IRS Releases Rental Real Estate Safe Harbor and Final Regulations for Section 199A Deduction

The IRS has released the long-awaited final regulations on the Section 199A qualified business income deduction. Along with the regulations, the IRS released Notice 2019-07 that contains a proposed revenue procedure with a safe harbor for rental real estate enterprises to qualify for this 20 percent deduction. The safe harbor is very important for businesses involved in commercial or residential real estate rentals because it gives certainty as to whether they meet the “trade or business” requirement necessary to claim the deduction. The final form of the revenue procedure and the safe harbor are subject to public comment, but taxpayers are, in the meantime, entitled to rely on the safe harbor of the proposed revenue procedure.

Section 199A was enacted as part of tax reform and provides non-corporate taxpayers up to a 20 percent deduction on qualified business income. One requirement for the deduction is that the taxpayer operates a “trade or business.” There is significant uncertainty under the law as to whether rental real estate operations constitute a “trade or business,” and to help resolve this uncertainty, the proposed revenue procedure provides a safe harbor under which a rental real estate enterprise will be treated as a “trade or business” solely for purposes of the 199A deduction. If the rental operation does not meet the safe harbor, it may still be treated as a “trade or business” if it meets the general definition under the final regulations.

To qualify for the safe harbor, a rental operation must meet three requirements. In general, it must (1) maintain separate books and records for each rental enterprise, (2) involve the performance of at least 250 hours of rental real estate services each year (which, according to Treasury officials announcing the safe harbor, may be performed by employees or contractors other than the taxpayer), and (3) maintain contemporaneous records regarding the rental real estate services performed. Certain rental real estate arrangements are excluded from the safe harbor, such as real estate rented or leased under a triple net lease, as specifically defined in the proposed revenue procedure.

The proposed revenue procedure applies to taxable years ending after December 31, 2017, and states that rental operations may use the safe harbor until the procedure is published in final form. To claim the benefit of the safe harbor a statement must be attached to the tax return which claims the 199A deduction or passes through the deduction. The IRS is requesting input on the proposed revenue procedure before it becomes final.

For questions or more information about the 20 percent deduction for rental real estate operations or Section 199A, please contact Katherine E. David, Chris Harris, Joshua Wu, Kenneth S. Wear, Christine M. Green or another member of Clark Hill's Tax and Estate Planning Business Unit or Corporate Business Unit.