Safe Harbor Guidance for Rent and Lease Income

On January 18th, the Internal Revenue Service issued Notice 2019-07 much to the delight of tax professionals throughout the country. Within the notice were guidelines for determining how rental activities should be treated with respects to the 20% pass-through deduction found within the Tax Cuts & Jobs Act.

In general, only income that meets the definition of “trade or business income” as defined in IRC §162 qualifies for 20% pass-through deduction. However, the notice provides an alternative test for real estate rent and lease income. This safe harbor election allows entities that do not rise to the level of an IRC §162 business to still produce qualified business income.

To qualify under the safe harbor election, the entity must meet all the following conditions:

  1. Separate books and records are maintained to reflect income and expenses for each rental real estate enterprise.
  2. For tax years beginning prior to January 1, 2023, 250 hours or more of rental services are performed per year with respects to each rental enterprise.
  3. The entity maintains contemporaneous records, including time reports, logs, or similar documents detailing the following: hours of all services performed, description of all services performed, dates on which services were performed, and who performed the service.

A rental real estate enterprise is defined as an interest on real property held for the generation of rents.  An entity can elect to treat each property as a separate enterprise or may treat all similar properties as a single enterprise. However, there must be separate enterprises for commercial and residential real estate.  In addition, electing to present each property independently or in a group can not be changed unless there is a significant change in the facts and operations from one year to the next.

Activities that can be factored in determining the 250-hour condition include: advertising, negotiating or executing leases, information verification or background checks of applicants, collection of rents, daily operations, repairs, maintenance, management activities, and supervision of employees or independent contractors.  These services can be performed by owners, employees, agents, or independent contractors as long as they are required and performed for the benefit of the rental real estate enterprise.

Activities that are not allowed to be factored in determine the 250-hour condition include: financial management activities, procuring property, reviewing financial statements, planning long-term capital improvements, or hours spent travelling to and from the real estate locations.

To be eligible for the safe harbor election, the entity must maintain contemporaneous records for all services described above that it wishes to include towards the 250-hour condition. Luckily, the Internal Revenue Service is not mandating that contemporaneous records are kept for tax years beginning prior to January 1, 2019. Entities should begin maintaining records for the 2019 tax year.

To claim the 20% pass-through deduction for rental real estate, the entity must include a statement with their tax return declaring that all relevant facts relating to the revenue procedure are true, correct and complete.

If you would like to know if your business qualifies for the safe harbor election, HORNE can help.

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