Treasury Offers Real Estate Safe Harbor for Purposes of the Qualified Business Income Deduction
On January 18, 2019, the Internal Revenue Service (IRS) and United States Treasury Department released Notice 2019-07 which provides a safe harbor to taxpayers with rental real estate income to be treated as qualified trades or businesses and claim the Section 199A deduction. To be eligible for the safe harbor, the taxpayer must maintain separate records for each rental real estate enterprise, perform at least 250 hours of real estate services, and maintain contemporaneous records of the performance. Taxpayers ineligible for the safe harbor may still qualify for the Section 199A deduction, provided the activity otherwise meets the definition of a trade or business.
Section 199A was enacted with the Tax Cuts and Jobs Act in late 2017 to provide non-corporate taxpayers a deduction of up to 20% of qualified business income (QBI) from each of the taxpayer’s qualified trades or businesses. A qualified trade or business is any trade or business other than a specified service trade, business, or work performed as an employee. Qualified trades or businesses include those operated through partnerships, S-Corps, sole proprietorships, and dividends from qualified REIT’s or publicly traded partnerships.
Uncertainty surrounded how a rental real estate enterprise could qualify as a trade or business for Section 199A purposes. Notice 2019-07 provides a safe harbor and a measure of certainty. Taxpayers may rely on this safe harbor for tax years ending after December 31, 2017.
A rental real estate enterprise will be eligible for the safe harbor, and thus be treated as a trade or business for purposes of Section 199A, if it satisfies the following three requirements:
- The taxpayer maintains separate books and records for each rental real estate enterprise to reflect income and expenses;
- 250-hour requirement:
- For tax years beginning before January 1, 2023, the taxpayer must perform at least 250 hours of rental real estate services each year
- For tax years beginning after December 31, 2022, the taxpayer must perform at least 250 hours of rental real estate services in three of five consecutive years ending with the current taxable year; and
- The taxpayer must maintain contemporaneous records of: 1) hours of service, 2) descriptions of the service, 3) dates of service, and 4) identification of those that performed the service. (Note: this third requirement will only apply to tax years beginning on or after January 1, 2019).
A rental real estate enterprise is an interest in real property held for rent and, solely for the purposes of this safe harbor, may consist of an interest in multiple properties. The taxpayer must either treat each property as its own separate enterprise or treat all similar properties as one single enterprise. However, the taxpayer may not include both commercial and residential real estate in the same enterprise.
The Notice also provides that rental services will include 1) advertising to rent or lease real estate, 2) negotiating and executing leases, 3) verifying information in prospective tenant applications, 4) rent collection, 5) daily maintenance, operation, and repair, and 6) supervision of employees and independent contractors. These services may be performed by owners, agents of the owners, or employees. Services do not include financial or investment management activities.
Of particular note, the Notice provides specific guidance for triple-net leases. Real estate rented or leased under a triple net lease is ineligible for the safe harbor. A triple net lease includes a lease agreement that requires tenants or lessees to be pay taxes, maintenance and insurance, as well as rent and utilities. Additionally, the real estate is ineligible for the safe harbor if it is used as a residence by the taxpayer for any part of the year.
To take advantage of the safe harbor, the taxpayer must include a signed statement with the tax return stating that the requirements have been met. The taxpayer or an authorized representative can sign the statement, but he or she must have personal knowledge of the pertinent facts and circumstances.
What Does CohnReznick Think?
The IRS has removed some of the uncertainty relating to real estate and the Section 199A deduction by providing a safe harbor for taxpayers with bright line tests in time for 2018 tax return filings. Additionally, the Notice provides much needed guidance for those taxpayers that have multiple rental real estate activities. Unfortunately, the question as to whether triple-net leases can qualify as a trade or business remains unanswered, although we do know it cannot qualify under the safe harbor. Taxpayers should consult their tax advisors to ensure their eligibility for and satisfaction of the safe harbor requirements.
For more information, please contact Brian Newman, Partner, National Tax, at Brian.Newman@CohnReznick.com or (959) 200-7009.
Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.
Tax Reform: The Tax Cuts and Jobs Act –
What you need to know, now