Along with the recent issuance of regulations under section 199A of the Internal Revenue Code (“I.R.C.”), the Internal Revenue Service (“the Service”) also published a revenue procedure setting forth a safe harbor under which rental real estate will be treated as a “trade or business” pursuant to I.R.C. § 199A.  For those in the real estate industry, this revenue procedure brings additional certainty on the application of the potential 20% deduction for qualified business income (“QBI”).  Much of these concerns leading up to this safe harbor were premised upon the notion that the rental of real estate might be considered “passive” or otherwise not qualify as an active trade or business based on a subjective review of the facts. 

While real estate enterprises not eligible for the safe harbor of Notice 2019-07 may still be classified as a trade or business under Treas. Reg. § 1.199A-1(b)(14)[1] – and thus counted towards QBI – real estate owners should perform an analysis to see which properties qualify for the safe harbor and which do not.  Otherwise, real estate owners may have to rely on a much more fact-intensive, and uncertain, classification.  In general, Section 3.01 and Section 3.02 provide that the safe harbor may be available to any enterprise or relevant pass-through entity (“RPE”) so long as “the individual or RPE…hold[s] the interest directly or through an entity disregarded as an entity separate from its owner under § 301.7701-3.”  Section 3.02 provides that taxpayers must treat each property, or similar properties, as a single property for purposes of the safe harbor.  Commercial and residential properties cannot be part of the same enterprise and a grouping must generally be consistent from year-to-year.

The bulk of the requirements of the safe harbor are provided in Section 3.03.  In order for a rental real estate enterprise to qualify, it must satisfy the following:

  • Separate books and records are maintained to reflect income and expenses for each rental real estate enterprise.
  • For tax years from 2018 to 2022, 250 or more hours of rental services must be performed per year with respect to the entity.  For later years, this threshold must be met for three of the five prior years (or each year if held less than five years).
  • Contemporaneous records must be kept to document (i) hours of services performed, (ii) description of services performed, (iii) dates when services performed, and (iv) who performed the services.

In terms of “rental services” that qualify towards the required 250 hours per year, Section 3.04 provides an exhaustive listing.  In particular, the following activities are considered rental services:

  • Advertising to rent or lease the real estate;
  • Negotiating and executing leases;
  • Verifying information in tenant applications;
  • Collection of rent;
  • Daily operation, maintenance, and repair of the real estate;
  • Management of the real estate;
  • Purchase of material relating to the real estate; and
  • Supervision of employees and independent contractors.

The revenue procedure makes clear, however, that “rental services” does not include financial or investment management, purchase of the property, financial analysis of operations, long-term planning or management, or traveling to and from the real estate.  Notice 2019-07, Section 3.04.

In addition, Section 3.05 of Notice 2019-07 contains two important categorical exclusions.  First, it excludes any real estate used for any part of the year as a personal residence from the safe harbor.  Second, and perhaps more importantly, the safe harbor excludes “real estate rented or leased under a triple net lease,” which “includes a lease agreement that requires the tenant or lessee to pay taxes, fees, and insurance, and to be responsible for maintenance activities for a property in addition to rent and utilities (or an allocable share of such expenses).  While it seems that these provisions categorized triple net landlords as “passive” in nature, this exclusion perhaps fails to consider the similar economic risks faced by these landlords.

Rental real estate enterprises now have a guidebook on how to qualify for the QBI deduction.  While the substantive requirements may require additional active participation and recordkeeping, the certainty afforded by the safe harbor provides significant value.  Given the lack of additional guidance in this area, enterprises failing to qualify for the safe harbor may put their owners at serious risk in an audit if they claim the QBI deduction.  Moreover, if a business already has some level of active participation in the rental process and rental real estate income is significant, the certainty will likely trump any incremental cost associated with compliance.  For other real estate enterprises where rental services are subcontracted, landlords may need to discuss recordkeeping with those subcontractors in order to count those activities towards the requirements of the safe harbor.  Finally, landlords with triple net leases already in place, or other leases requiring little participation on the part of the lessor, may want to re-draft or renegotiate those lease terms in order to qualify for the safe harbor under Notice 2019-07. 

Rosenberg Martin Greenberg has experience in all aspects of federal and state tax laws, including developments and required compliance affecting all types of business entities and their owners.  Our skilled tax advisors have counseled countless clients on how to minimize their tax liabilities. For a free consultation, please contact Brandon N. Mourges at or 410.951.1149.

[1] Generally means a “trade or business that is a trade or business under section 162 (a section 162 trade or business) other than the trade or business of performing services as an employee.”