Summer Reminder: Safe Harbor Rules for Rental Real Estate
The summer vacation season here, and everyone is ready to travel. If you own rental real estate, make sure you’re taking advantage of the tax deductions and savings opportunities available to you.
The qualified business income (QBI) deduction was arguably one of the more complicated changes in the Tax Cuts and Jobs Act. Through QBI, eligible businesses have the potential to reduce their tax bills. Part of the final regulations is a proposed revenue procedure that provides a safe harbor for rental real estate enterprises to be considered a trade or business and qualify for the deduction.
This deduction is available for tax years beginning after December 31, 2017, and before January 1, 2026. There is speculation whether a future Congress will uphold individual provisions, but, in the meantime, it will be essential to determine eligibility.
The first condition you must meet is the definition test. The IRS defines a rental real estate enterprise as an interest in real property held for the production of rents and may consist of an interest in multiple properties.
According to the IRS, the individual or relevant pass-through entity (RPE) relying on the revenue procedure must hold the interest directly or through an entity disregarded as an entity separate from its owner under Reg. § 301.7701-3. Taxpayers must either treat each property held to produce rents as a separate enterprise or treat all similar properties held for the production of rents as a single enterprise. Commercial and residential real estate may not be part of the same enterprise.
Taxpayers may not vary this treatment from year to year unless there has been a significant change in facts and circumstances. RPEs may use the safe harbor to determine whether a rental real estate enterprise is a trade or business.
If your real estate enterprise meets the above conditions, the next test in qualifying for the treatment outlined in Notice 2019-7 is to meet the following requirements during the tax year. Rental owners must:
- Maintain separate books and records that reflect income and expenses for each rental real estate enterprise.
- Either assign to employees, agents or independent contractors, or directly perform, 250 hours or more of rental services* (defined below) per year.
- Keep contemporaneous records, including time reports, logs or similar documents, regarding hours of all services performed; description of all services performed; dates on which such services were conducted; and who performed the services.
- Readily furnish records for inspection at the request of the IRS.
Under the proposed revenue procedure, rental services* include:
- Advertising to rent or lease the real estate
- Negotiating and executing leases
- Verifying information contained in prospective tenant applications
- Collecting rent
- Performing daily operation, maintenance and repair of the property
- Managing the real estate
- Purchasing materials
- Supervising employees and independent contractors
Rental services do not include:
- Arranging financing, procuring property, or studying and reviewing financial statements or reports on operations
- Planning, managing or constructing long-term capital improvements
- Hours spent traveling to and from the real estate
It is important to note that, if the real estate is used by the taxpayer (including an owner or beneficiary of an RPE relying on this safe harbor) as a residence for any part of the year under section 280A or is rented or leased under a triple net lease, the enterprise is no longer eligible for the safe harbor provision.
If you’ve met the conditions above, you may be well-qualified for this deduction. To discuss your options regarding the QBI deduction and confirm your eligibility under this safe harbor, call us today.
Frank Granatino, CPA, of Goering & Granatino is a graduate of Missouri State and a CPA, but, moreover, he is a problem solver who uses his deep knowledge and understanding of the industry to find ways to do things faster and more efficiently for his clients. From creating customized reporting templates to spending time with his clients to educate them on how best to organize their businesses, Frank helps companies perform at their best. Often, we have clients comment that Frank feels like a member of their teams. He gets in there, rolls up his sleeves and makes things happen.