The Rev Proc 2018-08 Rental Real Estate QBI Safe Harbor

The Qualified Business Income (QBI) deduction, introduced by the Tax Cuts and Jobs Act of 2017, created a tax benefit for owners of pass-through businesses. This deduction, found in Section 199A of the Internal Revenue Code, allows for a deduction of up to 20% of qualified business income. However, a point of uncertainty was whether rental real estate activities would be considered a “trade or business” eligible for this deduction, as the statutory language did not provide a clear definition.

To address this uncertainty, the Internal Revenue Service (IRS) issued Notice 2019-07, which provided a safe harbor for the 2018 tax year. This guidance established rules that, if met, would allow a rental real estate activity to be treated as a trade or business for the QBI deduction. While the rules were later updated by Revenue Procedure 2019-38 for 2019 and forward, the guidance in the notice is what applies to those analyzing or amending a 2018 return.

Defining a Rental Real Estate Enterprise

The core concept for applying the safe harbor is the “rental real estate enterprise,” which is the unit against which the tests are measured. The guidance defines this enterprise as an interest in real property held for the production of rents, which can consist of a single property or a group of properties. Taxpayers were given flexibility in how they defined their enterprise, a decision with lasting implications.

A property owner could choose to treat each individual rental property as its own separate enterprise or elect to group similar properties into a single, larger enterprise. For this purpose, properties were considered “similar” if they belonged to the same category, either residential or commercial. This means a taxpayer could group all their residential properties into one enterprise and all their commercial properties into another, but could not combine residential and commercial properties into a single enterprise.

This initial grouping decision could not be changed in subsequent years unless the taxpayer could demonstrate a significant change in their facts and circumstances. The choice was strategic; grouping properties could make it easier to meet the safe harbor’s hour requirements, while keeping them separate might be beneficial in other situations. Defining the enterprise was the first step before assessing the operational requirements.

Safe Harbor Requirements

To qualify for the safe harbor in 2018, a rental real estate enterprise had to satisfy several conditions. Failure to meet any one of these requirements meant the enterprise could not use the protection of the safe harbor for that tax year.

A primary requirement was the maintenance of separate books and records for each rental real estate enterprise. These records needed to accurately reflect the income and expenses for that specific enterprise. If a taxpayer chose to group multiple properties into a single enterprise, one set of consolidated books and records for that group was sufficient.

Another primary condition was the 250-hour test, requiring at least 250 hours of rental services be performed for the enterprise during the 2018 tax year. These services could be performed by the owner, their employees, or independent contractors. Qualifying activities included:

• Advertising the property for rent
• Negotiating leases
• Verifying tenant applications
• Collecting rent
• Daily operations, maintenance, and repairs
• Property management
• Supervising staff

Conversely, certain activities were explicitly excluded from counting toward the 250-hour requirement, such as arranging financing, acquiring property, reviewing financial statements or operational reports, and travel time to and from the real estate.

To substantiate the 250-hour test, the IRS could request records to prove eligibility. While maintaining contemporaneous records became a strict requirement in later years, it was not for 2018. These records, such as time reports or logs, were expected to document the hours, dates, description of services, and who performed them.

Excluded Rental Arrangements

The safe harbor was not available for all types of rental real estate. The guidance specifically excluded arrangements with a significant personal use component or those that operated under a structure that minimized the owner’s active involvement.

One exclusion was for real estate used by the taxpayer as a residence for any part of the year. Under Section 280A of the tax code, a property is considered a residence if used for personal purposes for more than the greater of 14 days or 10% of the days it is rented at fair market value. Any property meeting this definition was disqualified from the safe harbor.

The other major exclusion was for real estate rented or leased under a triple net lease. A triple net lease is an arrangement where the tenant is responsible for paying not only rent but also all, or a significant portion of, the costs associated with the property. These costs include real estate taxes, building insurance, and maintenance. Because this structure shifts most of the management and operational burdens to the tenant, the IRS determined that such arrangements do not represent a level of activity sufficient to qualify for the safe harbor.

Making the Safe Harbor Election

Taxpayers whose enterprise met all requirements had to formally elect the safe harbor on their 2018 tax return. This was not an automatic benefit and required attaching a signed statement to the original Form 1040. For the 2018 tax year only, this statement could also be attached to an amended return.

The statement required a declaration, made under penalties of perjury, that all the requirements of the safe harbor had been satisfied. The statement also needed to include a description of the rental real estate properties that were being treated as a single enterprise or as separate enterprises.

If a taxpayer claimed the safe harbor for multiple enterprises, a single statement could be used, but it had to list the required information separately for each one. This statement was the official method for informing the IRS that the taxpayer was relying on the safe harbor for the Section 199A deduction.

Consequences of Not Meeting the Safe Harbor

Failing to meet the safe harbor requirements did not automatically disqualify a rental activity from being considered a trade or business for the QBI deduction. The guidance stated that its rules constituted a safe harbor, not the definitive test for trade or business status.

If a rental enterprise did not qualify for the safe harbor, the taxpayer would have to fall back on the general definition of a “trade or business” under Section 162 of the Internal Revenue Code. This standard relies on a broader analysis based on case law and IRS rulings.

Under the Section 162 standard, a taxpayer must demonstrate that they are involved in the activity with continuity and regularity and that their primary purpose for engaging in the activity is for income or profit. This often requires a detailed, facts-and-circumstances analysis of the taxpayer’s level of involvement, the nature of the operations, and the overall business-like manner in which the activity is conducted. Proving this status without the clear checklist of the safe harbor can be more complex and may carry a higher burden of proof if challenged by the IRS.