IRS Finalizes Safe Harbor for Rental Real Estate Enterprise to Qualify as Business for QBI Deduction
Eli Noff, Esq., Partner
As we previously reported in Section 199A: New 20% Pass-Through Deduction,[1] the Tax Cuts and Jobs Act of 2017 created Internal Revenue Code (IRC) §199A, which provides a tax break to flow-through entities. Basically, some eligible taxpayers (excluding C corporations) may deduct up to 20% of “qualified business income” (QBI). Significantly, even qualified rental real estate businesses may benefit under this provision. We’ve closely followed the developments in the rental real estate business, reporting recently that the Internal Revenue Service (IRS) had issued a notice containing a proposed revenue procedure, providing a safe harbor for certain real estate enterprises eligible for treatment as a trade or business for purposes of the deduction.[2]We can now report that on September 24, 2019, the IRS issued IR-2019-158 stating that it finalized the safe harbor in Revenue Procedure 2019-38[3](Rev. Proc. 2019-38).
According to the IRS, if the safe harbor requirements are satisfied, an interest in rental real estate is treated as a single trade or business for purposes of the QBI deduction. The IRS clarified that:
Solely for purposes of this safe harbor, a rental real estate enterprise is defined as an interest in real property held to generate rental or lease income. It may consist of an interest in a single property or interests in multiple properties. The taxpayer or a relevant passthrough entity (RPE) relying on this revenue procedure must hold each interest directly or through an entity disregarded as an entity separate from its owner, such as a limited liability company with a single member.[4]
Taxpayers or RPEs must meet the following requirements to qualify for the safe harbor:
- Maintain separate books and records to reflect income and expenses for each enterprise;
- Rental real estate enterprises that have existed less than four years, must perform 250 or more hours of rental services per year. Other rental real estate enterprises must perform 250 or more hours of rental services in at least three of the past five years;
- Maintain contemporaneous records, such as time reports, logs, or similar documents, providing the following information regarding all services performed: (a) hours; (b) description; (c) dates of performance; and (d) the identity of who performed the services.
- Attach a statement to the return filed for the tax year(s) the safe harbor is being relied upon.
The IRS also explains that if an interest in real estate fails to satisfy the safe harbor requirements, it may still be treated as a trade or business for purposes of QBI deduction if it otherwise satisfies the definition of a trade or business in the §199A regulations.[5]
According to the IRS, Rev. Proc. 2019-38 applies to taxable years ending after December 31, 2017; however, taxpayers may continue to rely on the safe harbor set forth in the early proposed guidance, for the 2018 taxable year. Note that the contemporaneous records requirement is not applicable to taxable years beginning before January 1, 2020.
If you have questions about whether an investment in real estate qualifies as a real estate business entitled to the QBI deduction, call Frost Law today at 410-497-5947.
[1] https://www.districtofcolumbiataxattorney.com/Articles/Section-199A-New-20-Pass-Through-Deduction.shtml. [2] See QBI Guidance Issued; Safe Harbor Provided for Real Estate Enterprisesat: https://www.districtofcolumbiataxattorney.com/Articles/QBI-Guidance-Issued-Safe-Harbor-Provided-for-Real-Estate-Enterprises.shtml. [3] 2019-42 I.R.B. __ (Oct. 15, 2019). [4] IR-2019-158 (Sept. 24, 2019). [5] Id.
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