Section 199A Safe Harbors for Rental Property

In 2017, the Tax Cuts and Jobs Act introduced a 20% deduction for qualifying business income of small business owners, known as Section 199A. And with this deduction came a number of questions, especially concerning rental real estate activities and whether or not they will qualify for this deduction. With summer approaching and questions about vacation and rental homes increasing, it’s important to understand the pronouncements that the IRS has issued concerning rental properties.

The first step in knowing whether the property will qualify for the deduction is determining if the activity is considered a “trade or business,” which includes two stipulations. First, the rental activity must be regular and continuous, and second, the rental activity must be profit oriented. As you can imagine, this definition of “trade or business” has left a great deal open to interpretation, and taxpayers were left in a rental qualifications grey area. So in January 2019, the IRS released a notice that included a rental property safe harbor test that would allow real estate investors to determine with more certainty if their activity qualified as a “trade or business” for purposes of the 20% deduction.

This safe harbor outlines three requirements that, when satisfied, allow the rental activity to be classified as a “trade or business” for 199A deduction purposes. These requirements are: 

  1. Separate books/records are maintained for each rental real estate enterprise,
  2. At least 250 hours of “rental services” are performed per year, and
  3. The taxpayer maintains contemporaneous records of all services performed.

Reaching the 250 hours of “rental services” threshold is a concern for some taxpayers, but “rental services” can be performed by owners, employees, contractors, or agents and include services such as advertising, negotiating/executing leases, repairs, management, daily operations, rent collections and a number of other tasks. In addition, the taxpayer is allowed to aggregate similar rental activities into a single enterprise, which may make reaching the 250 hours threshold a bit easier.

It is important to note that if an enterprise fails to satisfy the requirements of this safe harbor, the rental real estate business may still be treated as a trade or business for purposes of Section 199A if it otherwise meets the definition of a trade or business based on facts and circumstances.

As with all safe harbors, the 199A rental property safe harbor was designed to simplify the support of a tax deduction. However, taxpayers need to be diligent in their record keeping to maximize tax deductions, while also maintaining peace of mind regarding their rental properties.

Your HORNE tax advisor is here to talk through your questions. Don’t hesitate to reach out to us.

Taxpayers need to be diligent in their record keeping in order to maximize tax deductions, while also maintaining peace of mind regarding their rental properties.