Is Rental Property Income Eligible for the Pass Through Income Deduction?
On January 18, 2019, final regulations and a special notice were published regarding the 20% income tax deduction related to certain pass through income.
The Notice (Notice 2019-07) offers owners of rental real estate an opportunity to benefit from significant deductions related to rental income. This blog discusses the content of the Notice.
As an appendix to previously posted videos on the pass through income deduction, we posted a video regarding the Notice:
For the other videos on the pass through deduction, click on this link: Pass Through Deductions and Other Tax Cuts and Jobs Act Subjects.
This blog is to discuss the Notice 2019-07 in more detail.
It’s not always easy to determine whether your rental real estate activity satisfies the somewhat vague definition of a trade or business so the IRS tried to provide a bright line test (call it a “safe harbor”) for determining whether the deduction will be available to you for the rental income you receive.
The safe harbor is described in Notice 2019-07 in the form of a Proposed Revenue Procedure. If your rental activity income satisfies the criteria described in the Notice, you can be confident that your rental activity income will qualify for the 20% pass through income deduction under section 199A of the Internal Revenue Code.
The safer harbor provisions apply only to Rental Real Estate Enterprises. A Rental Real Estate Enterprise is an interest, or multiple interests, in real estate held directly by an individual or Relevant Pass Through Entity (aka “RPE” such as a limited liability company, S corporation or partnership), for the production of rents but the definition excludes triple net leases and interests used to any extent as a personal residence. Commercial and residential real estate cannot be part of the same Rental Real Estate Enterprise.
For purposes of the 20% deduction that applies to pass through income under Section 199A of the IRC, your Rental Real Estate Enterprise will be deemed a trade or business if certain requirements described in the Notice are satisfied. Keep in mind that only certain income of a trade or business can qualify for the deduction so this is a key point for income earned through your rental activities.
The Notice says that your rental activity will be treated as a trade or business if (i) you maintain separate books and records for each rental real estate enterprise; (ii) you or your agents devote 250 or more hours per year to rental services with respect to the rental real estate enterprise; and (iii) you keep contemporaneous records related to the rental services.
The records must include: (i) the hours performed, (ii) a description of the services performed, (iii) dates on which the services were performed, and (iv) who performed the services.
The requirement that the records must be contemporaneous has been waived for 2018 so, if you do not have good records for 2018, you can try to do the best you can to reconstruct how you performed rental services in 2018.
Some things you do will count as rental services and some things will not. The Notice includes a specific list of activities that count as rental services. Here is the list:
- Advertising to rent or lease property;
- Negotiating and executing leases;
- Verifying information in the applications of prospective tenants;
- Daily operations, maintenance and repairs;
- Management of real estate;
- Purchasing materials; and
- Supervision of employees and independent contractors.
Keep in mind that you will get credit for the time put in by your employees, agents and independent contractors so, if you have others doing the work for you, you should insist that they keep contemporaneous records of the work they do.
Also keep in mind that some of the time devoted to your rental activity will not count as rental services. The time you or your agents spend traveling from property to property will not count. Also, time devoted to financial and investment management relating to your real estate rental activities will not count. Accordingly, the time you spend arranging financing, acquiring property, studying or reviewing financial statements or reports regarding your properties, or planning, managing, or constructing long term capital improvements will not count.
To claim the benefits of the safe harbor, you must file a statement indicating that all the requirements of the Notice have been satisfied. The statement must be signed by the taxpayer or authorized representative and include the following:
“Under penalties of perjury, I (we) declare that I (we) have examined the statement, and, to the best of my (our) knowledge and belief, the statement contains all the relevant facts relating to the revenue procedure, and such facts are true, correct, and complete.”
We are currently working on Section 2 of Part 3 of our video which will cover:
- Planning to avoid the phase-out zone;
- Additional planning to maximize pass-through income deductions based on wages and capital expenditures;
- How transferring business interests to family members and trusts can create additional pass through income deductions; and
- How converting pass through income to wages can increase pass through deductions.
You can access our playlist of previously posted videos by clicking on this link: Pass Through Deductions and Other Tax Cuts and Jobs Act Subjects.
To subscribe to the YouTube channel click here: YouTube Channel.
Posted by Richard S. Land on February 24, 2019.
Chipman Mazzucco Emerson
Attorneys at Law
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