IRS Provides Section 199A Safe Harbor for Rental Real Estate

Rev. Proc. 2019-38,Internal Revenue Service,(Sept. 24, 2019)

The IRS issued a final revenue procedure that provides a safe harbor treating a rental real estate enterprise as a trade or business for purposes of section 199A of the Internal Revenue Code (Code) and §§1.199A-1 through 1.199A-6 of the Income Tax Regulations (26 CFR Part I). The safe harbor provided by this revenue procedure applies solely for purposes of section 199A. If an enterprise fails to satisfy the requirements of this safe harbor, it may be treated as a trade or business for purposes of section 199A if the enterprise otherwise meets the definition of trade or business in §1.199A-1(b)(14).

If the safe harbor requirements are met, the rental real estate enterprise will be treated as a single trade or business as defined in section 199A(d) for purposes of applying the regulations under section 199A, including the application of the aggregation rules in §1.199A-4. A relevant passthrough entity (“RPE”), as defined in §1.199A-1(b)(10), may also use this safe harbor. To rely on the safe harbor, taxpayers and RPEs must satisfy all of the requirements of the revenue procedure. Failure to satisfy the requirements of this safe harbor does not preclude a taxpayer or the Service from otherwise establishing that an interest in rental real estate is a trade or business for purposes of section 199A. Solely for purposes of this safe harbor, a rental real estate enterprise is defined as an interest in real property held for the production of rents and may consist of an interest in a single property or interests in multiple properties. The taxpayer or RPE relying on this revenue procedure must hold each interest directly or through an entity disregarded as an entity separate from its owner under any provision of the Code.

Once a taxpayer or RPE treats interests in similar commercial properties or similar residential properties as a single rental real estate enterprise under the safe harbor, the taxpayer or RPE must continue to treat interests in all similar properties, including newly acquired properties, as a single rental real estate enterprise when the taxpayer or RPE continues to rely on the safe harbor. However, a taxpayer or RPE that chooses to treat its interest in each residential or commercial property as a separate rental real estate enterprise may choose to treat its interests in all similar commercial or all similar residential properties as a single rental real estate enterprise in a future year.

The determination to use this safe harbor must be made annually. Solely for the purposes of section 199A, each rental real estate enterprise will be treated as a single trade or business if 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. If a rental real estate enterprise contains more than one property, this requirement may be satisfied if income and expense information statements for each property are maintained and then consolidated;
  • For rental real estate enterprises that have been in existence less than four 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. For rental real estate enterprises that have been in existence for at least four years, in any three of the five consecutive taxable years that end with the taxable year, 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; and
  • 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. If services with respect to the rental real estate enterprise are performed by employees or independent contractors, the taxpayer may provide a description of the rental services performed by such employee or independent contractor, the amount of time such employee or independent contractor generally spends performing such services for the enterprise, and time, wage, or payment records for such employee or independent contractor. Such records are to be made available for inspection at the request of the IRS.
  • The taxpayer or RPE attaches a statement to a timely filed original return (or an amended return for the 2018 taxable year only) for each taxable year in which the taxpayer or RPE relies on the safe harbor. An individual or RPE with more than one rental real estate enterprise relying on this safe harbor may submit a single statement but the statement must list the required information separately for each rental real estate enterprise. The statement must include the following information:(1) A description (including the address and rental category) of all rental real estate properties that are included in each rental real estate enterprise;(2) A description (including the address and rental category) of rental real estate properties acquired and disposed of during the taxable year; and (3) A representation that the requirements of this revenue procedure have been satisfied.

Rental services for purpose of this revenue procedure include, but are ot limited to: (i) advertising to rent or lease the real estate; (ii) negotiating and executing leases; (iii) verifying information contained in prospective tenant applications; (iv) collection of rent; (v) daily operation, maintenance, and repair of the property, including the purchase of materials and supplies; (vi) management of the real estate; and (vii) supervision of employees and independent contractors. Rental services may be performed by owners, including owners of an RPE, or by employees, agents, and/or independent contractors of the owners. The term rental services does not include financial or investment management activities, such as arranging financing; procuring property; studying and reviewing financial statements or reports on operations; improving property under §1.263(a)-3(d); or hours spent traveling to and from the real estate.

The following types of property may not be included in a rental real estate enterprise and are therefore not eligible for the safe harbor:

  • (A) Real estate used by the taxpayer (including an owner or beneficiary of an RPE) as a residence under section 280A(d).
  • (B) Real estate rented or leased under a triple net lease. For purposes of this revenue procedure, a triple net lease includes a lease agreement that requires the tenant or lessee to pay taxes, fees, and insurance, and to pay for maintenance activities for a property in addition to rent and utilities.
  • (C) Real estate rented to a trade or business conducted by a taxpayer or an RPE which is commonly controlled under §1.199A-4(b)(1)(i).
  • (D) The entire rental real estate interest if any portion of the interest is treated as an SSTB under §1.199A-5(c)(2) (which provides special rules where property or services are provided to an SSTB).

Safe Harbor Tax Return Statement

A taxpayer relying on Rev Proc 2019-38 must attach a statement to its tax return stating that it intends to rely upon the safe harbor. Except for tax year 2018 (where tax returns may have been filed before Rev Proc 2019-38 was released), the taxpayer must attach the statement to its original tax return. The statement cannot be added by amending the tax return.

This statement for each RREE must include:

  • The address and rental category of each rental real estate property in the RREE
  • The address and rental category of all rental real estate properties which the RREE acquired or disposed of during the tax year
  • A representation that the RREE has satisfied all requirements in Rev Proc 2019-38.
  • Although not stated in Rev Proc 2019-38, the taxpayer also should state its intention to rely upon the safe harbor.

Effective Date

The revenue procedure applies to taxable years ending after December 31, 2017. Alternatively, taxpayers and RPEs may rely on the safe harbor set forth in Notice 2019-07, 2019-09 IRB 740, for the 2018 taxable year. The contemporaneous records requirement will not apply to taxable years beginning prior to January 1, 2020, but taxpayers bear the burden of showing the right to any claimed deductions in all taxable years.