On January 18, 2019 the IRS issued final regulations under Internal Revenue Code § 199A (“199A”)—the Qualified Business Income Deduction, better known as the 20% Pass-Through Deduction. This provision provides certain non-corporate taxpayers a deduction of up to 20% of qualified business income from flow-through entities, Schedule C sole proprietorships, Schedule E rental activities, and Schedule F farm activities.
In addition to these final regulations, the IRS also issued proposed regulations on a real estate safe harbor. These proposed regulations will be used to determine whether your rental real estate activities are eligible for the 199A deduction. To be eligible, you must engage in regular, systematic and continuous involvement with your properties with a profit motive. Meeting the new safe harbor requirements will ensure eligibility for the 199A deduction. However, not meeting the safe harbor requirements does not preclude you from taking the 199A deduction if you can prove that you are operating the rentals as a trade or business.
To apply the safe harbor, taxpayers must either treat each rental property as a separate enterprise or treat all similar rental properties as a single enterprise. Commercial and residential real estate may not be part of the same enterprise. The treatment cannot vary from year-to-year unless there has been a significant change in facts and circumstances.
What are the Safe Harbor requirements?
- Separate books and records are maintained to reflect income and expenses for each real estate enterprise;
- 250 or more hours of rental services are performed each year; and
- Taxpayer maintains contemporaneous records (time reports, logs, similar documents) regarding hours, description, dates of all services performed and who performed the services. This contemporaneous records requirement applies to tax years beginning January 1, 2019.
What are rental services?
“Rental services” includes advertising, negotiating and executing leases, verifying tenant applications, collection of rent, daily operation, maintenance and repair, management of the real estate, purchase of materials and supervision of employees and independent contractors. The services may be performed by owners, employees, agents and/or independent contractors of the owners.
“Rental services” DOES NOT include financing or investment management activities, procuring property, studying and reviewing financial statements or reports on operation or hours spent traveling to and from the real estate.
A taxpayer taking a 199A deduction who relies on the safe harbor must include a statement with their return disclosing their safe harbor position. It must be signed under penalty of perjury.
Examples of rentals that would NOT qualify include real estate used by the taxpayer as a residence for any part of the year and activities with very minimal involvement.
Should rentals eligible for 199A file Forms 1099-MISC?
Yes, if required. It is specifically mentioned in the final regulations for rentals to issue 1099s if they consider themselves a trade or business for 199A purposes. Form 1099 is required if you pay an independent worker or unincorporated business $600 or more for the year for work related to the rental property.
You can read the proposed regulation on the real estate safe harbor here. Most taxpayers who will use the 20% Pass-Through deduction will have unique circumstances related to this deduction. For help with your questions, please contact us at 479-484-5740.