trade or business, the safe harbor does not apply.
In order to determine whether an activity is a trade or business for §199A, you must look to §162. There is a provision in §1.199A-1(b)(14) that allows a rental activity that does not otherwise rise to the level of a §162 trade or business to be treated as such for purposes of §199A so long as the property is rented to a trade or business conducted by the individual or a commonly controlled relevant passthrough entity (RPE). Noting that determining whether or not a rental activity rises to the level of a trade or business was not easy to do, the IRS previously issued a proposed revenue procedure in Notice 2019-07 that outlined a safe harbor for rental real estate activities. This final Revenue Procedure is the guidance that should be referred to going forward.
The safe harbor is available to all rental real estate enterprises that meet the requirements outlined in the Revenue Procedure. 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 a single property or multiple properties. A taxpayer applying the safe harbor must own the property either directly or through a disregarded entity. The taxpayer may either treat each rental enterprise separately or may treat all similar properties together as one enterprise. While all commercial properties or all residential properties may be considered similar, residential and commercial properties cannot be combined into a single real estate enterprise. Once a taxpayer opts to treat rental activities as a single enterprise, they must continue to do so and must include any newly acquired properties for as long as they rely on the safe harbor. Interest in a mixed-use property may be treated as a single rental real estate enterprise or may be bifurcated into a residential and commercial enterprise. If a mixed-use property is treated as a single rental real estate enterprise under the safe harbor, a taxpayer will not be able to combine it with other residential or commercial activities.
199A Safe Harbor Requirements
The requirements that must be satisfied are as follows:
- Separate books and records must be maintained to reflect income and expenses for each rental real estate enterprise. If the enterprise contains more than one property, information can be maintained separately and then consolidated.
- For enterprises in existence fewer than four years, 250 or more hours of rental services must be performed each year. For enterprises in existence at least four years, 250 or more hours of rental services must be performed per year in any of three of the five consecutive taxable years that end with the taxable year.
- Taxpayer must maintain contemporaneous records, including time reports or logs reflecting the following information:
- Hours of all services performed
- Description of all services performed
- Dates on which the services were performed
- Who performed the services
If the services are performed by an employee or independent contractor, the taxpayer may provide a description of services, the amount of time spent and time, wage and payment records.
- The taxpayer or RPE attaches a statement to a timely filed return (or an amended return for the 2018 tax year only) for each taxable year in which the taxpayer or RPE relies on the safe harbor. A single statement may be attached but it must list the required information for each separate rental real estate enterprise. The statement must include the following:
- Description of all rental real estate properties that are included in each enterprise;
- Description (including the address and rental category) of all properties acquired or disposed in the year; and
- A representation that the requirements of Rev. Proc. 2019-38 have been met.
In determining whether or not a taxpayer meets the 250 hour requirement for rental services, the activities listed below are specifically included. The services can be performed by owners, employees or agents of the owner. Rental services do not include financial or investment activities including arranging financing or preparing financial statements, or hours traveling to and from the real estate.
- Advertising to rent or lease
- Negotiating and executing leases
- Verifying prospective tenant information
- Collection of rents
- Daily operation, maintenance, and repair of the property, including purchase of materials and supplies
- Management of the real estate
- Supervision of independent contractors and employees
There are also types of real estate that may not take advantage of the safe harbor: (1) Property used by the taxpayer; (2) Property rented or leased under a triple net lease; (3) Real estate rented to a trade or business conducted by the taxpayer or an RPE under common control under §1.199A-4(b)(1)(i); or (4) Property that has any portion treated as a specified service trade or business (SSTB) under §1.199A-5(c)(2). A triple net lease agreement is defined as one that requires the tenant or lessee to pay taxes, fees, and insurance and to pay for maintenance activities for a property in addition to rent and utilities.
If you have any questions about how this safe harbor may apply to your facts and circumstances, please reach out to the Withum Real Estate Services Group.
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