IRS Notice Grants Favorable Safe Harbor for Real Estate Professionals
Much of the talk surrounding the Tax Cuts and Jobs Act (“TCJA”) has been about the new Section 199A Qualified Business Income (“QBI”) deduction and its impact on pass-through entities and their owners. This provision allows for pass-through entity owners to receive a deduction up to 20% of their qualified business income if they meet certain criteria.
However, there has been tremendous uncertainty as to whether the rules, as written, allowed for those engaged in a real estate business to qualify for the QBI deduction. In order for income to qualify it must be derived from a qualified trade or business. Both the Internal Revenue Code (“IRC”) and the Treasury Regulations define a trade or business as any trade or business under IRC Section 162, but excludes specified service businesses and any income earned while performing services as an employee.
This definition left uncertainty for some taxpayers engaged in rental real estate activities. Recognizing the need for clarification, the IRS recently released Notice 2019-07. This notice contains a proposed revenue procedure providing a safe harbor under which a rental real estate enterprise is considered a trade or business solely for purposes of Section 199A and the accompanying regulations.
The safe harbor requires that taxpayers meet all of the following criteria:
- Separate books and records are maintained to reflect income and expenses for each rental real estate enterprise;
- For tax years prior to January 1, 2023, 250 or more hours of rental services are performed. For tax years beginning after December 31, 2023, 250 hours or more hours of rental services are performed in three out of five consecutive years ending with the current tax year; and
- The taxpayer must maintain contemporaneous records documenting the rental services hours including time logs as well as reports or similar documents detailing the dates, number of hours, services performed, and who performed the services.
This is a safe harbor, meaning that failing to meet the above criteria does not preclude a taxpayer from otherwise establishing that their rental real estate enterprise is a trade or business. Taxpayers claiming the Section 199A deduction or are passing through Section 199A information must attach a signed statement to their return stating that the safe harbor provisions have been met.
The proposed revenue procedure explicitly excludes taxpayers renting real estate with a triple net lease from claiming this safe harbor. As with many of the changes under the TCJA, each taxpayer’s facts and circumstances should be analyzed individually. However, the proposed revenue procedure appears to be taxpayer-friendly and an opportunity for those engaged in the real estate business.