Effective for taxable years beginning after Dec. 31, 2017, Sec. 199A of the Internal Revenue Code (IRC) provides a deduction to a non-corporate taxpayer of up to 20 percent of the taxpayer’s qualified business income (QBI) from each of the taxpayer’s “qualified trades or businesses,” including those operated through a partnership, S corporation or sole proprietorship.
The statute defines a “qualified trade or business” as anything other than one that is a specified service or one that performs services as an employee. However, applying Sec. 199A can be a little confusing because the statute failed to define “trade or business” for purposes of Sec. 199A.
In August 2018, the IRS proposed regulations stating that IRC Sec. 162(a) provides the most appropriate definition of a trade or business for purposes of Sec. 199A. However, taxpayers may have difficulty determining whether their rental real estate activity is sufficiently regular, continuous and considerable for the activity to constitute a Sec. 162 trade or business.
The IRS recognized the frustration, and to help calm the uncertainty, they issued Notice 2019-7. This provided a safe harbor under which a taxpayer’s rental real estate enterprise will be treated as a trade or business for purposes of Sec. 199A. This notice was issued with the release of the final Sec. 199A regulations.
Safe Harbor Requirements
For purposes of the safe harbor, a “rental real estate enterprise” is defined as an interest in real property held for the production of rents. It may consist of an interest in one or multiple properties.
This means a taxpayer may treat each property held for the production of rents as a separate enterprise, or they may treat all “similar” properties held as a single enterprise. The treatment of a taxpayer’s rental properties as a single enterprise or as separate enterprises cannot be changed from year-to-year unless there has been a significant change in facts and circumstances.
Keep in mind, that aggregating rental properties for the purpose of Sec. 199A does not group the properties when it comes to passive activity losses or qualifying as a real estate professional. This election is solely for the application of the Sec. 199A deduction.
The requirements set forth by the safe harbor include the following:
- Maintenance of separate books and records to report the income and expenses of each rental real estate enterprise, including a separate bank account for each enterprise.
- For tax years beginning before Jan. 1, 2023, 250 or more hours of rental services must be performed each year for the rental real estate enterprise.
- Beginning Jan. 1, 2019, the taxpayer must maintain contemporaneous records with details about any services related to the rental, including a description of what was done, who did it, the date and the number of hours.
- A statement to the tax return showing the requirements of the safe harbor are satisfied must be attached.
Practical Application and QuickBooks® Online
Reviewing and discussing safe harbor can be an excellent planning opportunity with your clients who have rental income but do not qualify as real estate professionals. If you have clients who are eligible to use this safe harbor, they could benefit from some guidance as to how to set up and keep their records.
QuickBooks is a great tool to keep detailed records of each property, separately or together. The best way to use Quickbooks is to set up classes for different properties, customers for the actual units (in a multi-unit building), and jobs for tenants. Then, use items to track repairs, maintenance, rent and any other expense.
Some rental scenarios that are not eligible for the safe harbor include IRC Sec. 280A (personal use of a dwelling including vacation homes) and triple net leases (tenant pays taxes, fees, insurance and maintenance).
If an enterprise fails to meet the safe harbor, it may still qualify for QBI as long as trade or business standards are met. On the issue of using Sec. 162 to qualify your rental activity as a business, the IRS cautions Landlords to be consistent with information return filing under Sec. 6041. In general Landlords are not required to issue 1099’s, but trade of business owners must issue 1099’s to anyone they pay more than $600 to during the tax year. Check out these resources:
- An Intuit® Tax Pro Center article about real estate professionals and deducting rental losses.
- A special episode of TaxProTalk on safe harbor for rental real estate.
- How to use QuickBooks for rental income.