New regulations provide rental real estate safe harbor for 20 percent pass-through deduction

Last week, the IRS released final section 199A regulations for the 20 percent pass-through deduction enacted under the Tax Cuts and Jobs Act (TCJA). For taxable years beginning after Dec. 31, 2017, and before Jan. 1, 2026, noncorporate taxpayers (individuals, trusts and estates) may take a deduction of up to 20 percent of qualified business income (QBI) from partnerships, S corporations and sole proprietorships, plus 20 percent of qualified REIT dividends and publicly traded partnership (PTP) income. There are a number of important changes and clarifications compared to the proposed regulations, which we will address in future alerts. As part of the regulations package, the IRS also provided a safe harbor in Notice 2019-07 for rental real estate to be treated as a trade or business solely for purposes of section 199A.

Key takeaways

• Under the safe harbor, a rental real estate enterprise will be treated as a trade or business for section 199A purposes if 250 hours per year of rental services are performed with respect to the rental enterprise.
• Triple net leases are specifically prohibited from using the safe harbor. Triple net leases will need to be analyzed outside of the safe harbor to determine if they are eligible for the section 199A deduction.
• Taxpayers can rely on the safe harbor until a final revenue procedure is issued.
• The safe harbor is strictly limited to the application of section 199A.
• Taxpayers can treat each rental real estate property as a stand-alone enterprise or group together similar properties and treat each group as an enterprise.
• Although the safe harbor applies solely for purposes of section 199A, clients should be reminded that treating rental properties as a trade or business may require filing Form 1099 to report rental expenses and treating mortgage interest as business interest expense subject to the new limitations on the business interest expense deduction.

Safe harbor for rental real estate                                            

Under the safe harbor, a “rental real estate enterprise” (defined below) will be treated as a trade or business for section 199A purposes if it meets the following requirements:

1. separate books and records are maintained to reflect income and expenses for each rental real estate enterprise;