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Advising on New Safe Harbor Under the QBI Deduction for Real Estate Activities

To deal with the confusion about when real estate activities constitute a trade or business, the IRS has created a safe harbor for a “rental real estate enterprise” (Revenue Procedure 2019-38).

Mar 19th 2020
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With everything going on in the world, filing season has not been cancelled. Moreover, your clients still have pressing tax deduction questions for you to be able to answer. The final article in this series of busy season tips, J.K. Lasser authors Barbara Weltman and Eliot Eiss addresses income on real estate activities.

If real estate activities constitute a trade or business, a taxpayer may be eligible for a deduction of up to 20 percent of qualified business income (QBI). Also, if a landlord meets the safe harbor conditions for a rental real estate enterprise, the real estate activities are treated as a trade or business for purposes of the QBI deduction. The safe harbor applies only for the QBI deduction, so being treated as having a trade or business for purposes of this deduction does not trigger self-employment tax or other consequences.

Real Estate Enterprises

The IRS safe harbor applies to a “rental real estate enterprise,” which is defined as an interest in real property held for the production of rents and may consist of an interest in multiple properties. The interest may be owned directly or through a passthrough entity.

If the taxpayer has interests in multiple rent-producing properties, each is a separate enterprise, but all similar properties may be aggregated and treated as a single enterprise. However, commercial and residential real estate cannot be combined in the same enterprise.

Certain rental real estate interests are not eligible for the safe harbor. This includes property that is treated as used by the taxpayer as a residence, meaning that personal use of the property exceeds the greater of 14 days or 10 percent of the days it is rented at a fair market rental price.

In addition, real estate rented or leased under a “triple net lease” is not eligible. A triple net lease refers to an agreement that requires the tenant or lessee to pay taxes, fees, and insurance, and to pay for maintenance activities of the property in addition to rent and utilities.

Safe Harbor Conditions

All of the following requirements must be met for a rental real estate enterprise to be treated as a business under the safe harbor for the QBI deduction:

1. The taxpayer maintains separate books and records to reflect income and expenses for each rental real estate enterprise

2. 250 or more hours of rental services are performed per year with respect to the rental real estate enterprise. For rental real estate enterprises in existence for at least 4 years, the hours of rental services requirement can be met by performing 250 or more hours of rental services in at least 3 of the 5 consecutive taxable years that end with the current taxable year. The services must be performed by the taxpayer, or by employees, agents, and/or independent contractors. Time spent on investor-type activities does not count.

3. For 2020 and later years, the taxpayer maintains contemporaneous records, including time reports, logs, or similar documents, regarding the following: (i) hours of all services performed; (ii) description of all services performed; (iii) dates on which such services were performed; and (iv) who performed the services. Such records are to be made available for inspection at the request of the IRS. For taxable years beginning before 2020 (e.g., the 2019 tax year), the contemporaneous records requirement does not apply, but the taxpayer must be prepared to prove that he or she is entitled to any QBI deduction claimed.

4. Attach a statement to the return for each year that the safe harbor is used. The statement must describe all properties being treated as a rental real estate enterprise and any rental real estate properties acquired or disposed of during the year. It also must state that all conditions of the safe harbor have been satisfied.

Conclusion

Even if a taxpayer can’t meet the safe harbor, he or she can still try to demonstrate a profit motive and other indicia of being in a trade or business in order to claim the QBI deduction. Of course, once a taxpayer with rental real estate is treated as being in a trade or business, the usual rules for claiming the QBI deduction under Code Sec. 199A apply.

J.K. Lasser's Your Income Tax 2020 gives you step-by-step instructions for easy, stress-free filing.
Download the book here.

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