The Tax Cuts and Jobs Act, (The Act), has brought with it many changes that impact all taxpayers. Real property owners in particular, need to be aware of the impacts of these changes, and plan for them accordingly.
One of the most significant changes in The Act effecting income property owners is the newly created 199A deduction. 199A was designed to reduce the effective tax rate on business taxable income. Under the new Code Section 199A, there is a 20% deduction for qualified business income (QBI) from a pass-through entity (Partnerships & S-Corps). However, without proper planning, limitations may apply. In circumstances where the full 20 percent deduction is available, the top federal tax rate for pass-through entities would drop from 37% to 29.6%, which can represent significant savings.
The IRS has recently published proposed revenue procedures on how to apply and who qualifies for, the 20% pass-through deduction. One of these proposed revenue procedures as part of IRS Notice 2019-07 provides for a safe harbor under which a rental real estate enterprise will be treated as a trade or business for purposes of section 199A. This safe harbor is available to taxpayers who seek to claim the deduction under section 199A with respect to a rental real estate enterprise.
According to the provision, solely for the purposes of this safe harbor, a rental real estate enterprise will be treated as a trade or business if all of the following requirements are satisfied during the taxable year with respect to the rental real estate enterprise:
- Separate books and records are maintained to reflect income and expenses for each rental real estate enterprise.
- For taxable years beginning prior to January 1, 2023, 250 or more hours of rental services are performed per year with respect to the rental enterprise. For taxable years beginning after December 31, 2022, in any three of the five consecutive taxable years that end with the taxable year (or in each year for an enterprise held for less than five years), 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.
- The taxpayer maintains contemporaneous records, including time reports, logs, or similar documents, regarding the following: (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. Such records are to be made available for inspection at the request of the IRS. The contemporaneous records requirement will not apply to taxable years beginning prior to January 1, 2019.”
The proposed revenue procedure also provides an explanation of rental services for purposes of the 250 hours mentioned above. If these requirements are met, you may apply for the safe harbor by including a statement attached to the return on which you claim the section 199A deduction or passes through section 199A information that the requirements for the safe harbor as described have been satisfied.
This revenue procedure applies to taxable years ending after December 31, 2017. Until such time that the proposed revenue procedure is published in final form, taxpayers may use the safe harbor described in this proposed revenue procedure for determining when a rental real estate enterprise may be treated as a trade or business solely for purposes of section 199A.
Note: this revenue procedure does not affect the 199A deduction associated with dividends from real estate investment trusts.
How MBAF Can Help
This 199A safe harbor for qualified rental entities is only one complication raised by The Act that taxpayers, and particularly earners of qualified business income, need to be aware of under the new tax laws.
While there are some new laws which simplify certain things for taxpayers, most add complexities. Since tax season is upon us, now is the time to be sure you are entirely up to speed, and understand how to maximize the potential benefits to be found in this tax legislation.
There may be options and opportunities that the new reforms create that you may not be aware of. We can help you answer any questions you may have regarding the 199A deduction or any impacts of the Tax Cuts and Jobs Act.
Understanding the opportunities and tax savings created by the Tax Cuts and Jobs Act of 2017 can be quite complex. If you would like to benefit from our expertise in these areas, or if you have further questions on this Advisory, do not hesitate to contact our Real Estate Specialists, or call us at 1-800-239-1474.