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.
On Sept. 24, 2019, the IRS issued Revenue Procedure 2019-38, which finalized the proposed procedure issued earlier this year. There are some changes between the new procedure and Notice 2019-7 that are worth noting.
Language was added to clarify that once the election to treat all properties on an enterprise is made, the taxpayer or relevant passthrough entity (RPE) must continue to treat interests in all similar properties, including newly acquired properties, as a single rental real estate enterprise when the taxpayer or RPE continues to rely on the safe harbor. The original language used in Notice 2019-7 indicated that taxpayers may not vary this treatment from year to year unless there has been a significant change in facts and circumstances. Arguably, this could have included obtaining a new property. In addition, the procedure dictates that the determination to use on the safe harbor must be made annually.
To our relief, Revenue Procedure 2019-38 also addresses mixed-use property. For purposes of this procedure, mixed-use property is defined as a single building that combines residential and commercial units. An interest in mixed-use property may be treated as a single rental real estate enterprise, or may be bifurcated into separate residential and commercial interests. If treated as a single rental real estate enterprise, the property may not be treated as part of any other enterprise.
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 to determine if a taxpayer is eligible to use 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. If a rental real estate enterprise contains more than one property, this requirement may be satisfied if income and expense information statements for each property are maintained and then consolidated.
- For rental real estate enterprises that have been in existence less than four years, 250 or more hours of rental services are performed each year for the rental real estate enterprise. For those that have been in existence for at least four years, in any three of the five consecutive taxable years that end with the taxable year, 250 or more hours of rental services are performed.
- 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. An individual or RPE with more than one rental real estate enterprise relying on this safe harbor may submit a single statement, but the statement must list the required information separately for each rental real estate enterprise. The statement must include a description (including the address and rental category) of all rental real estate properties that are included in each rental real estate enterprise, a description of rental real estate properties acquired and disposed of during the taxable year, and a representation that the requirements of this revenue procedure have been satisfied.
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.
Editor’s note: This article was originally published Sept. 6, 2019, and updated on Oct. 3, 2019.