Rental Real Estate qualified for IRC 199A

Rental Real Estate qualifies for IRC 199A 

The Internal Revenue Service has issued conclusive regulations introducing a secure harbor provision. This provision stipulates that a rental real estate enterprise will be treated as a trade or business exclusively for the purposes of Internal Revenue Code Section 199A, which governs the qualified business income deduction.

The Tax Cut and Jobs Act (TCJA) of 2017 established the Internal Revenue Code Section (IRC) 199A to grant non-corporate taxpayers a deduction of up to 20% on their qualified business income from each of their qualified trades or businesses. This deduction applies to businesses operated through partnerships, S corporations, sole proprietorships, as well as a deduction of up to 20% of aggregate qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership income.

According to Code Section 199A(d), a qualified trade or business is defined as any trade or business except for a Specified Service Trade or Business (SSTB) or the trade or business of performing services as an employee.

Furthermore, Regulation 1.199A-1(b)(14) defines a trade or business as outlined under IRC 162, except for the trade or business of performing services as an employee.

With these regulations in place, the IRS has brought clarity to the treatment of rental real estate enterprises as a trade or business for the purposes of the qualified business income deduction, providing taxpayers with clearer guidelines for their tax filings. 

Last year, the IRS finalized the safe harbor rules, deeming rental real estate qualified for the IRC 199A. This development has opened doors for numerous real estate investors to claim an additional 20% business deduction under the mentioned IRC section.

The safe harbor rules, now in effect, are applicable to taxpayers seeking to claim the deduction under Code Section 199A concerning a rental real estate enterprise, as defined in "Rental real estate enterprise."

If the safe harbor requirements are met, the rental real estate enterprise will be considered a single trade or business, as defined in Code Section 199A(d), for the purpose of applying the regulations under Code Section 199A, including the aggregation rules.

A Relevant Passthrough Entity (RPE) comprises a partnership (excluding publicly traded partnerships) or an S corporation owned, directly or indirectly, by at least one individual, estate, or trust. RPEs can also take advantage of this safe harbor provision.

To benefit from the safe harbor, both taxpayers and RPEs must fulfill all the requirements outlined in the revenue procedure.

Not meeting the requirements of this safe harbor does not prevent a taxpayer or the IRS from otherwise demonstrating that an interest in rental real estate qualifies as a trade or business.

It's important to note that the safe harbor provided by the revenue procedure applies solely for the purposes of Code Sec. 199A. 

A rental real estate enterprise, as defined solely for the purposes of the safe harbor, pertains to an interest in real property held to generate rental income. It can comprise a single property or multiple properties.

Taxpayers or Relevant Passthrough Entities (RPEs) utilizing the Revenue Procedure must directly hold each interest or hold it through an entity disregarded as separate from its owner according to any Internal Revenue Code provision.

With the exception of property interests categorized as "Excluded real estate arrangements," taxpayers and RPEs may either treat each interest in similar properties held for rental income as separate rental real estate enterprises or combine interests in all similar properties to form a single rental real estate enterprise.

For this Revenue Procedure's application, properties held for rental income are considered similar if they belong to the same rental real estate category. The two categories are residential and commercial, meaning commercial properties can only be part of the same enterprise with other commercial properties, and residential properties with other residential properties.

Once a taxpayer or RPE designates interests in similar commercial or residential properties as a single rental real estate enterprise under the safe harbor, they must continue treating all similar properties, including newly acquired ones, as a single rental real estate enterprise as long as they rely on the safe harbor.

Alternatively, those who choose to treat each residential or commercial property interest as a separate rental real estate enterprise may opt to treat all similar commercial or residential properties as a single rental real estate enterprise in a future year.

Mixed-use property, which combines residential and commercial units within a single building, can be treated as a single rental real estate enterprise or separated into distinct residential and commercial interests.

Each rental real estate enterprise that meets the safe harbor requirements is considered a separate trade or business for applying these rules.

The Safe Harbor Defined

The decision to utilize this safe harbor must be made on an annual basis.

For the purposes of IRC 199A, each rental real estate enterprise will be regarded as a single trade or business if the following requirements are fulfilled during the tax year:

1. Separate books and records are maintained for each rental real estate enterprise to reflect income and expenses. If there are multiple properties within the enterprise, income and expense information statements for each property can be maintained and then consolidated.
2. For rental real estate enterprises in existence for less than four years, a minimum of 250 hours of rental services must be performed per year with respect to the enterprise. For rental real estate enterprises in existence for at least four years, 250 or more hours of rental services are required in any three of the five consecutive tax years that end with the current tax year.
3. Contemporaneous records, such as time reports, logs, or similar documents, must be kept, detailing the hours, descriptions, dates, and performers of all services related to the rental real estate enterprise. If services are performed by employees or independent contractors, relevant records and payment information should also be available for IRS inspection.
4. A statement must be attached to a timely filed original return (or an amended return for the 2018 tax year only) for each tax year in which the safe harbor is relied upon. If a taxpayer or RPE has multiple rental real estate enterprises using the safe harbor, a single statement may be submitted, but it should list the required information separately for each enterprise, including property descriptions and representations of compliance with the Revenue Procedure.

Rental Services

Rental services, for the purposes of this Revenue Procedure, encompass activities like advertising for rental or lease, lease negotiation and execution, tenant application verification, rent collection, property maintenance and repair, property management, and employee or contractor supervision. However, it does not include financial or investment management activities like property financing, procurement, financial analysis, or travel time to and from the real estate.

Excluded Real Estate

Certain types of property may not be included in a rental real estate enterprise and are thus ineligible for the safe harbor:

1. Real estate used by the taxpayer (including an owner or beneficiary of an RPE) as a personal residence under Code Sec. 280A(d).
2. Real estate leased under a triple net lease, which requires the tenant to pay taxes, fees, insurance, and maintenance costs in addition to rent and utilities.
3. Real estate rented to a trade or business conducted by the taxpayer or an RPE under common control.
4. Any rental real estate interest that includes a portion treated as a Specified Service Trade or Business (SSTB).

Effective Date

The Revenue Procedure applies to tax years ending after December 31, 2017. Alternatively, taxpayers and RPEs can rely on the safe harbor outlined in Notice 2019-7 for the 2018 tax year. The contemporaneous records requirement will not apply to tax years beginning before January 1, 2020. However, taxpayers are reminded that they bear the burden of providing evidence for claimed deductions in all tax years.