Section 199A Safe Harbor

Will Rental Real Estate Activity Qualify for the 20% Deduction?

Allow our team to walk you through the details of this new IRS deduction, what it means, and how it might affect your business.

Here's the Breakdown

Last year, we informed you of a new 20% deduction for Qualified Business Income (QBI) under the Internal Revenue Code Section 199(a). There has been considerable question whether rental real estate activities would qualify as a trade or business eligible to take the QBI deduction. Although the answer to this question is not yet settled, the IRS has given some guidance in this area.

Recently, the IRS issued Notice 2019-07 providing a safe harbor for rental real estate to be treated as a trade or business solely for the purposes of section 199A.

A business man explaining a stack of documents to a client.

  • Under the safe harbor, a rental real estate enterprise will be treated as a trade or business for section 199A purposes if 250 hours per year of rental services are performed with respect to the rental enterprise.
  • Triple net leases are specifically prohibited from using the safe harbor. Triple net leases will need to be analyzed outside of the safe harbor to determine if they are eligible for the section 199A deduction.
  • Taxpayers can rely on the safe harbor until a final revenue procedure is issued.
  • The safe harbor is strictly limited to the application of section 199A.
  • Taxpayers can treat each rental real estate property as a stand-alone enterprise or group together similar properties and treat each group as an enterprise. Commercial & residential properties may not be combined as part of the same enterprise.
  • Although the safe harbor applies solely for purposes of section 199A, clients should be reminded that treating rental properties as a trade or business may require filing Form 1099 to report rental expenses and treating mortgage interest as business interest expense subject to the new limitations on the business interest expense deduction.

Safe Harbor Requirements

Under the safe harbor, a “rental real estate enterprise” (defined below) will be treated as a trade or business for section 199A purposes if it meets the following requirements:

  • Separate books and records are maintained to reflect income and expenses for each rental real estate enterprise
  • 250 or more hours of rental services (examples below) are performed per year for tax years beginning before January 1, 2023; more liberal for years beginning after December 31, 2022.
  • The taxpayer maintains contemporaneous records to consist of time reports, logs, or similar documents regarding:
  1. Hours of all services performed
  2. A description of all services performed
  3. Dates on which such services were performed
  4. Who performed the services
  • Records to be available for inspection at the request of IRS
  • Contemporaneous records requirement waived for 2018

What's Covered Under the 199A?

What is a Rental Service in 199A?

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
  • May be performed by owner, employees, agents and/or independent contractors of owners

What is NOT a Rental Service?

Financial or investment management activities

  • Arranging financing
  • Procuring property
  • Studying & reviewing financial statements or reports on operations
  • Planning, managing, or construction long-term capital improvements
  • Hours spent traveling to and from the real estate

What Activities are Excluded from the Safe Harbor?

  • Triple net leases
  • Real estate used by the taxpayer (including an owner or beneficiary of an RPE relying on this safe harbor) as a residence for any part of the year under section 280A

What are the Procedural Requirements with 199A?

  • Taxpayer or RPE must include a statement attached to the return, signed under penalties of perjury by the taxpayer or an authorized representative of the RPE, that the requirements of the revenue procedure have been met
  • Taxpayer or RPE must include a statement attached to the return, signed under penalties of perjury by the taxpayer or an authorized representative of the RPE, that the requirements of the revenue procedure have been met
  • The individual signing must have personal knowledge of the facts and circumstances

A rental real estate enterprise is defined as an interest in real property held to produce rents and may consist of an interest in multiple properties. The individual or relevant pass-through entity must hold the interest directly or through a disregarded entity. Taxpayers can treat each rental real estate property as a stand-alone enterprise or group together similar properties and treat each group as an enterprise.

Commercial and residential real estate may not be a part of the same rental real estate enterprise. Taxpayers must be consistent with this treatment unless there is a significant change in facts and circumstances.

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