Certain rental real estate owners are likely resting more comfortably knowing that they may take certain deductions from their federal taxes due to the IRS’ recent finalization of its earlier proposed Revenue Procedure. This Revenue Procedure delineates a safe harbor under which certain rental real estate owners may deduct income from qualified businesses or trades under Internal Revenue Code Section 199A. Until now, there had been much confusion as to which rental real estate owners were permitted to take this deduction.

Section 199A permits non-corporate taxpayers to deduct up to twenty percent of their qualified business income from each qualified trade or business. The IRS’ safe harbor resolves certain ambiguity that existed in determining whether a rental real estate enterprise is a qualified trade or business under this Section. The IRS will now treat a rental real estate enterprise as a single entity under this Section if it meets the safe harbor’s requirements. Failure to meet all the safe harbor’s requirements does not automatically result in the preclusion of the rental real estate enterprise from taking the deduction; however, rental real estate enterprises that meet all the requirements can more confidently take the deduction.

To qualify, a rental real estate enterprise must be held for the production of rents and consist of an interest in a single property or interests in multiple properties. These interests must be held either directly by the taxpayer or through disregarded entities. Such taxpayers have the option to treat “similar properties” held for the rental production as one rental real estate enterprise, or they may treat each interest as a separate rental real estate enterprise. “Similar properties” means they are all either commercial or residential. Mixed use properties qualify under the safe harbor and may either be viewed as separate commercial and residential interests or as a single real estate enterprise that may not combined with other interests.

The requirements to meet the safe harbor are:

• Each rental real estate enterprise must keep separate books and records reflecting income and expenses. Rental real estate enterprises comprised of more than one property may satisfy this requirement if the income and expense information for each property is consolidated.
• Rental real estate enterprises that have been in existence less than four years must have 250 or more hours of rental services performed annually. Enterprises in existence for at least four years must have 250 or more hours of rental services performed in any three of the five preceding tax years. The IRS provides a non-comprehensive list of examples of activities that constitute rental services, they are:
  • 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, including the purchase of materials and supplies;
  • Management of the real estate; and
  • Supervision of employees and independent contractors.
• The taxpayer must maintain records including time reports, logs or similar documents regarding: (i) the hours of all services performed; (ii) a description of services provided; (iii) the dates on which services were provided; and (iv) the identity of who performed the services.
• The taxpayer must attach a statement to its annual return containing: (i)  a description of the rental real estate properties; (ii) a description of rental real estate acquired and disposed of during the year; and (ii) a representation that the requirements of the safe harbor have been met.

It is of note, that owners of certain real estate are not included as rental real estate enterprises, and may therefore not take the deduction under Section 199A. Owners of the following real estate are excluded:

• Real estate used as a residence by the taxpayer.
• Real estate rented or leased under a triple net lease.
• Real estate rented to a trade or business conducted by a taxpayer which is under common control (the real estate would be aggregated with the other trade or business).
• Certain real estate of which a portion is treated as a specified service trade or business under Regulation § 1.199A-5(c)(2).

Opinions and conclusions in this post are solely those of the author unless otherwise indicated. The information contained in this blog is general in nature and is not offered and cannot be considered as legal advice for any particular situation. Any federal tax advice provided in this communication is not intended or written by the author to be used, and cannot be used by the recipient, for the purpose of avoiding penalties which may be imposed on the recipient by the IRS. Please contact the author if you would like to receive written advice in a format which complies with IRS rules and may be relied upon to avoid penalties.