IRS offers safe harbor for rental real estate business deduction

The Internal Revenue Service is giving rental real estate owners a safe harbor to allow them to claim interests in property as a qualified business deduction.

The IRS issued Revenue Procedure 2019-38 on Tuesday, finalizing a tax break under section 199A of the Tax Cuts and Jobs Act, giving owners of rental real estate the ability to claim the deduction, which can be up to 20 percent of income from a pass-through business. The revenue procedure provides a safe harbor permitting certain interests in rental real estate, including interests in mixed-use property, to be treated as a trade or business for purposes of the QBI deduction. A mixed-use property includes both commercial and residential space.

If all the safe harbor requirements are met, the IRS said an interest in rental real estate would be treated as a single trade or business for purposes of the section 199A deduction. Even if an interest in real estate doesn’t satisfy all the requirements of the safe harbor, it can still be treated as a trade or business for purposes of the section 199A deduction if it otherwise meets the definition of a trade or business in the section 199A regulations.

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This safe harbor is available for taxpayers who want to claim the section 199A deduction with respect to a “rental real estate enterprise.” Only for purposes of the new safe harbor, the IRS is defining a rental real estate enterprise 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 that relies on the revenue procedure has to 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.

The IRS listed the following requirements that need to be met by taxpayers or relevant pass-through entities to qualify for the new safe harbor:

• Separate books and records are maintained to reflect income and expenses for each rental real estate enterprise.

• For rental real estate enterprises that have been around for 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: 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 relevant pass-through entity attaches a statement to the return filed for the tax year(s) the safe harbor is relied upon.

Earlier this year, the Treasury Department and the IRS issued a notice saying they were aware that whether an interest in rental real estate rises to the level of a trade or business for purposes of section 199A was the subject of uncertainty for some taxpayers. To help mitigate the uncertainty, they released for public comment in Notice 2019-07 a proposed version of a revenue procedure containing a safe harbor for treating a rental real estate enterprise as a trade or business solely for purposes of section 199A. The revenue procedure that was released Tuesday finalizes that guidance and spells out the procedural requirements for the safe harbor.