October 16, 2019

QBI Rental Real Estate Safe Harbor Regulations Finalized

On September 24, 2019, the IRS released a final revenue procedure that helps taxpayers with rental real estate activities to understand how to apply Section 199A. Section 199A often referred to as the qualified business income deduction (QBI deduction), lets business owners deduct 20% of the qualified business income they report from pass-through entities or sole proprietorships. When Congress wrote the QBI deduction into law by passing the Tax Cuts and Jobs Act (TCJA), taxpayers participating in rental real estate activities were unsure if they were eligible for the deduction. The law did not specify when a rental real estate activity would be considered a trade or business worthy of the deduction.

Proposed Guidelines

A proposed revenue procedure released earlier this year, Notice 2019-07, addressed taxpayers’ concerns. The guidelines provided that rental real estate owners can take the QBI deduction when they meet the following four safe harbor requirements:

1. The business is considered a “rental real estate enterprise.” This is defined as a company that holds one or more interests in real property that are (or will be) rented. The interests can be held directly or through a disregarded entity like a single-member LLC.
2. The taxpayer must keep separate records for each rental activity. These records should include rental income, depreciation, maintenance expenses, utilities costs, and any other accounting items related to the rental.
3. The taxpayer should be actively involved in the rental activity. This means that the taxpayer (or their agents, employees, contractors, etc.) should perform at least 250 hours of services each year with respect to the rental business. These services include advertising, maintenance, supervising employees, processing tenant applications, etc. Once the taxpayer has held their interest for at least four years, this 250-hour test need only be satisfied in three out of the previous five years.
4. The taxpayer should maintain adequate service records. These records should show who performed services for the enterprise, when, and for how long.

Final Guidelines

Revenue Procedure 2019-38 finalized the safe harbor guidelines outlined in Notice 2019-07 and added a few more helpful details.

• Taxpayers who are owners of corporate entities cannot utilize this safe harbor, but this does not mean they are disallowed from taking the QBI deduction. Taxpayers of flow-through entities like S corporations and partnerships who run real estate businesses can qualify for the QBI deduction by meeting the standard conditions of Section 199A.
• Taxpayers can aggregate interests in similar properties and treat them as a single rental real estate enterprise to help them pass the 250-hour test, but only when:
  • The properties are in a similar category (residential or commercial)
  • Newly acquired properties in the same category are added to the existing enterprise

• Mixed-use property, where a single building has both residential and commercial units, can be treated as one enterprise or can be bifurcated into separate residential and commercial interests. Mixed-use property treated as one enterprise cannot be aggregated with other mixed-use properties.
• The taxpayer should attach a statement to their tax return that states they are relying on the safe harbor. This statement should include the following information about each rental property:
  • Address
  • Rental category
  • Description of property
  • A representation that the safe harbor requirements are satisfied

• Some types of property are prohibited from being considered a part of a rental real estate enterprise, including:
  • Properties that are used as a residence by the taxpayer
  • Properties rented under a triple net lease
  • Properties rented to one of the taxpayer’s other businesses
  • Properties whose interests are treated as specified service trades or businesses under Section 199A.

• Almost all parts of Revenue Procedure 2019-38 are effective no later than the 2019 tax year but can be applied retroactively to taxable years ending in 2018. The requirement to maintain adequate service records can be delayed until the 2020 tax year.

Contact Us

The Section 199A deduction is nothing new, but the IRS and the Treasury Department are still releasing guidance that helps taxpayers understand how to apply the deduction. Since the details can be complicated it’s important to connect with a qualified advisor to guide your efforts. If you have questions about the new final rules or need assistance with another tax planning issue, Wilson Lewis can help! For additional information call us at 770-476-1004 or click here to contact us. We look forward to speaking with you soon.