On Friday, January 18, 2019, the IRS released final regulations on the 20% deduction for qualified business income (or Section 199A, pass-through deduction, etc.). Under the proposed regulations, an activity had to rise to the level of a trade or business in order to get the deduction, but the regulations gave very little guidance on how a rental activity would qualify.
The proposed regulations were clear as to related party rentals where a trade or business leases a building from its common owners. In most cases, those would be considered to be a trade or business by association.
The final regulations give some additional clarity by establishing a safe harbor that rental property owners can rely upon to determine if their rental activity rises to the level of a trade or business.
Under the safe harbor, a rental real estate enterprise will be treated as a trade or business for the 20% deduction purpose if the following requirements are satisfied during the taxable year:
- Separate books & records are maintained to reflect income and expenses for each rental real estate enterprise
- 250 or more hours of rental services (as defined below) are performed per year with respect to the rental enterprise
- 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
- Who performed the services
Rental services include 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; management of the real estate; purchase of materials, and supervision of employees and independent contractors.
Rental services do not include financial or investment management activities such as arranging financing, procuring property, studying and reviewing financial statements or reports on operations, planning, managing, or constructing long-term capital improvements, or hours spent traveling to and from the real estate.
Rental activities not included in the safe harbor would be property that is rented and also used for personal purposes for more than 14 days and most triple net leases where the tenant is responsible for the payment of all bills, maintenance, etc.
Taxpayers can also group multiple rental activities as a “rental real estate enterprise” in order to meet the safe harbor requirements. Commercial and residential real estate may not be part of the same enterprise. Taxpayers may not vary this treatment from year-to-year unless there has been a significant change in facts and circumstances.
Under the final regulations, beginning in 2019, rental property owners will need to spend more time documenting their activity in the business as “contemporaneous records including time reports, logs, or similar documents” are required. As a trade or business, you will also be required to file Form 1099s to report payments that you make to certain vendors. As the final regulations came out late, if your rental activities will qualify as a trade or business for 2018, please contact us immediately so that Form 1099s can be filed. They are due on January 31, 2019!
If you would like more information on Form 1099s, please listen to our podcast.