As tax season unfolds, it's crucial for rental property owners to be aware of tax deductions that can significantly lower their tax bill. One essential tax provision – Section 199A – offers a deduction of up to 20% on qualified business income, including income from rental real estate. However, not all rental activities qualify as a "trade or business" under this section, leading to some confusion among taxpayers.
To clarify this, the IRS provides a safe harbor rule that, if met, assures the rental real estate enterprise is treated as a trade or business for the purposes of claiming the Section 199A deduction. Let's break down what this means for you and how you can ensure your rental activities qualify.
What is the Safe Harbor Rule?
The safe harbor is a set of criteria that, when met, automatically treats a rental real estate enterprise as a trade or business. Meeting these requirements is optional, but doing so provides certainty regarding your qualification for the Section 199A deduction.
Requirements for Qualification
To qualify under the safe harbor:
Maintain Separate Books and Records: Keep diligent financial records for each property or consolidated records if you own multiple properties.
Meet the 250 Hours of Rental Services Requirement: You must perform at least 250 hours of rental services per year. These services can include marketing, lease management, maintenance, and more. For enterprises older than four years, this requirement must be met in any three of the past five years.
Keep Contemporaneous Records: Document the amount of time spent on services, the description of the services, dates, and the identity of those who performed the services (whether yourself, employees, or contractors).
Include a Statement with Your Tax Return: Attach a detailed statement to your tax return each year you claim the deduction, outlining your rental activities and confirming that you meet the safe harbor requirements.
What Counts as Rental Services?
Qualifying rental services include a variety of operational tasks such as advertising, rent collection, property maintenance, and managing the real estate. However, financial management tasks like arranging financing or reviewing financial statements do not count.
Exclusions from the Safe Harbor
Some rentals do not qualify, such as those used as a personal residence or those under triple net leases where tenants assume responsibility for taxes, insurance, and maintenance.
How to Use This Information
If you're a rental property owner, evaluating your activities against the safe harbor requirements could mean a significant tax deduction. Start by reviewing your practices, bookkeeping, and record maintenance to ensure they align with the IRS guidelines.
By planning accordingly and possibly restructuring your operations, you might position yourself to take advantage of this valuable deduction, thereby lowering your taxable income.
The Bottom Line
Qualifying for the Section 199A deduction can lead to tangible tax savings. Although the safe harbor is not mandatory, it provides a clear pathway to ensure your rental enterprise is recognized as a trade or business. As you navigate this tax season, consider if your rental activities meet the standard set by the IRS and take appropriate steps to leverage this opportunity.
Please note that this information is current as of the publication date. Always consult with Schwartz & Schwartz for advice tailored to your specific situation.