Posted: March 16, 2020 | By: Derric Isensee, CPA

Rules Finalized on Rental Real Estate Tax Deduction

Overview

The Tax Cuts and Jobs Act, which was introduced and effective January 1, 2018, introduced a new section 199A deduction equal to 20% of qualified business income. This deduction is available to pass-through entities including sole proprietorships, LLCs, partnerships or S-corporation but is only available to entities which have income from a trade or business.

Rental Real Estate “Safe Harbor”

The passing of this legislation created uncertainly for taxpayers who own rental real estate as it is unclear when rental real estate rises to the level of a trade or business. Due to this uncertainty, on September 24, 2019, the IRS issued Rev. Proc. 2019-38, which affords a limited “safe harbor” for taxpayers who are owners in rental real estate. Under this safe harbor, taxpayers can have confidence that their rental activities qualify as a trade or business and therefore qualify for the 20% deduction.

Safe Harbor Guidelines

To qualify under the safe harbor provisions, on an annual basis, a rental real estate enterprise meet the following compliance provisions:

Separate books and records must be maintained to reflect income and expenses for each rental real estate enterprise.
Each enterprise must perform 250 or more hours of rental services each year with respect to the rental real estate enterprise.
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.

If services with respect to the rental real estate enterprise are performed by 6 employees or independent contractors, the taxpayer may provide a description of the rental services performed by such employee or independent contractor, the amount of time such employee or independent contractor generally spends performing such services for the enterprise, and time, wage, or payment records for such employee or independent contractor. Such records are to be made available for inspection at the request of the IRS.

Rental services for purpose of this revenue procedure include, but are not limited to:

advertising to rent or lease the real estate;
negotiating and executing leases;
verifying information contained in prospective tenant applications;
collection of rent;
daily operation, maintenance, and repair of the property, including the purchase of materials and supplies;
management of the real estate; and
supervision of employees and independent contractors.

Rental services may be performed by owners, or by employees, agents, and/or independent contractors of the owners. The term rental services does not include financial or investment management activities, such as arranging financing; procuring property; studying and reviewing financial statements or reports on operations; improving property under § 1.263(a)-3(d); or hours spent traveling to and from the real estate.

Rental Real Estate Excluded

The following types of property may not be included in a rental real estate enterprise and are therefore not eligible for the safe harbor:

Real estate used by the taxpayer as a residence
Real estate rented or leased under a triple net lease. For purposes of this revenue procedure, a triple net lease includes a lease agreement that requires the tenant or lessee to pay taxes, fees, and insurance, and to pay for maintenance activities for a property in addition to rent and utilities
Real estate rented to a trade or business conducted by a taxpayer or an RPE which is commonly controlled under § 1.199A-4(b)(1)(i)
The entire rental real estate interest if any portion of the interest is treated as an SSTB under § 1.199A-5(c)(2) (which provides special rules where property or services are provided to an SSTB).

Though these types of properties do not qualify for the QBI 20% deduction under the safe harbor provisions, there may be alternative ways to qualify for the deduction. For example, under certain situations, your business may rise to the level of a trade or business based on other facts and circumstances (e.g. materiality of the operations, number of properties rented, structure of the lease, etc.). The property may also qualify if it is a self-rental and rented primarily to your business entity that qualifies as a trade or business. Additionally, you may consider adjusting the terms of your lease if you have the economic flexibility to also achieve the benefits of the QBI deduction.

Key Takeaways

The most important takeaway for our clients in 2020 is to ensure that all compliance requirements are being met for any real estate enterprise that otherwise would qualify under the safe harbor provisions of this revenue procedures. Beginning in 2020, taxpayers must keep separate books and records for the activities of the enterprise and must also keep contemporaneous records supporting the 250 hour compliance requirement.

How Can We Help?

The changes born from the Tax Cuts and Jobs Act provides individuals a once in a lifetime opportunity to take advantage of these unique tax savings opportunities. At Midcoast, our team of expert advisors can help you determine whether you qualify for this provision or, if you do not, can assist you in exploring alternative ways to qualify for the 20 percent Section 199A deduction.