By Don Zidik, CPA
The IRS recently issued final regulations in regard to the 20% Qualified Business Income (QBI) deduction (Sec. 199A) on January 18, 2019. At the same time they also issued Notice 2019-7 that provides proposed safe harbor guidance that will permit the 20% QBI deduction to be taken against rental activity which rises to the level of a trade or business.
This safe harbor provides a way for the rental activity to qualify as a trade or business by meeting all of the following requirements:
- Separate books and records are maintained to reflect income and expenses for each rental real estate enterprise.
- For taxable years beginning prior to January 1, 2023, 250 or more hours of rental services are performed per year with respect to the rental enterprise.
- The taxpayer maintains contemporaneous records, including time reports, logs, or similar documents, regarding the following: (i) hours of all services performed; (ii) description of all services performed; (iii) dates on which such services were performed; and (iv) who performed the services. Such records are to be made available for inspection at the request of the IRS. The contemporaneous records requirement will not apply to taxable years beginning prior to January 1, 2019.
The proposed Revenue Procedure describes rental services as:
- 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;
- Management of the real estate;
- Purchase of materials;
- Supervision of employees and independent contractors.
Rental services may be performed by owners, employees, agents, and/or independent contractors of the owners. Please note that rental services do not include financial or investment management activities, such as arranging financing; procuring property; studying and reviewing financial statements or reports on operations; planning, managing, or constructing long-term capital improvements; or hours spent traveling to and from the real estate.
Additionally, the following is also excluded for rental services for purposes of this proposed Revenue Procedure:
- Real estate used by the taxpayer as a residence for any part of the year is not eligible for this safe harbor.
- Real estate rented or leased under a triple net lease is also not eligible for this safe harbor.
A taxpayer must include a signed statement attached to the return verifying qualification for this safe harbor.
The newly released proposed safe harbor guidance is different from what most practitioners had expected since the new tax law became effective, and requires analysis and affirmative action for real estate owners to benefit from the QBI deduction.
In conclusion, the rental safe harbor requirement is very strict in its qualification. The taxpayer’s rental activity can still qualify as a trade or business eligible for the 20% QBI deduction depending on facts and circumstances. Please contact Waldron Rand to discuss your unique fact pattern.