Rev. Proc. 2019-43: The Safe Harbor for Rental Real Estate

Revenue Procedure 2019-38 established a safe harbor for owners of rental real estate. This guidance provides a pathway for a rental real estate activity to be treated as a trade or business, a necessary step for claiming the Section 199A Qualified Business Income (QBI) deduction. The QBI deduction allows eligible taxpayers to deduct up to 20% of their qualified business income from pass-through entities but is set to expire for tax years after 2025 unless extended by Congress.

For many landlords and real estate investors, determining whether their rental activities rose to the level of a trade or business created uncertainty. The procedure simplifies this determination by setting forth specific criteria that, if met, automatically qualify the rental activity as a trade or business for the QBI deduction. This removes the need for a more subjective analysis of a taxpayer’s facts and circumstances.

Safe Harbor Qualification Requirements

To qualify for the safe harbor, a rental real estate enterprise must satisfy several requirements annually. These rules are designed to ensure the safe harbor is used only by those engaged in a certain level of activity that resembles a business operation rather than a passive investment.

Separate Books and Records

A requirement is the maintenance of separate books and records for each rental real estate enterprise. All income and expenses related to the enterprise must be tracked distinctly from the taxpayer’s personal finances and other business ventures. If a taxpayer groups multiple properties into a single enterprise, consolidated records are permitted, but the underlying data for each property’s income and expenses must be maintained.

The 250-Hour Requirement

At least 250 hours of rental services must be performed each year with respect to that enterprise. For enterprises that have been in existence for at least four years, this test is slightly more flexible, requiring that 250 or more hours of rental services were performed in any three of the five consecutive tax years ending with the current year. These hours can be performed by the property owners, their employees, or independent contractors.

The IRS provides specific guidance on what constitutes “rental services.” Qualifying activities include:

• Advertising the property for rent
• Negotiating and executing leases
• Verifying tenant applications
• Collecting rent payments
• Supervising employees and contractors
• Performing repairs and maintenance
• Managing the property

Conversely, certain activities are explicitly excluded from the 250-hour calculation. These non-qualifying activities include financial and investment management tasks like arranging financing, acquiring property, or reviewing financial statements. Time spent planning for and constructing long-term capital improvements or travel to and from the property does not count toward the annual hour requirement. This distinction focuses the test on the operational aspects of the rental, not its investment management.

Contemporaneous Records

To substantiate the 250-hour requirement, taxpayers must maintain contemporaneous records created at the time services are performed. These records should include time reports or logs that detail the hours of all services, a description of the services, the dates performed, and who performed them. This documentation is required to claim the safe harbor.

Property Exclusions

Certain types of property are ineligible for the safe harbor. Real estate used by the taxpayer as a residence for any part of the year under Internal Revenue Code Section 280A cannot be included in a safe harbor enterprise. This prevents applying the safe harbor to personal vacation homes that are also rented out.

Additionally, property subject to a triple net lease is excluded. A triple net lease is a rental agreement where the tenant is responsible for paying all, or nearly all, of the costs and expenses related to the property in addition to rent. These expenses include real estate taxes, building insurance, and maintenance. Because the landlord’s involvement is minimal, it is considered a passive investment and is ineligible.

Grouping Rental Enterprises

The revenue procedure allows taxpayers to group properties to meet the qualification requirements. A taxpayer may treat each rental property as a separate enterprise or elect to combine similar properties into a single, larger enterprise. By combining the hours spent across multiple properties, a taxpayer who would not meet the threshold for any single property might qualify with a grouped enterprise.

Taxpayers can only group similar properties, which are defined as being in the same rental real estate category: either residential or commercial. A taxpayer who owns several apartment buildings can group them into a single residential enterprise, and an owner of multiple office buildings could group them into a single commercial enterprise. Commercial and residential properties cannot be mixed within the same enterprise.

For mixed-use properties, such as a building with apartments on the upper floors and retail space on the ground floor, a taxpayer may treat the entire property as a single enterprise but cannot group it with other properties. The owner can also bifurcate the property into separate residential and commercial interests, which could then be grouped with other similar properties.

Making the Safe Harbor Election

Once a taxpayer determines they meet the qualification requirements, they must formally make an election to use the safe harbor. The election is made by attaching a statement to a timely filed original tax return for each year the taxpayer relies on the safe harbor.

The statement must contain a description of all rental real estate properties that are part of each enterprise being claimed under the safe harbor, including properties acquired or disposed of during the tax year. The taxpayer must also clearly state whether they are treating each property as a separate enterprise or grouping similar properties together.

Not Meeting the Safe Harbor

Failing to meet the criteria of the safe harbor does not automatically disqualify a rental activity from being considered a trade or business for the QBI deduction. If a taxpayer cannot or chooses not to use the safe harbor, they can still potentially claim the deduction by demonstrating that their rental activity qualifies as a trade or business under the general tax law principles of Internal Revenue Code Section 162.

This standard is a “facts and circumstances” test that has been developed over time through court rulings. It requires the taxpayer to be involved in the activity with continuity and regularity, and the primary purpose for engaging in the activity must be for income or profit.

Factors the IRS and courts consider when evaluating a rental activity under this standard include the number of properties rented, the day-to-day involvement of the owner or their agents, and the types of services provided to tenants. An owner who personally handles tenant screening, rent collection, and repairs for multiple properties is in a stronger position to argue that their activity is a trade or business.