Do Your Real Estate Activities Qualify for the New Pass-Through Deduction?

Following the release of proposed regulations on the 199A deduction, determining which rental activities would qualify for the deduction was a topic of many comments. In response, the IRS issued Notice 2019-07, establishing a proposed safe harbor for real estate enterprises.

To be treated as a business, the 199A safe harbor says the rental real estate activity must meet all of the following requirements:

  • Taxpayer must keep a separate set of books and records to reflect income and expenses for each rental real estate activity. You can combine multiple rentals conducted in one enterprise. However, commercial properties cannot be grouped with residential properties, and each activity must meet the facts and circumstances test for being an actual business to be aggregated.
  • For taxable years beginning prior to January 1, 2023, at least 250 hours per year must be spent on rental services. These hours can be performed either by owners, employees, or independent contractors. After December 31, 2022, entities must meet this requirement for three out of five consecutive years.
    • Rental services include: advertising to rent, negotiating and executing leases, verifying tenant applications, collection of rent, daily operations and maintenance, management, purchase of materials, and supervision of employees and independent contractors
  • For taxable years beginning after December 31, 2018, the taxpayer must maintain contemporaneous records (including time reports, logs or similar documents) regarding all of the following:
    • Hours of all services performed
    • Description of all services performed
    • Dates on which such services were performed
    • Who performed the services

The IRS notice also states that, to qualify for Section 199A, real estate must not be rented or leased under a triple net lease (under which the tenant is responsible for taxes, insurance and common area maintenance fees, in addition to rent and utilities). The real estate also must not be used by the taxpayer as a residence (or vacation home) for more than 14 days or 10 percent of the number of days the unit is rented at a fair rental rate.

For use of the safe harbor, tax returns must have a signed statement attached, in which the taxpayer claims or passes through the 199A information and affirms, under penalties of perjury, personal knowledge of the facts and circumstances related to the statement and that all safe harbor requirements are met.

It’s important to note that failing to satisfy these requirements doesn’t automatically mean the rental activity is not a trade or business under 199A. Alternatively, businesses could meet a facts and circumstances determination that their activities rise to the level of a legitimate business. However, this will be a little harder to quantify, and the IRS doesn’t have a clear definition of what the facts and circumstances must be.

There is one exception to the safe harbor rules, and that is for self-rentals. Rental activity will be considered a trade or business, for purposes of Section 199A, if it is rented to commonly controlled trade or business owned by the taxpayer, and none of the safe harbor rules have to be met.

This rental real estate safe harbor is one bright spot for many professionals who otherwise would not qualify for the 20% deduction under Section 199A. However, complying with these requirements will take careful attention to detail. If you’re ready to discuss the tax impact of your real estate activities, reach out to your HORNE tax advisor to schedule a time to walk through your personal circumstances.

This rental real estate safe harbor is one bright spot for many professionals who otherwise would not qualify for the 20% deduction under Section 199A. However, complying with these requirements will take careful attention to detail.

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