On September 24, 2019, the IRS issued Revenue Procedure 2019-38, which implements a safe harbor under which a real estate enterprise will be treated as a trade or business for purposes of IRC § 199A and so be able to take the deduction under that section. The safe harbor generally maintains the same framework laid out in the proposed notice issued earlier in the year, but some changes were made in response to comments from practitioners. Folks with triple net leases remain out in the cold however.
Section 199A allows individuals, including certain trusts and estates, to deduct up to 20% of their pass-through qualified business income. To qualify for the deduction, the entity must be a trade or business under section 162 of the Tax Code. The final regulations limit the “trade or business” treatment for rental real estate to commonly controlled rental property, or those rental properties providing services to an SSTB. The safe harbor attempts to mitigate the uncertainty for rental real estate activities that don’t fit neatly into those two categories.
The Revenue Procedure defines a rental real estate enterprise as an interest in real property held for the production of rents. Rental properties are categorized as either residential or commercial properties. The rental real estate enterprise may treat interests in similar properties and of the same category either as a separate rental real estate enterprise or as a single rental real estate enterprise.
The safe harbor requires a taxpayer or relevant pass-through entity to continue to treat the interest in all similar properties, including newly acquired properties, as a single rental real estate enterprise. Therefore, taxpayers who continue to rely on this safe harbor should evaluate the tax impact of treating the rental properties as a single or separate enterprise.
The Revenue Procedure also addresses the treatment of interests in mixed-use properties. It allows properties that have both commercial and residential rental arrangements to be treated as either a single rental real estate enterprise or, if the taxpayer so chooses, to bifurcate the interest into the separate real estate categories.
Safe Harbor Requirements
Taxpayers wishing to rely on the safe harbor must make an annual determination as to whether they meet the following requirements:
- Maintain separate books and records that reflect income and expenses for each rental real estate enterprise.
- Spend 250 hours or more on each rental real estate enterprise (as specified within the safe harbor).
- Maintain contemporaneous records, logs to show the rental services performed.
The Revenue Procedure allows taxpayers to include the hours performed by employees or independent contractors in satisfying the safe harbor’s 250 hours rental services requirement. However, the safe harbor excludes tangential activities such as travel time between properties.
As mentioned, the triple net lease exclusion is still in effect, along with the residential property exception. The Revenue Procedure excludes two additional rental arrangements from the purview of the safe harbor: real estate rented by a commonly controlled trade or business, and rental estate that provides services or property to an SSTB (a business that generally does not qualify for the 199A deduction).
As with any safe harbor, taxpayers who do not meet the requirements of the Revenue Procedure but are not faint of heart may still be able to claim the deduction if they meet the trade or business definition for purposes of Section 199A.
A taxpayer claiming the deduction, and relying on this safe harbor must attach a statement to a timely filed original return for each taxable year. For 2018 returns, the statement may be attached to an amended return.
Taxpayers impacted by this Revenue Ruling should consider consulting with a tax attorney to determine whether they qualify for it, and thereby the 20% deduction. If you have questions regarding 199A or other complex tax issues, please contact Steven Miller, alliantgroup, LP’s National Director of Tax.