Individuals whose taxable income includes income from a qualified trade or business are eligible to deduct up to 20% of the qualifying income from eligible businesses.
The IRS issued a safe harbor (a statement that provides for taxpayers) under which a rental real estate enterprise will be treated as a trade or business for purposes of the qualified business income (QBI) deduction of Sec. 199A (Rev. Proc. 2019-38). Taxpayers whose real estate business does not meet the specific conditions set out in the revenue procedures may still qualify as a trade or business if it otherwise meets that definition under the Sec. 199A regulations.
Sec. 199A allows taxpayers other than corporations a deduction of 20% of qualified business income earned in a qualified trade or business, subject to certain limitations.
Under the safe harbor, a “rental real estate enterprise” is treated as a trade or business for purposes of Sec. 199A if at least 250 hours of services are performed each tax year with respect to the enterprise.
The IRS says these hours include services performed by owners, employees, and independent contractors and time spent on maintenance, repairs, rent collection, payment of expenses, provision of services to tenants, and efforts to rent the property. However, hours spent in the owner’s capacity as an investor, such as arranging financing, procuring property, reviewing financial statements or reports on operations, and traveling to and from the real estate, will not be considered hours of service for the enterprise.
A rental real estate enterprise is defined, for purposes of the safe harbor, as an interest in real property held for the production of rents. A rental real estate enterprise may consist of multiple properties. The interest must be held directly or through a disregarded entity. Taxpayers either must treat each property held for the production of rents as a separate enterprise or must treat all similar properties held for the production of rents as a single enterprise. Commercial and residential real estate cannot be combined in the same enterprise.
The safe harbor requires that separate books and records be maintained for the rental real estate enterprise. Property leased under a triple net lease or used by the taxpayer (including an owner or beneficiary of a relevant passthrough entity) as a residence under Sec. 280A(d) would not be eligible under the safe harbor.
Other requirements in the safe harbor are:
- The taxpayer must maintain strict records, including time reports, logs, or similar documents, regarding the following: hours of all services performed, description of all services performed, dates on which those services were performed, and who performed the services.
- The taxpayer or relevant passthrough entity must attach a statement to the tax return filed for the tax year(s) the safe harbor is relied upon. This must be done each year. This statement for each relevant passthrough entity must include:
- The address and rental category of each rental real estate property in the relevant passthrough entity.
- The address and rental category of all rental real estate properties which the relevant passthrough entity acquired or disposed of during the tax year
- A representation that the relevant passthrough entity has satisfied all requirements in Rev Proc 2019-38.
- Although not stated in Rev Proc 2019-38, the taxpayer also should state its intention to rely upon the safe harbor.
The safe harbor is effective for tax years 2018 and forward. Because the final revenue procedure differs from the proposed revenue procedure, taxpayers may rely on Notice 2019-07 for the 2018 tax year.
For more information regarding your eligibility for the QBI or other questions regarding your US tax matters, please contact the office of Grant Thornton Israel.