8581 / What is the safe harbor that allows rental real estate businesses to claim the Section 199A deduction?

Only pass-through entities that qualify as a “trade or business” are entitled to claim the new 20 percent deduction for qualified business income under Section 199A. Many business owners engaged in rental real estate activities had questioned whether their businesses would qualify for the deduction. In response, the IRS released proposed Revenue Procedure 2019-07, finalized by Revenue Procedure 2019-38, which provides a safe harbor so that rental real estate businesses will qualify as “trades or businesses” and can claim the 199A deduction if they satisfy certain criteria. For purposes of the safe harbor, “rental real estate enterprise” is defined to include any interest in real property held to generate rental or lease income, and can be comprised of an interest in a single property or multiple properties.

To qualify under the safe harbor, the following requirements must be met:

(1) Separate books and records for each rental enterprise must be maintained,

(2) If the rental real estate enterprise has been in existence for less than four years, 250 or more hours of rental real estate services must be performed each year,

(3) If the rental real estate enterprise has been in existence for more than four years, at least 250 hours of rental real estate services must have been performed in at least three of the past five years (these services can be performed by employees or independent contractors of the business), and

(4) The taxpayer must maintain contemporaneous records regarding the rental real estate services that are performed each year, including time reports, logs or similar documents, with respect to (a) description of all services performed, (b) dates on which the services were performed and (c) who performed the
services,

(5) The taxpayer must attach a statement to the relevant tax return indicating that the safe harbor is being relied upon.

To qualify under the safe harbor, the interest in real property must also be held directly by the taxpayer or through an entity disregarded as an entity separate from the owner (i.e., a single-member LLC).¹

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1. Rev. Proc. 2019-38.