IRS Provides a Trade or Business Safe Harbor under 199A for Rental Property

January 18, 2019 | Kristine A. Tidgren

Today, Treasury and IRS issued long-awaited final IRC §199A regulations. In conjunction with these regulations, the agencies also released IRS Notice 2019-07, a proposed revenue procedure to provide a safe harbor under which a rental real estate enterprise will be treated as a trade or business solely for purposes of IRC § 199A. This safe harbor, which includes a 250-hour per year activity requirement, was offered to give taxpayers and their practitioners more certainty with respect to the application of the 199A deduction to some rental real estate activities. The rule does little to help typical landlords who lease Iowa farmland to an unrelated party.

Trade of Business Requirement

The new § 199A 20 percent deduction is available for “qualified business income” arising from a “qualified trade or business.” Final Treas. Reg. § 1.199A-1(b)(14) defines “trade or business” as a trade or business under IRC § 162, other than the trade or business of performing services as an employee. This is generally the same definition that was set forth in the proposed regulations. In response to many comments, however, the agencies acknowledge that whether an activity rises to the level of an IRC §162 trade or business is inherently a factual question and that taxpayers and practitioners may have difficulties in determining whether a taxpayer’s rental real estate activity is sufficient to meet this standard. For more background on this issue, read our August post.

New Safe Harbor for Real Estate Trade or Business

In response to the requests for more certainty, the agencies released Notice 2019-07, a proposed safe harbor under which a rental real estate enterprise may be treated as a trade or business solely for purposes of § 199A.

Note: If an enterprise fails to satisfy the requirements of the new safe harbor, the rental real estate enterprise may still be treated as a trade or business for purposes of § 199A if it otherwise meets the definition of trade or business in § 1.199A-1(b)(14).  The safe harbor merely provides assurance for those who meet its parameters.

The safe harbor applies to individuals or relevant pass through entities (RPEs) holding their interest in rental property directly or through a disregarded entity.

Taxpayers must either treat each property held for the production of rents as a separate enterprise or treat all similar properties held for the production of rents (with the exception of properties rented under a triple net lease) as a single enterprise. Commercial and residential real estate may not be part of the same enterprise.  Taxpayers may not vary this treatment from year-to-year unless there has been a significant change in facts and circumstances.

Safe harbor Factors

To meet the safe harbor requirements, the taxpayer must satisfy the following factors during the taxable year.

  • Maintain separate books and records to reflect income and expenses for each rental real estate enterprise;
  • For taxable years beginning prior to January 1, 2023, perform 250 or more hours of rental services per year with respect to the rental enterprise. 
    • For taxable years beginning after December 31, 2022, in any three of the five consecutive taxable years that end with the taxable year (or in each year for an enterprise held for less than five years), 250 or more hours of rental services are performed per year with respect to the rental real estate enterprise; and
  • The taxpayer maintains contemporaneous records, including time reports, logs, or similar documents, regarding the following:
    • hours of all services performed;
    • description of all services performed;
    • dates on which such services were performed; and
    • who performed the services.   

These records are to be made available for inspection at the request of IRS. The contemporaneous records requirement will not apply to taxable years beginning prior to January 1, 2019.

What rental services qualify?

Rental services, for purposes of the revenue procedure, include the following:

  • Advertising to rent or lease the real estate
  • Negotiating and executing leases
  • Verifying information contained in the prospective tenant applications
  • Collection of rent
  • Daily operation, maintenance, and repair of the property
  • Management of the real estate
  • Purchase of materials
  • Supervision of employees and independent contractors

These activities may be performed by owners or employees, agents, or independent contractors of the owners.

What activities do not count?

Time devoted to the following financial or investment management activities will not constitute rental activities and cannot be counted toward the 250-hour requirement:

  • Arranging financing
  • Procuring property
  • Studying and reviewing financial statements or reports on operations
  • Planning, managing, or constructing long-term capital improvements
  • Hours spent traveling to and from the real estate

Excluded from the Safe Harbor

The proposed revenue procedure excludes two types of rental arrangements from the protection of the safe harbor. These include:

  • Real estate used by the taxpayer (or owner or beneficiary of a pass-through entity) as a residence for any part of the year
  • Real estate rented or leased under a triple net lease

Procedural Requirements

A taxpayer or RPE using the safe harbor must include a statement attached to the return specifying that the requirements of the revenue procedure have been satisfied. The statement must be signed by the taxpayer, or an authorized representative of an eligible taxpayer or RPE, and it must say, “Under penalties of perjury, I (we) declare that I (we) have examined the statement, and, to the best of my (our) knowledge and belief, the statement contains all the relevant facts relating to the revenue procedure, and such facts are true, correct, and complete.”  The individual or individuals who sign must have personal knowledge of the facts and circumstances related to the statement. 

Effective Date

The proposed revenue procedure may be applied generally to taxpayers with taxable years ending after December 31, 2017. Taxpayers may rely on it until final guidance is issued.

Self-Rental Rule Tweaked

It should also be noted that the final regulations continue to provide that rental activity that does not rise to the level of an IRC § 162 trade or business is nevertheless treated as a trade or business for purposes of § 199A, if the property is rented to a commonly controlled trade or business. In other words, self-rental activities do not have to rise to the level of a trade or business for the rental income to qualify as QBI. Common control under the final regulations means that the same person or group of persons, directly or by attribution under IRC §§ 267(b) or 707(b), owns 50 percent or more of each trade or business. Notably, the final rule was written to exclude self-rental income received from a C corporation from this special treatment. The final rule does expand the family attribution rules to include siblings and grandparents.

No Rules for Agricultural Cooperatives

We are reviewing the final regulations and will provide additional analysis soon. Still no proposed regulations were issued with respect to the special agricultural and horticultural provisions under section 199A(g). The introduction to the final regulations states that the agencies intend to issue a future notice of proposed rulemaking describing proposed rules for applying §199A to specified agricultural and horticultural cooperatives and their patrons. The wait continues!