Final Section 199A IRS Regulations Propose Safe Harbor for Rental Real Estate

By Nick Spoltore, Esq. 

January 21, 2019

As you probably are aware, final regulations were issued January 18, 2019 implementing the new Qualified Business Income (QBI) deduction of §199A. In response to arguably the most requested clarification from tax professionals, Notice 2019-07 separately issued a proposed revenue procedure containing a safe harbor under which a rental real estate enterprise will be treated as a trade or business solely for purposes of §199A. The failure to satisfy the safe harbor requirements will not preclude a rental real estate enterprise from otherwise establishing itself as a trade or business for §199A purposes.

For purposes of the safe harbor, a rental real estate enterprise is defined as an interest in real property held for the production of rents. It may consist of an interest in multiple properties. However, residential and commercial real estate may not be included in the same enterprise.

Solely for §199A purposes, then, a rental real estate enterprise will be treated as a trade or business if the following three requirements are met:

1. Separate books and records are maintained to reflect income and expenses for each rental real estate enterprise;
2. 250 or more hours of rental services are performed with respect to the enterprise in either three of the most recent five tax years or all tax years if the enterprise is under five years old; and
3. 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. This requirement does not apply to taxable years beginning prior to January 1, 2019.

The active requirement of 250 hours is roughly one hour per day for every Monday through Friday business day of the year. That’s not too bad a hurdle, particularly since specific rental services include (a) advertising to rent or lease the real estate; (b) negotiating and executing leases; (c) verifying information contained in prospective tenant applications; (d) collection of rent; (e) daily operation, maintenance, and repair of the property; (f) management of the real estate; (g) purchase of materials; and (h) supervision of employees and independent contractors. In addition, rental services may be performed by owners or by employees, agents, and/or independent contractors of the owners.

Rental services do not include financial or investment management activities, such as arranging financing; procuring property; studying and reviewing financial statements or reports on operations; planning, managing, or constructing long-term capital improvements; or hours spent traveling to and from the real estate. §280A real estate used as a residence is not eligible for the safe harbor. Nor are triple net leases eligible for the safe harbor.

Though this active participation provision may shake out to be the flagship item under the regs, the guidance also clarified issues regarding anti-abuse rules, REIT dividends, the determination of W-2 wages for purposes of QBI, and many other provisions – a number of which will generally be seen as taxpayer-friendly.

Nick Spoltore is VP of Tax & Advisory Content for Surgent CPE. Mr. Spoltore is a graduate of the University of Notre Dame and of Delaware Law School. Before joining Surgent, he practiced tax and business law at the firm of Heaney, Kilcoyne in Pennsylvania and also in Delaware.