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Rental Real Estate Safe Harbor for Qualified Business Income Deduction (Code Section 199A)

One of the major provisions of the Tax Cuts and Jobs Act was the creation of a new deduction (Code Section 199A) for business owners operating as a sole proprietor, as a shareholder in an S Corporation or a partner in a partnership venture. This new deduction also extended to the owners of rental real estate; however, the initial guidelines were unclear as to what properties qualified and how to substantiate the activities of the rental owner.

Subsequently, the IRS has released safe harbor guidelines for those who think they may qualify for the new deduction. Solely for the purposes of the qualified business income deduction, Section 199A, a rental real estate enterprise will be treated as a trade or business if the following safe harbor requirements are satisfied during the taxable year with respect to the rental real estate enterprise:

  • Separate books and records are maintained to reflect income and expenses for each rental real estate enterprise;

  • 250 or more hours of rental services (see below for listing) are performed per year with respect to the rental enterprise; and

  • The taxpayer maintains contemporaneous records, including time reports, logs, or similar documents, regarding the following: (i) hours of all services performed; (ii) description of all services performed; (iii) dates on which such services were performed; and (iv) who performed the services. Such records are to be made available for inspection at the request of the IRS.

Rental services include: (i) advertising to rent or lease the real estate; (ii) negotiating and executing leases; (iii) verifying information contained in prospective tenant applications; (iv) collection of rent; (v) daily operation, maintenance, and repair of the property; (vi) management of the real estate; (vii) purchase of materials; and (viii) supervision of employees and independent contractors. Note that travel to and from the rental property(ies) does not count towards the 250 hours.

Real estate used by the taxpayer as a residence for any part of the year is not eligible for this safe harbor. Real estate rented or leased under a triple net lease is also not eligible for this safe harbor (however, it may still qualify as a trade or business based on the activities of the owner). A triple net lease includes a lease agreement that requires the tenant or lessee to pay taxes, fees, and insurance, and to be responsible for maintenance activities for a property in addition to rent and utilities. This includes a lease agreement that requires the tenant or lessee to pay a portion of the taxes, fees, and insurance, and to be responsible for maintenance activities allocable to the portion of the property rented by the tenant.

If the taxpayer elects the safe harbor method, they must include a statement attached to the return on which it claims the section 199A deduction. The IRS has created a new form, Form 8995, Qualified Business Income Deduction, to be used when claiming this deduction.

 

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