IRS Provides Rental Real Estate Safe Harbor for QBI Deduction

The IRS has provided new clarity on what types of rental real estate activities qualify as a trade or business for purposes of the qualified business income deduction under IRC Sec. 199A (the “QBI deduction”). IRC Sec. 199A provides a deduction to non-corporate taxpayers of up to 20% of the taxpayer’s qualified business income from each of the taxpayer’s qualified trades or businesses, including those generated through a partnership, S corporation or sole proprietorship.

Revenue Procedure 2019-38, issued September 24, 2019, provides a safe harbor allowing certain rental real estate activities, including interests in mixed-use property, to be treated as a trade or business for purposes of the QBI deduction. If a rental real estate activity does not meet the safe harbor, it can still be treated as a qualifying trade or business for purposes of the QBI deduction if the taxpayer (or IRS) otherwise establishes that the interest in rental real estate is a trade or business for purposes of IRC Sec. 199A.

The safe harbor is available with respect to a “rental real estate enterprise," which is defined as “an interest in real property held for the production of rents [either consisting] of an interest in a single property or interests in multiple properties.” A taxpayer relying on this revenue procedure must hold each interest directly or through an entity disregarded as an entity separate from its owner.

The following requirements must be met by the taxpayer in order to qualify for the safe harbor:

• 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 are performed per year. For rental real estate enterprises that have been in existence at least four years, 250 or more hours of rental services are performed in any three of the prior five consecutive taxable years.
• The taxpayer maintains contemporaneous records, including time reports, logs, or similar documents, regarding the following: 
  1. hours of all services performed,
  2. description of all services performed,
  3. dates on which such services were performed, and
  4. who performed the services.
• The taxpayer attaches a statement to a timely filed original tax return (or an amended return for the 2018 taxable year only) filed for each tax year in which the taxpayer relies on the safe harbor.

The revenue procedure specifically excludes the following types of property from eligibility for the safe harbor:

1. Real estate used by the taxpayer as a residence,
2. Real estate rented or leased under a triple net lease,
3. Real estate rented to a commonly controlled trade or business, and
4. Any rental real estate interest if any portion of the interest is treated as a “specified service trade or business” (SSTB) under the QBI deduction rules.