The Tax Cuts and Jobs Act of 2017 (“TCJA”) offered a new tax deduction of up to 20% for owners of certain pass-through entities such as limited liability companies, partnerships, and other entities. Section 199A of TCJA offers the potential for some real estate investors to receive an added tax deduction while owning and managing investment properties. This deduction has several limitations on type and amount of income subject to the potential deduction that should be reviewed with a qualified tax advisor.
The potential to receive additional tax benefits per Section 199A combined with the option for tax deferral in a 1031 Exchange at the time of sale, can provide real estate investors with potentially significant tax advantages.
On January 18, 2019, the Treasury released Notice 2019-07 which provides added additional guidance on how investors can qualify for the new deduction including specific guidelines (“safe harbor”) for real estate investors. The Notice also introduced a new tax term, a “rental real estate enterprise” along with conditions that must be met for a rental real estate enterprise to be eligible for the 199A deduction.
To meet the safe harbor and qualify for the deduction, investors must meet the following:
- Separate records must be maintained for each rental real estate enterprise:
- A real estate enterprise can consist of a single or multiple real estate rentals.
- Commercial and residential rentals must be in separate enterprises and cannot be combined into the same real estate enterprise.
- In the tax years 2019 – 2023, at least 250 documented hours of rental services must be performed by the taxpayer or workers for the taxpayer for each rental real estate enterprise.
- The taxpayer must maintain written records to document the following:
- Hours of all services performed;
- Description of services performed;
- Dates on which such services were performed;
- Who performed the services.
Rental services that may be counted toward the 250-hour requirement include:
- Advertising to rent or lease the real estate;
- Negotiating and executing leases;
- Verifying information contained in tenant applications;
- Collection of rent;
- Daily operation, maintenance, and repair of rental property;
- Management of the real estate;
- The purchase of materials for repairs;
- Supervision of employees and independent contractors.
Rental services for purposes of the rental real estate enterprise safe harbor do not include the following:
- Financial activities, such as arranging financing;
- Procuring property;
- Reviewing financial statements or reports;
- Planning, managing, or constructing capital improvements;
- Hours spent traveling to and from rental real estate.
Rental services counted toward the 250-hour requirement may be performed by owners or employees, agents, and/or independent contractors working for the owners. The activities of several individuals may be aggregated for purposes of meeting the 250-hour requirement.
The following types of rental real estate are not eligible for the safe harbor:
- Real estate owned or managed under a triple net (“NNN”) lease agreement.
- Rental property leased under an agreement that requires the tenant or lessee to pay a portion of the taxes, fees, insurance, and to be responsible for maintenance activities allocable to the portion of the property leased by the tenant.
- Vacation property used by the taxpayer for any portion of the year.
Taxpayers should discuss the 199A deduction and their specific investment situation with tax and/or legal advisors as the 20% deduction rules are complex in some areas. For more information, please contact us at 866 398-1031 or via email at info@FirstGuardianGroup.com.