Safe harbor available for taxpayers who seek to claim the section 199A deduction with respect to a “rental real estate enterprise.”
On September 24, 2019, the Internal Revenue Service issued Revenue Procedure 2019-38, which finalized the real estate safe harbor election initially proposed in January. This election allows for real estate owners to treat their rental activities as a trade or business for purposes of the 20 percent qualified business income deduction. While meeting the election requirements may not require much additional effort for taxpayers owning real estate conglomerates, the importance of documentation and retention has become increasingly more important for taxpayers who own, say, one or two rental properties. Such taxpayers may want to revisit their current recordkeeping methods to ensure they are able to reap the full benefit of the 20 percent deduction, which could result in substantial tax dollars saved.
Within the final literature, the IRS provides specifications and additional clarifications on a variety of crucial aspects, such as the treatment of mixed-use property and the implementation of the 250-hour requirement. This article will focus on these items; however, for a more in-depth look at the election including definitions, requirements, and implementation, please refer to our previous article, 199A Trade or Business Safe Harbor: Rental Real Estate.
When the election was initially proposed, the IRS provided important details regarding rental real estate enterprises (“RREE”) and how a taxpayer may choose to group similar properties into a single enterprise. Such groupings allow requirements such as the 250-hour rental services to span across several properties. However, take note that commercial and residential real estate my not be part of the same RREE. This specification left many taxpayers with questions on how their multi-use properties should be handled under the new rules.
Revenue Procedure 2019-38 provides that a taxpayer may choose to treat a multi-use property, which is defined as a single property combining both commercial and residential units, as a single RREE or bifurcate it into separate commercial and residential interests. If treated as a single RREE, a multi-use property may not be grouped with other residential, commercial, or mixed-use properties. Although bifurcation may seem like the obvious answer so rental service hours and records can be aggregated with similar properties, the task of maintaining separate books and records for a multi-use property between the commercial and residential units may be a daunting enough prospect that some may decide otherwise.
Once a taxpayer decides on treatment of any multi-use property and establishes his/her RREE(s), in order to take advantage of the 20 percent deduction the initial election literature provides the following requirements which each RREE must meet:
1. Separate books and records are maintained to reflect income and expenses for each RREE;
2. 250 or more hours of rental services are performed per year with respect to each RRRE. Remember that rental service hours include not only your hours as an owner, but also hours spent by employees and independent contractors, such as a repairman or snowplowing service provider; and
3. Taxpayer maintains contemporaneous records, including time reports, logs, or similar documents regarding hours, descriptions, and dates of all services performed as well as who performed the services.
Revenue Procedure 2019-38 provides the following clarifications for each requirement:
1. Any RREE containing more than one property meets the first requirement if income and expense information statements for each property are maintained and then consolidated.
2. RREEs in existence for less than four years must meet the 250-hour requirement for each year of existence. However, in the event an RREE has existed for at least four years, the 250-hour requirement must be met in any three of the five consecutive taxable years that end with the taxable year.
3. A taxpayer’s requirement to maintain contemporaneous records does not apply to taxable years beginning prior to January 1, 2020. This extension provides taxpayers with ample time to develop good documentation habits to comply with this requirement.
Last, but certainly not least, the final literature provides the following two additional types of property that may not be included in a RREE and are, therefore, not eligible for the safe harbor:
1. Real estate rented to a trade or business conducted by a taxpayer or a Relevant Passthrough Entity (“RPE”) which is commonly controlled.
2. An entire rental real estate interest if any portion of the interest is treated as a Specified Service Trade or Business (“SSTB”).
If you have any questions about the safe harbor election or would like further assistance in demystifying the many aspects of the new tax law, please contact our office or your Bonadio representative.
This material has been prepared for general, informational purposes only and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Should you require any such advice, please contact us directly. The information contained herein does not create, and your review or use of the information does not constitute, an accountant-client relationship.
