What Does the 199A Rental Real Estate Safe Harbor Do?
Qualified business income (QBI) under Section 199A normally must come from a “trade or business” that is eligible to deduct business expenses under IRC §162. A Section 162 business must be:
- considerable, regular and continuous, and
- intended to make a profit.
The safe harbor for rental real estate replaces the Section 162 business test. This means that a rental real estate enterprise that doesn’t rise to the level of a Section 162 business can still produce qualified business income, as long as it satisfies the other QBI requirements.
However, the safe harbor applies only to the Section 199A deduction. It does not qualify the rental enterprise as a trade or business for any other purpose.
Of course, the safe harbor is not the only way a rental enterprise can produce QBI. If the rental activity satisfies the usual tests for a qualified business, including the IRC §162 business test, it does not need to qualify for the safe harbor.
Rental Real Estate Businesses Eligible for the 199A Safe Harbor
The safe harbor applies if:
- separate books and records are maintained to reflect income and expenses for each rental real estate enterprise;
- at least 250 hours of rental services are performed per year; and
- the taxpayer maintains sufficient contemporaneous records.
Both individuals and pass-through entities can use the safe harbor, as long as they hold the real property interest directly or through a disregarded entity.
What is a 199A Rental Real Estate Enterprise?
A rental real estate enterprise is an interest in real property held for the production of rents. In other words, it is the ownership of real estate for renting or leasing. The rental enterprise may consist of an interest in multiple properties. The owner must:
- treat each property as a separate enterprise, or
- treat all similar properties as a single enterprise.
Commercial vs. Residential Real Estate
However, commercial and residential real estate cannot be in the same enterprise. In addition, the taxpayer cannot change the treatment of an enterprise from year to year unless there is a significant change in facts and circumstances.
Rental Real Estate Excluded from the Section 199A Safe Harbor
Real estate does not qualify for the safe harbor if an owner uses the property as a residence during the year. Owners include:
- individuals who own the property, and
- owners and beneficiaries of an entity that owns the property.
The safe harbor also does not apply to property that is rented or leased under a triple net lease. A triple net lease includes a lease that requires the tenant or lessee to:
- pay any taxes, fees, and insurance; and
- be responsible for maintenance activities for the property, including maintenance allocable to the leased portion of the property, in addition to rent and utilities.
250 Hours of Annual Rental Services Required for Safe Harbor
To qualify for the safe harbor, the property owner must perform at least 250 hours of rental services per year. This includes rental services performed by the owner’s employees, agents, and independent contractors.
What are Safe Harbor Rental Services?
Rental services include:
- advertising to rent or lease the real estate;
- negotiating and executing leases;
- verifying information contained in prospective tenant applications;
- collection of rent;
- daily operation, maintenance, and repair of the property;
- management of the real estate;
- purchase of materials; and
- supervision of employees and independent contractors.
For tax years beginning after 2022, the owner must satisfy the 250-hour rental service requirement in any three of the last five consecutive tax years.
Excluded from Rental Services
Rental services do not include:
- financial or investment management activities, such as arranging financing;
- procuring property;
- studying and reviewing financial statements or reports on operations;
- planning, managing, or constructing long-term capital improvements; or
- hours spent traveling to and from the real estate.
How to Claim the 199A Rental Real Estate Safe Harbor
The taxpayer must attach the following safe harbor statement to a tax return that claims the 199A deduction for safe harbor income:
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.
The signers of the statement must have personal knowledge of the facts and circumstances.
IRS Seeks Comments on 199A Rental Real Estate Safe Harbor
The 199A rental real estate safe harbor applies to tax years ending after 2017. However, the IRS has invited public comments before it finalizes the safe harbor rules. Comments may be mailed or hand-delivered to the IRS, or submitted electronically through the Federal eRulemaking Portal at www.regulations.gov (indicate IRS and NOT-133582-18).
By Kelley Wolf, JD, LL.M