IRS issues new 199A guidance on safe harbor for rental real estate
Published March 1, 2019
The IRS recently released new guidance on several Tax Cuts and Jobs Act Sec. 199A questions, including a new Safe Harbor position regarding regular operating lease agreements vs. triple net leases. Section 199A allows eligible taxpayers to deduct up to 20% of net income earned from a qualified “passthrough” trade or business, including partnerships and LLCs, among others. Known as the QBI deduction, it became available in tax year 2018. Up until recently, the required “trade or business” status caused confusion in how the rental of real property should be treated in this realm, but the fresh IRS guidance sheds some light.
In Notice 2019-7, the IRS proposed a revenue procedure that provides safe harbor for certain real estate enterprises that may qualify for the QBI deduction. A rental activity (or multiple rentals if aggregated into a single operation) will qualify for the QBI deduction as a “trade or business” if the following requirements are met:
- Separate records are maintained for each rental activity (or the aggregate if grouped together)
- 250 hours or more of “rental services” are performed each year for the activity or aggregate
- The taxpayer maintains contemporaneous records, including time logs or similar reporting, that keeps track of the hours, descriptions, dates and named performer of all services performed.
Tax years beginning in 2018 desiring to meet the new safe harbor 250 hour test, in order to claim up to a 20% Section 199A deduction, will require a signed perjury statement attached to the entity tax return and individual income tax return.
Rental services could include advertising, lease execution, application processing, rent collection, as well as maintenance or general management, among other tasks. These services DO NOT include financial management activities, hours spent traveling to and from the properties, financial statement review or the planning, managing or constructing of long-term capital improvements.
Two large exceptions to the safe harbor is with regard to real estate used by the taxpayer as a residence for any portion of the year, and properties rented on a triple net basis.
A quick primer on triple net leases—a triple net lease includes a lease agreement that requires the tenant to pay taxes, fees and insurance, as well as maintenance activities on the property, in addition to rent and utilities. However, if a landlord is responsible for any maintenance, it would not be a triple net lease.
The new guidance did however preserve a “self-rental” exception, applying only for purposes of section 199A. Here, the rental or licensing of tangible or intangible property to a related trade or business (other than a C-corporation) is treated as a trade or business if the rental or licensing activity and other trade or business are commonly controlled with more than 50% common ownership. This applies to triple net leases as well.
The new QBI deduction guidance sheds a lot of light for taxpayers just in time for the 2018 filing season, though we expect the new record keeping requirements to be particularly onerous for many of our clients.