Concurrent with the Section 199A final regulations, the IRS released a proposed Revenue Procedure in order to provide a safe harbor that rental real estate businesses can rely upon in order to qualify as “trades or businesses” for purposes of taking advantage of the new 20 percent deduction for qualified business income of certain pass-through entities.
Rental real estate business owners will qualify as trades or businesses, so that they can claim the 199A deduction, if the entity (1) maintains separate books and records for each rental enterprise, (2) is involved in the performance of at least 250 hours of rental real estate services each year (these services can be performed by employees or independent contractors of the business), and (3) maintains contemporaneous records regarding the rental real estate services that are performed each year. Notably, if the real estate is rented or leased under a triple net lease, the safe harbor is unavailable.
We asked Professors Robert Bloink and William Byrnes, who write for ALM’s Tax Facts and hold opposing political viewpoints, to their opinions on the new rental real estate carve out and its implications going forward.
Below is a summary of the debate that ensued between the two professors:
Byrnes: I’m all for this clearly laid out safe harbor, it gives rental real estate professionals specific guidance as to whether they will qualify for the new deduction, and lets them move forward knowing whether they will be characterized as a trade or business and able to take the deduction.
Bloink: While I applaud the IRS for releasing the 199A final regulations so quickly, I think that this is yet another issue that they’ve simply kicked down the road. Addressing issues in a piecemeal fashion is only going to create more confusion, make it difficult for clients to engage in efficient planning and also add to future litigation of the issue.
Byrnes: I don’t find any confusion in the safe harbor—it follows guidance similar to the rules that apply to rental real estate professionals in the passive activities context, so the safe harbor should be simple and easy to apply. It’s really as clear as we could have hoped for.
Bloink: The safe harbor excludes triple net leases entirely—this is a huge faction of the rental real estate industry. These “businesses” now aren’t sure whether they are able to qualify, so the safe harbor actually could provide motivation for a huge portion of the real estate industry to shift their business models to something that might not be as efficient or effective under the circumstances—this situation also creates uncertainty for the tenants who are relying upon those leases.
Byrnes: Sure, but many real estate investors get involved in triple net leases for—among other important reasons—the fact that they get to have less involvement in the day-to-day of the business while still making money.
Bloink: I just think that if the entire premise of this new Section 199A is revolving around the idea that the activity has to rise to the level of a “trade or business”, we should have some more definitive guidance on what it actually means to operate as a trade or business. It seems simple, but it really isn’t—especially in the real estate sphere.
Byrnes: If it wasn’t a trade or business before 199A existed, it shouldn’t be a trade or business just because there’s now a deduction involved. The hard fact is that many real estate investors can’t legitimately say that those activities are businesses instead of investments that don’t require enough activity to qualify. That’s not the point of the new code section, and we can’t spell out how the law applies to every circumstance.
Bloink: What I’m trying to say is that by providing so little guidance on the issue—in addition to telling taxpayers to rely upon a body of case law that really isn’t all that clear—we’re creating an incentive for manipulation of what 199A is supposed to be. What the IRS has provided is a box for real estate professionals to try to fit inside of—I don’t think we can deny that a lot of real estate investors may spend a significant amount of time and money trying to fit into that box where they otherwise were left outside. When we’re talking about a deduction that could expire in a few years, I’m not sure that’s the best use of resources, and more clarity in the guidance could prevent this situation.
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