January 24, 2019
Today I want to discuss the changes to the tax laws related to a new provision known as Section 199A or the Qualified Business Income (QBI) deduction. Some language in the new tax laws indicated that rental activities could qualify for the QBI deduction if it rises to the level of a business.
The tax codes have had no clear definition of a business as it would relate to rental activities which has left us tax professionals wondering how to make this work. Since we as preparers could be subject to stiff penalties if we get it wrong, we have been looking for some reliable guidance on this question.
The IRS issued temporary regulations in August related to Section 199A, but they did not address the questions we have related to rental property. In January 2019 the IRS issued Notice 2019-07 which proposes guidelines to determine when rental real estate activities will be treated as a trade or business for the purposes of Section 199A.
The benefit of qualifying rental activities as a trade or business is a potential deduction of 20% of the qualified net rental income against your taxable income. This could result in a significant reduction in your federal taxes depending on the amount of qualified rental income and other limiting factors.
The guidelines published in Notice 2019-07 provide a safe harbor to determine if a rental activity rises to the level of a business and include the following:
· Separate books and records must be maintained to reflect income and expenses for each rental real estate enterprise;
· 250 or more hours of rental services are performed per year with respect to the rental enterprise;
· Beginning in 2019 the taxpayer must maintain contemporaneous records regarding
o hours of all services performed;
o dates on which such services were performed; and
o who performed the services.
Each property held for the production of rents is held as a separate enterprise or all similar properties held for the production of rents can be grouped as a single enterprise. There is an advantage to grouping similar rentals together for purposes of Section 199A. You would only need to keep a separate accounting for all rentals rather than EACH rental, and you would only need to meet the 250-hour test on the entire group rather than on EACH rental.
Contemporaneous recordkeeping means you have the documentation prepared prior to the filing of your tax return.
The types of services that count toward your 250 hours are identified in Notice 2019-07 as the following:
· 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.
These services can be provided by the owner or by the owners representative including repairmen.
The notice goes on to say that rental services does not include financial or investment management activities, such as arranging financing; procuring property; studying and reviewing financial statement or reports on operations; planning, managing, or constructing long-term capital improvements; or hours spent traveling to and from the real estate.
Real estate used by the taxpayer as a residence for any part of the year is not eligible for this safe harbor. Real estate rented or leased under a triple net lease is also not eligible for this safe harbor. A triple net lease includes a lease agreement that requires the tenant or lessee to pay taxes, fees, and insurance, and to be responsible for maintenance activities for a property in addition to rent and utilities.
Not meeting the safe harbor guidelines does not preclude the rental from qualifying for Section 199A, however there are other questions that need to be answered to determine if the rental rises to the level of a business. These follow guidelines and case law in defining a business (other than rental activities business), and relate to involvement of the owner and profit motive.
We have prepared a document for you to complete and return to us to assist with the accurate preparation of your 2018 tax return. The IRS will require a signed statement to accompany your tax return if the safe harbor option is selected. We believe our document will satisfy this requirement. You need to consider which properties you are grouping into a single rental enterprise prior to completing the enclosed statement.
Feel free to request a copy of our Section 199A statement if you haven’t received one from us already.