Rev. Proc. 2019-38 Safe Harbor for Rental Real Estate
Understand the framework under Rev. Proc. 2019-38 for treating rental real estate as a business to secure the Section 199A QBI deduction.
The Section 199A Qualified Business Income (QBI) deduction offers a tax break of up to 20 percent for pass-through entities, but it is set to expire for taxable years after December 31, 2025. Its enactment created uncertainty for rental real estate owners, as it was unclear if their activities qualified as a “trade or business” under Section 162 of the Internal Revenue Code, a prerequisite for the deduction.
To provide clarity, the IRS issued Revenue Procedure 2019-38. This guidance established a “safe harbor,” a clear set of rules that, if met, allows a rental real estate activity to be treated as a trade or business for the QBI deduction. This provides a straightforward path to qualification.
Safe Harbor Qualification Requirements
To qualify for the safe harbor, an activity must be a “rental real estate enterprise,” defined as an interest in real property held to generate rental income. Taxpayers have flexibility in defining their enterprise; they can treat each property as a separate enterprise or group similar properties. For example, all residential properties can be combined into one enterprise and all commercial properties into another, but commercial and residential properties cannot be mixed.
A core requirement for using the safe harbor is the maintenance of separate books and records for each rental real estate enterprise. These records must accurately reflect the income and expenses for that specific enterprise, ensuring its financial activities are clearly delineated from other business or personal finances.
The primary condition is the 250-hour test. For an enterprise in existence for less than four years, at least 250 hours of rental services must be performed annually. For an enterprise that has existed for four or more years, the requirement is met if 250 or more hours are performed in any three of the five consecutive tax years ending with the current year.
Rental services can be performed by the property owner, their employees, or independent contractors. Qualifying activities include:
- Advertising the property for rent
- Negotiating and executing leases
- Verifying tenant applications
- Collecting rent
- Performing maintenance and repairs
- General supervision of the properties
Activities that do not count toward the 250-hour requirement include arranging financing, acquiring property, or travel time to and from the real estate. To substantiate the hours, taxpayers must maintain contemporaneous records detailing the hours worked, a description of the services, the dates provided, and who performed them.
Certain properties are excluded from this safe harbor, including real estate used by the taxpayer as a personal residence. Property rented under a “triple net lease” is also ineligible. A triple net lease is one where the tenant is responsible for paying not only rent and utilities but also the real estate taxes, insurance, and maintenance on the property.
Making the Safe Harbor Election
Meeting the qualifications is not enough; a taxpayer must formally elect to use the safe harbor. The election is made on a year-by-year basis by attaching a signed statement to their income tax return.
This statement must include a description of all rental properties that are part of the enterprise. It must also contain a declaration, made under penalties of perjury, affirming that all requirements of Revenue Procedure 2019-38 have been satisfied for the tax year.
Treatment of Rental Real Estate Outside the Safe Harbor
Failing to meet the requirements of the safe harbor does not automatically disqualify a rental activity from being considered a trade or business for the Section 199A deduction. The safe harbor is a simplified path for qualification, not the exclusive one.
If a rental enterprise falls outside the safe harbor, the determination reverts to the traditional standard under Section 162. This involves a “facts and circumstances” test, which is less defined and requires a more detailed analysis of the taxpayer’s operational involvement.
To meet this test, the taxpayer must demonstrate that their involvement in the rental activity is “regular, continuous, and substantial.” This means the level of management is significant enough to be considered business-like, rather than passive investment activity. Factors considered include the number of properties, the day-to-day involvement of the owner or their agents, and the type and frequency of tasks performed.