What are the Final Regulations for 20% Pass-through Deductions?
posted Jan 29, 2019 by Harold Shapiro, CPA in the Global Tax Blog
One of the most complicated provisions of December 2017’s Tax Cuts and Jobs Act (TCJA) is the brand new code Section 199A deduction, otherwise known as the 20% pass-through deduction. The deduction is effective for tax years beginning after December 31, 2017 and continuing through 2026.
What is the Section 199A Deduction?
The Section 199A deduction, sometimes referred to as the 20% Pass Through Deduction, allows business owners to take a deduction for up to 20% of their qualified business income (QBI) from schedule C businesses, certain rental businesses and business income from partnerships and S corporations.
What is a Section 162 Trade or Business?
One of the areas that has received a lot of discussion and uncertainty is that in order to qualify for the deduction, the business must first rise to the level of a “section 162 trade or business”.
The determination of whether a rental business rises to the level of a section 162 trade or business is usually difficult to determine. The IRS received numerous questions and comments regarding this issue after the TCJA was passed.
In Revenue Procedure 2019-7, the IRS offered a safe harbor providing that a rental activity (or multiple rentals if the taxpayer chooses to treat them as a combined enterprise, with the understanding that commercial properties cannot be grouped with residential properties) will rise to the level of a Section 162 trade or business if:
- Separate books and records are maintained for each rental activity (or the combined enterprise),
- 250 hours or more of rental services are performed per year for the activity (or the combined enterprise), and
- The taxpayer maintains contemporaneous records, including time reports or similar documents, regarding 1) hours of all services performed, 2) description of all services performed, 3) dates on which such services are performed and 4) who performed the services.
In addition to separate books and records, taxpayers should have a separate bank account for their rental activity or combined enterprise.
The contemporaneous recordkeeping requirement applies to tax years beginning in 2019 and forward.
It is important to understand that the IRS Notice provides a safe harbor but a taxpayer may still be able to show that an activity rises to the level of a section 162 trade or business.
The IRS Notice is generally good news for taxpayers but a taxpayer cannot use the safe harbor for any property rented on a triple net basis, but still has the ability to claim the deduction if the taxpayer can show the activity rises to the level of a section 162 trade or business.
The final regulations provide an exception to the trade or business requirement if the property is rented to a commonly controlled business. This is generally referred to as a “self-rental”.
What services are considered rental services?
Rental services include advertising to rent, negotiating and executing leases, verifying tenant applications, collection of rent, daily operation and maintenance, management of the real estate, purchase of materials, and supervision of employees and independent contractors.
Not included in rental services are travel to and from the property and financial activities such as financing.
The new safe harbor rule provides some planning opportunities. Taxpayers should always do their best to complete contemporaneous records to meet the safe harbor requirements. Taxpayers should begin making a chart of all rental related tasks they do on a regular basis as well as those done periodically like repairs and maintenance and purchasing supplies. It would be helpful to estimate the hours spent on those tasks now. Taxpayers who have rents directly deposited into accounts and bills automatically withdrawn from bank accounts may want to collect the rents and initiate bill payments themselves.
Taxpayers who have triple net leases may wish to renegotiate leases and raise rents to cover certain tasks they take on.
If you have any questions concerning this topic, please do not hesitate to contact us.
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