Rick Allen, CPA-East Texas
IRC Section 199A provides a 20% qualified business income (QBI) deduction for certain trades or businesses. Congress included certain rental real estate enterprises in the definition of trades or businesses which qualify for the 20% deduction. One of the areas needing clarification was “what constitutes a rental real estate trade or business?”
In January 2019, the IRS released Notice 2019-07, which included a safe harbor rule for rental properties that would allow taxpayers to claim the QBI deduction and not have to worry that any of their rental properties might be disqualified as a trade or business. However, the safe harbor rule comes with its own complications and taxpayers need to use caution if electing this rule.
Safe harbor rules often provide a safe, more streamlined way to claim certain income tax deductions. These safe harbor rules may do just the opposite.
In Notice 2019-07, the IRS outlined three requirements that taxpayers must meet in order to claim the rental safe harbor:
- Taxpayers must keep separate books and records for each rental real estate enterprise.
- They or their agents must spend at least 250 hours performing services on the rental enterprise.
- They must maintain contemporaneous records, which include time logs that report all services, the dates on which they were performed and who performed the services.
Just briefly reading the list shows the difficulty most clients would have in meeting these requirements. Taxpayers who own more than one rental property must decide whether to treat each property as a separate “real estate enterprise” or combine them. If they own both residential and commercial real estate, they cannot combine them and thus must have at least two real estate rental enterprises. Taxpayers must then keep separate books and records for each rental enterprise.
In addition, taxpayers or others must spend at least 250 hours performing services on the rental enterprise. These hours do not have to be personally performed by the owner, but may include maintenance performed by contractors or services provided by a property manager. This does not include financial or investment management services, such as procuring financing or reviewing financial statements. Nor does it include time spent traveling to or from the property. Detailed records must be kept to show that at least 250 hours of service were performed on the rental enterprise, which means contemporaneous records must provide contractors’ hours worked. (Note, the contemporaneous records requirement goes in effect for tax years beginning on or before Jan. 1, 2019.) Most safe harbor rules simplify the record keeping involved, but the rental safe harbor rules seem to actually increase the burden.
Finally, taxpayers who opt for the safe harbor election must sign the following statement:
“Under penalties of perjury, I (we) declare that I (we) have examined the statement and, to the best of my (our) knowledge and belief, the statement contains all the relevant facts relating to the revenue procedure and such facts are true, correct and complete.”
Taxpayers need to fully understand the implications of signing this statement, which appears much more rigorous than the usual tax return sworn statement. In contrast, taxpayers who do not meet or elect the safe harbor rules can still claim the QBI deduction on rental real estate enterprises.
Notice 2019-07 did provide some clarification for taxpayers wishing to claim the 20% QBI deduction for their rental real estate enterprises. Due to the additional requirements found in the safe harbor rules, many taxpayers and practitioners will choose to not elect the safe harbor and will rely on being able to support their deduction and position under the Section 162 rules.
I am sure it will take a few years of IRS challenges to clarify what will be required when the safe harbor is not elected. Practitioners should be aware of the options and insure their clients are aware of ramifications of choosing the safe harbor. Time will tell what the best route will be. In the meantime, use caution here.