Small U.S. rental-property operators do not have to perform all the work themselves to meet the service-hours test in a new IRS safe harbor. Revenue Procedure 2019-38, issued September 24, 2019, lets qualifying work by employees, agents and independent contractors count alongside owners’ work. The procedure offers a way to treat a rental enterprise as a trade or business for the section 199A qualified business income deduction. It does not turn every hour spent on a property into qualifying service time. [S1][S2]
The test depends on the enterprise’s age. An enterprise that has existed for less than four years needs at least 250 hours of rental services each year. For one that has existed for at least four years, the requirement is at least 250 hours in any three of the five consecutive tax years ending with the year being tested. Those hours belong to the rental enterprise, not necessarily to one owner’s personal timesheet. [S2]
Qualifying rental services include advertising vacancies, negotiating leases, checking prospective tenants, collecting rent, and operating, maintaining or repairing the property. Managing the real estate and supervising workers also count. Arranging financing, buying property, reviewing financial reports, property improvements covered by Treasury regulation 1.263(a)-3(d), and travel to or from the property do not. A contractor’s repair work can count while the owner’s drive to the building cannot. Keeping those activities separate in the records would make the hours total easier to check. [S2]
The safe harbor covers interests held directly or through a tax-disregarded entity, such as a single-member LLC. Grouping determines which properties share an hours total. Owners can treat eligible properties separately or combine all similar properties, but separate residential and commercial holdings cannot share one enterprise. Once all similar holdings are combined, that treatment must continue—including newly acquired properties—while the owner keeps relying on the safe harbor. A single mixed-use building has a separate choice: split its residential and commercial interests or treat it as its own enterprise. If kept as one enterprise, it cannot be combined with other properties. [S1][S2]
The books must follow the enterprise. Separate income and expense records are required for each one, although records for individual properties can be maintained and then consolidated. The contemporaneous service records generally identify the hours, work performed, dates and person doing it. For employees or contractors, the procedure allows a description of their rental services, the time they generally spend on them, and time, wage or payment records. Hiring help therefore does not remove the need to document what that help did. [S2]
The log requirement starts later than the safe harbor. The procedure applies to tax years ending after December 31, 2017, but its contemporaneous-record requirement does not apply to tax years beginning before January 1, 2020. Taxpayers still bear the burden of proving earlier deductions. For an operator preparing to use the safe harbor in 2020, the change calls for a routine that records services as the work happens rather than reconstructing them at filing time. [S2]
Some rental arrangements cannot use this safe harbor. One is a triple-net lease under which the tenant pays taxes, fees, insurance and maintenance in addition to rent and utilities. Property used as the taxpayer’s residence under the tax code is also excluded. Other exclusions cover rentals to a commonly controlled business and an entire rental interest if any portion is treated as a specified service trade or business under the procedure’s cited rule. A full service log cannot overcome an excluded arrangement. [S2]
An operator relying on the safe harbor must attach a statement to a timely filed original return; an amended return is allowed for the 2018 tax year only. The statement identifies the properties, their addresses and rental categories, acquisitions and disposals during the year, and represents that the requirements were met. One statement can cover several enterprises if it lists the required information separately for each. Failure to meet the safe harbor does not automatically defeat the deduction: the IRS says a rental activity may still qualify as a trade or business under the section 199A regulations. [S1][S2]
Source documents
- IRS finalizes safe harbor to allow rental real estate to qualify as a business for qualified business income deductionhttps://www.irs.gov/newsroom/irs-finalizes-safe-harbor-to-allow-rental-real-estate-to-qualify-as-a-business-for-qualified-business-income-deduction
- Revenue Procedure 2019-38 — rental real estate enterprise safe harborhttps://www.irs.gov/pub/irs-drop/rp-19-38.pdf