In Notice 2019-07, the Internal Revenue Service (IRS) and the Treasury Department issued a proposed revenue procedure outlining a safe harbor rule for treating certain rental real estate activities as a trade or business solely for purposes of the new pass-through deduction regime of Section¹ 199A. A failure to satisfy the requirements of this safe harbor does not preclude a taxpayer from otherwise establishing that the enterprise is a trade or business for purposes of Section 199A. Taxpayers should be aware that claiming that a rental real estate enterprise is a trade or business may have unexpected consequences, such as additional reporting and, in certain cases, a limitation on the deductibility of interest expense.

Under the proposed safe harbor, a rental real estate enterprise is defined as an interest in real property held for the production of rents and may consist of an interest in multiple properties. A taxpayer must treat each property separately or all similar properties, in general, as a single enterprise. Commercial and residential properties must be treated as separate enterprises. A rental real estate enterprise will be treated as a trade or business if the following requirements are satisfied during the particular tax year:

• 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 must be performed per year with respect to the rental real estate enterprise for tax years beginning prior to January 1, 2023. For tax years beginning after December 31, 2022, in any three of the five past tax years, 250 or more hours per year must be performed with respect to each rental real estate enterprise. Note that these services need not be performed by the owner, but instead may be performed by employees, agents or independent contractors.
• The taxpayer must maintain contemporaneous records that include (i) hours of all services performed, (ii) description of all services performed, (iii) dates on which such services were performed and (iv) who performed the services. This recordkeeping requirement does not apply for tax years beginning prior to January 1, 2019.
• The taxpayer must provide a statement, signed under the penalties of perjury, with its tax return, stating that the taxpayer satisfied all of the requirements above.

Real estate used by the taxpayer as a residence for any part of the year is generally not eligible for the safe harbor. Real estate rented or leased under a triple net lease (generally a lease where the tenant is responsible for ongoing expenses other than mortgage payments) is also excluded.

Rental services

The proposed revenue procedure lists qualifying and non-qualifying rental services as set forth below:

Background

Section 199A was enacted on December 22, 2017, as part of the Tax Cuts and Jobs Act. Congress enacted Section 199A to provide a deduction to non-corporate taxpayers of up to 20 percent of a taxpayer’s “qualified business income” from each of the taxpayer’s qualified “trades or businesses.” Recognizing that the treatment of a rental real estate enterprise as a trade or business was unclear, the IRS and Treasury Department issued this safe harbor, and, although this revenue procedure is only proposed, the IRS and Treasury Department provide that taxpayers may rely on the safe harbor for tax years beginning after December 31, 2017. In addition, the Treasury Department and IRS invite taxpayers to comment on the proposed revenue procedure, which comments are due by April 9, 2019.

1. All “Section” references are to the Internal Revenue Code of 1986, as amended.↩