Real Estate Revenue: Meeting Safe Harbor Rules for Section 199A

By Mark Kruczek, CPA, MST – Shareholder, Doeren Mayhew

The Internal Revenue Service (IRS) recently released Notice 2019-07, which provided taxpayers a proposed revenue procedure to determine when a real estate entity would rise to the level of a trade or business under Section 199A, and thus qualify for the 20 percent deduction. It also provided a safe harbor provision, where if a taxpayer meets the safe harbor provision, then a signed election on the taxpayer’s return is required to elect the safe harbor rules.

Rental Real Estate Safe Harbor Rules

To understand the rental real estate safe harbor rules, its first important to understand what constitutes a rental real estate enterprise. Defined as an interest in real estate property held to produce rents and may consist of an interest in multiple properties, a rental real estate enterprise will have the individual or relevant pass-through entity holding the interest directly or through a disregarded entity.

Each rental real estate property can be treated as a stand-alone enterprise or be grouped together with similar properties to treat each group as an enterprise. Commercial and residential real estate may not be a part of the same rental real estate enterprise. However, it’s important to note taxpayers must be consistent with this treatment unless there is a significant change in facts and circumstances.

Additionally, triple net leases and self-rentals are specifically excluded under IRS Notice 2019-07. Self-rentals are already considered a trade or businesses under current Section 199A regulations.

A rental real estate enterprise will be treated as a trade or business for Section 199A, if it meets all of the following requirements:

• Separate books and records are maintained to reflect income and expenses for each rental real estate enterprise.
• There are 250 hours or more of rental services performed per year for tax years beginning before Jan. 1, 2023. Qualifying rental services performed by owners, employees, agents or independent contractors, that qualify for the 250-hour test are as follows:
  • Advertising to rent or lease the real estate
  • Negotiating and executing leases
  • Verifying information contained in prospective tenant applications
  • Collecting rent
  • Daily operation, maintenance and repair of the property
  • Managing the real estate
  • Purchasing materials
  • Supervising employees and independent contractors
  • Activities such as traveling to and from the properties, arranging financing, procuring property, reviewing financial statements or operation reports; or planning, managing or constructing long-term capital improvements do not qualify for the 250-hour test.

• The taxpayer maintains contemporaneous records, including time reports, logs or similar documents regarding hours of all services performed, a description of all services performed, dates on which the services were performed and who performed the services. It is important to note, this requirement is effective for tax years beginning after Jan. 1, 2019.

New Actions to Take

In order to take the Section 199A deduction for rental property, the taxpayer or pass-through entity must include a statement attached to the tax return claiming the Section 199A deduction or the pass-through of Section 199A meets the new requirements set forth by the IRS Notice 2019-07. The statement must be signed by the taxpayer, or an authorized representative of the taxpayer or pass-through entity. Doeren Mayhew will help to ensure your compliance with this.

For now, taxpayers can rely on the safe harbor until the final revenue procedure is issued, which is expected at a later date. If you have questions related to if your rental property qualifies for the Section 199A deduction, contact Doeren Mayhew’s tax advisors.