The IRS just released new instructions clarifying part of the 2018 Tax Cuts and Jobs Act (TCJA) and providing a safe harbor for real estate rentals to qualify for a special 20% deduction (Section 199A) and therefore a lower tax under the new tax law. In order to qualify for this deduction, the lessor must be treated as an “active trade or business.”
IRS Notice 2019-7 states that solely for purposes of 199A, rental real estate will be treated as a trade or business if the following requirements are met:
- Separate books and records are maintained to reflect income and expenses for each rental.
- 250 or more hours of rental services are performed per year. Rental services include advertising to rent, negotiating and executing leases, verifying information, collecting rent, operating and maintenance of the property, management, purchase of materials, and supervision of employees or independent contractors. It does NOT include arranging financing, procuring property, studying or reviewing financial statements, reports on operations, planning or constructing long-term capital improvements, or hours spent traveling to or from the real estate. The 250 hours may be performed by the owner or someone hired by the owner.
- The taxpayer must maintain contemporaneous records to include time logs documenting hours of all services performed, a description of the services performed, dates of the services performed, and who performed the services. For 2018 only, the IRS has allowed that owners need not be held to the “contemporaneous record” standard if they can now document the time spent during the year. For 2019, it will be critical to keep accurate contemporaneous records of time spent on the specific rental property – meaning a weekly log of time spent on each property.
We also recommend that the lessor prepare 1099MISCs for any services performed by contractors.
It is very important to note that the safe harbor rules above do not apply to any properties with a triple net lease, even if they meet the 250 hour requirement.
This notice is good news for most of our clients with rental real estate enterprises, as it clarifies how and when to qualify for the 20% deduction for real estate rentals.
Please feel free to contact us if you have any questions.