Rental Real Estate Activities: Safe-Harbor and the Section 199A Deduction

Rental Real Estate Activities: Safe-Harbor and the Section 199A Deduction

By CST Manager Jim Kelly, CPA

 

 

To qualify for the new Section 199A deduction known as the Qualified Business Income Deduction (QBID), Qualified Business Income (QBI) has to be from a trade or business (Section 162).  After Section 199A became law, one question frequently asked was: Are rental real estate activities considered a trade or business under this new law?

The IRS issued Notice 2019-7 in January 2019 offering a safe-harbor for rental real estate owned “directly or through a disregarded entity”. To qualify for the safe-harbor for Section 199A, certain requirements must be met. The following requirements are:

 

  1. Separate books and records are maintained for the rental activity
  2. 250 hours or more of “rental services” are performed per year for the rental activity by the owner, agent or contractor. Rental services include:
    1. Advertising to rent, negotiating and executing leases, verifying tenant applications, collection of rent, daily operation and maintenance, management of real estate, purchase of materials and supervision of employees or independent contractors
    2. Accounting and financial activities such as keeping the books is not a “rental service”
  1. The rental activity maintains contemporaneous records or time reports regarding:
    • Hours of all performed services
    • Description of all performed services
    • Dates which services are performed
    • Who performed the services

The safe-harbor is not available if the owner uses the real estate or if the real estate is “rented or leased under a triple net lease”.  A triple net lease is a lease where the tenant pays the property taxes, insurance and repairs and maintenance expenses.

If the rental activity fails to meet the safe-harbor requirements, it can still qualify as a trade or business if the activity is “considerable, regular and continuous” and has a “profit motive”.

Owners of multiple rental real estate activities can elect to combine “similar” activities and treat as one activity or treat each activity as a separate activity.  The owner cannot combine commercial and residential real estate into one activity and cannot change the election to combine or not combine in future years “unless there is a significant change in facts and circumstances”.

The owners of rental real estate activities that are treated as a trade or business for Section 199A purposes, and thus qualify for the QBID, should be aware that trades or businesses are required to file Forms 1099-MISC for payments to nonincorporated entities that exceed $600.

To make the safe-harbor election, IRS Notice 2019-7 statement must be signed and dated by the owner and attached to the tax return.