Doesn’t the sound of “safe harbor” sound great? It’s a comforting thought for most people. However, if you are like a lot of people the sound of the IRS creating a safe harbor for Section 199A rental property may not sound too exciting. If you did the work, you may not feel like you need a safe harbor for your rental property trade or business. The IRS is a little more excited about it and thinks that it’s your new best friend.
Safe Harbor Rules
The Safe Harbor creates a fork in the road for you. Now you have to make another choice by figuring out whether your rentals qualify for the 20% tax deduction. You now have to choose between these two methods:
- Use existing laws to claim rentals are businesses or trades.
- Use the new safe-harbor rules.
If you meet the guidelines, the IRS considers your profits from rental trades or businesses as QBI (qualified business income) per Section 199A deductions. You may decide not to use safe harbor rules since they contain arduous provisions. Additionally, you may not even qualify for using the the deduction. That’s not a problem either, as you can use the second method to claim the 199A tax deduction claiming the existing tax law rules.
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Introducing a New Tax Term – “Rental Real Estate Enterprise”
The new safe harbor rule under Section 199A classifies each rental state property individually. You do have the choice of classifying them as a group if your properties fall into one of these categories:
- Residential (real estate) enterprise
- Triple net lease real estate
- Commercial real estate enterprise
So, the grouping rule is that each rental property is treated as a separate enterprise. Or, you can treat similar properties as one sole enterprise. Also, when you use the safe harbor, the enterprise must stay the same from year to year. Its classification cannot be changed unless there is a significant change in the circumstances. Please note that you do not have to use the safe harbor rules. You can instead, continue to use the previous rules to qualify your rental property for the Section 199A tax deduction.
Requirements for Claiming Safe Harbor
Just for purposes pertaining to Section 199A, the IRS will consider rental estate enterprises as trades or businesses. However, they must satisfy these requirements:
- Separate books and records reflecting each rental real estate enterprise’s income and expenses.
- You provide at least 250 “rental services” hours during the tax year.
- You maintain concurrent records that include time reports or logs for hours of services performed, description of those services, who performed the services, and the date on which they were performed.
Rental Services Defined
Rental services can be performed by you, your agent, your employee, or by your independent contractor. They include services such as:
- Leasing or renting advertisements
- Negotiation or execution of leases
- Verifying information on tenant lease applications
- Collecting rent payments
- Daily operations pertaining to the property such as maintenance and repairs
- Management services
- Purchasing materials
- Supervision of independent contractors or employees
Some rental service activities that do not qualify under the safe harbor rule include investment management, reviewing financial reports or statements, time spent traveling to or from the property and dealing with long-term capital improvements.
