The passage of the Tax Cuts and Jobs Act in December 2017 led to numerous changes in the tax code, including the centerpiece reduction of the corporate tax rate from 35 percent to 21 percent. However, this new rate applied only to C corporations and not to other “pass-through entities” like S corporations, partnerships, LLCs, and others. In order to create an opportunity for pass-through entities left out of the tax cut regime central to the new law, Section §199A was enacted, allowing pass-through entities to deduct up to 20% of their business income when they calculate their taxes.
There is another catch for certain enterprises like real estate ventures involving the rental of multiple properties throughout the year. In order to qualify for the 20% deduction, a company typically must be considered a “Qualified Trade or Business.” Traditionally, many real estate rental businesses were not considered a “qualified trade or business,” as each transaction was treated individually rather than as part of a larger business venture. However, our skilled dual licenses Tax Attorneys & CPAs at the Tax Law Offices of David W. Klasing have been closely monitoring how our clients with real estate businesses may be able to save money due to the issuance of Revenue Procedure 2019-38 (PDF), which creates a safe harbor provision for real estate rental ventures to be treated as a qualified business and therefore be eligible for the 20% deduction.
Who Qualifies for the Rev. Proc. 2019-38 Safe Harbor Provision?
As noted above, Revenue Procedure 2019-38 created a rental real estate safe harbor for purposes of the §199A trade or business rules. This applies for tax years ending after December 31, 2017. Under this new safe harbor provision, a real estate enterprise is to be treated as a qualifying trade or business for purposes of §199A if the following requirements are satisfied during the tax year:
- Separate books and records are maintained to reflect income and expenses for each rental real estate enterprise.
- For rental real estate enterprises that have been in existence less than four years, 250 or more hours of rental services (defined later) are performed per year with respect to the rental real estate enterprise.
For rental real estate enterprises that have been in existence for at least four years, in any three of the five consecutive taxable years that end with the taxable year, 250 or more hours of rental services are performed (as described in this revenue procedure) per year with respect to the rental real estate enterprise; and
- The taxpayer maintains contemporaneous records, including time reports, logs, or similar documents, regarding the following:
- hours of all services performed;
- description of all services performed;
- dates on which such services were performed; and
- who performed the services.
Suppose services concerning the rental real estate enterprise are performed by employees or independent contractors (i.e., a property management company). In that case, the taxpayer may provide a description of the rental services performed by such employee or independent contractor, the amount of time such employee or independent contractor generally spends performing such services for the enterprise, and time, wage, or payment records for such employee or independent contractor. Such documents are to be made available for inspection at the request of the IRS.
- The taxpayer must attach a statement to a timely filed original return (or, for 2018 ONLY, an amended return) for each taxable year in which the taxpayer relies on the safe harbor.
The statement must include the following information: (1) a description (including the address and rental category) of all rental real estate properties that are included in each rental real estate enterprise; (2) a description (including the address and rental category) of rental real estate properties acquired and disposed of during the taxable year; and (3) a representation that the requirements of this revenue procedure have been satisfied.
What are “Rental Services” Under Rev. Proc. 2019-38?
Rev. Proc. 2019-38 defines a real estate enterprise as “an interest in real property held for the production of rents,” whether it consists of an interest in a single property or interests in multiple properties. However, a taxpayer must hold each such interest in real property directly or through a disregarded entity. “Rental services” for the purpose Rev. Proc 2019-38 include, but are not limited to: (i) advertising to rent or lease the real estate; (ii) negotiating and executing leases; (iii) verifying information contained in prospective tenant applications; (iv) collection of rent; (v) daily operation, maintenance, and repair of the property, including the purchase of materials and supplies; (vi) management of the real estate; and (vii) supervision of employees and independent contractors.
The term rental services does not include financial or investment management activities, such as arranging financing, procuring property, studying and reviewing financial statements or reports on operations; improving property under, or hours spent traveling to and from the real estate. It also does not include real estate used by the taxpayer as a residence, rented or leased under a triple net lease, rented to a trade or business conducted by the taxpayer, or when the interest in the property is treated as a specified service trade or business under Reg. §1.199A-5(c)(2).
If You Believe You May Qualify for the §199A Safe Harbor Provision, Contact Our Skilled Tax Attorneys Today
The 20% deduction on business income offered through §199A can be a huge boon for business enterprises. As such, the existence of Rev. Proc. 2019-38 is big news for owners of real estate rental businesses. To determine if you qualify, reach out to an experienced dual tax attorney and CPA like those at the Tax Law Offices of David W. Klasing right away. You can set up a consultation by calling our offices at (661) 432-1480.
Do not get these concepts with those surrounding being a real estate professional.
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