The IRS recently issued Notice 2019-7 to provide a safe harbor for rental real estate owners to qualify for the 20% deduction on the rental income.
In order to qualify for the 20% deduction, the rental properties are treated as a rental real estate “enterprise” and qualify as a trade of business for purposes of Section 199A. A rental real estate enterprise is defined as an interest in real property held for the production of rents. It may consist of multiple properties, but if taxpayers combine multiple properties for purposes of determining whether they are engaged in a rental real estate enterprise, they must continue this treatment from year-to-year unless there has been a significant change in facts and circumstances. Commercial and residential property may not be part of the same enterprise. Therefore, for purposes of the safe harbor, a taxpayer with both residential and commercial properties must meet the requirements separately with respect to each.
There are three requirements to meet in order to be qualified for the safe harbor:
- Separate books and records must be maintained to reflect income and expenses for each rental real estate enterprise.
- At least 250 or more hours of rental services must be performed per year with respect to the rental enterprise. For tax years beginning after December 31, 2022, this test can be satisfied in any three of the five consecutive tax years that end with the tax year.
- The taxpayer must maintain contemporaneous records of relevant items, including time reports, logs, or similar documents. (This requirement does not apply to tax years beginning in 2018.) Relevant items include hours of all services performed, description of all services performed, dates on which such services were performed, and who performed the services.
The rental services for the 250-hour requirement do not include financial or investment activities, such as:
- arranging financing;
- procuring property;
- studying reports on operations;
- planning, managing, or construction of long-term capital improvements; or
- hours spent traveling to and from the real estate.
To take advantage of the safe harbor, the taxpayer must attach a signed statement, under penalties of perjury, that the requirements of the safe harbor have been met.
It is very important for taxpayers to be aware of the above requirements for their 2018 income tax filing and also the record keeping mandate for 2019 and beyond. Taxpayers should start keeping track of the time and the services provided to each real estate enterprise now and not wait until next year when it is time to prepare the 2019 income tax returns.
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