IRS Finalizes QBI Deduction Safe Harbor for Rental Real Estate
On September 24, the Internal Revenue Service (IRS) issued Revenue Procedure 2019-38 that has a safe harbor allowing certain interests in rental real estate, including interests in mixed-use property, to be treated as a trade or business for purposes of the qualified business income (QBI) deduction under section 199A of the Internal Revenue Code. This safe harbor is available for taxpayers who seek to claim the QBI deduction with respect to a “rental real estate enterprise.” Solely for purposes of this safe harbor, a rental real estate enterprise is defined as an interest in real property held to generate rental or lease income. It may consist of an interest in a single property or interests in multiple properties. The taxpayer or a relevant passthrough entity (RPE) relying on this revenue procedure must hold each interest directly or through an entity disregarded as an entity separate from its owner, such as a limited liability company with a single member. This revenue procedure applies to tax years ending after December 31, 2017. Nevertheless, taxpayers and RPEs may rely on the safe harbor set forth in Notice 2019-07 for tax year 2018 (read our previous newsletter here). If all the safe harbor requirements are met, an interest in rental real estate will be treated as a single trade or business for purposes of the QBI deduction. In the event an interest in real estate fails to satisfy all the requirements of the safe harbor, it may still be treated as a trade or business for purposes of the QBI deduction if it otherwise meets the definition of a section 162 trade or business.
Safe Harbor Requirements
The following requirements must be met by taxpayers or RPEs to qualify for this safe harbor:
- Separate books and records are maintained to reflect income and expenses for each rental real estate enterprise. If a rental real estate enterprise contains more than one property, this requirement may be satisfied provided income and expense information statements for each property are maintained and then consolidated;
- For rental real estate enterprises that have been in existence less than four years, 250 or more hours of rental services are performed per year. For other rental real estate enterprises, 250 or more hours of rental services are performed in at least three of the past five years;
- The taxpayer maintains contemporaneous records, including time reports, logs, or similar documents, regarding the following. If services with respect to the rental real estate enterprise are performed by 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:
- hours of all services performed;
- description of all services performed;
- dates on which such services were performed; and
- who performed the services.
- The taxpayer or RPE attaches a statement to a timely filed original return (or an amended return for tax year 2018 only) for each tax year in which the taxpayer or RPE relies on the safe harbor. An individual or RPE with more than one rental real estate enterprise relying on this safe harbor may submit a single statement but the statement must list the required information separately for each rental real estate enterprise. The statement must include the following information:
- A description (including the address and rental category) of all rental real estate properties that are included in each rental real estate enterprise;
- A description (including the address and rental category) of rental real estate properties acquired and disposed of during the tax year; and
- A representation that the requirements of this revenue procedure have been satisfied.
Rental Real Estate Enterprise
With few exceptions, such as vacation home rental and triple net leases, taxpayers and RPEs may either treat each interest in similar property held for the production of rents as a separate rental real estate enterprise or treat interests in all similar properties held for the production of rents as a single rental real estate enterprise. For the purpose of combining properties into a single rental real estate enterprise, residential and commercial real estates are of separate categories. Thus, commercial real estate held for the production of rents may only be part of the same enterprise with other commercial real estate, and residential properties may only be part of the same enterprise with other residential properties. Once similar commercial properties or similar residential properties are treated as a single rental real estate enterprise under the safe harbor, the taxpayer or RPE must continue to treat interests in all similar properties, including newly acquired properties, as a single rental real estate enterprise when the taxpayer or RPE continues to rely on the safe harbor. However, a taxpayer or RPE that chooses to treat its interest in each residential or commercial property as a separate rental real estate enterprise may choose to treat its interests in all similar commercial or all similar residential properties as a single rental real estate enterprise in a future year. An interest in mixed-use property, where residential and commercial units co-exist in a single building, may be treated as a single rental real estate enterprise or may be bifurcated into separate residential and commercial interests. If treated as a single rental real estate enterprise, it may not be treated as part of the same enterprise as other residential, commercial, or mixed-use property. Each rental real estate enterprise that satisfies the requirements of this safe harbor is treated as a separate trade or business for purposes of QBI deduction.
Rental services may be performed by owners, including owners of an RPE, or by employees, agents, and/or independent contractors of the owners. Such services may include but 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.
However, activities related to financial or investment management are not considered. Examples include arranging financing, procuring property, studying and reviewing financial statements or reports on operations, developing or improving property, and hours spent traveling to and from the real estate.
Burden of Proof
Although the requirement for contemporaneous records will not apply to tax years beginning prior to January 1, 2020, the IRS reminds taxpayers that they bear the burden of showing the right to any claimed deductions in all tax years.
American Expatriate Tax is a part of Contexo Global Mobility Solutions & Tax Consulting Ltd. registered in Hong Kong. Together, we help companies and individuals navigate through the complexities of global mobility and related tax issues. Here is where you will find a blend of expertise from Big 4 accounting firms and Fortune Global 500 companies but the attention of a boutique consulting practice. The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.