Real Estate Gets Its Rule |

One of the largest components (by number of practitioners) in our financial and managerial advisory services is real estate.

Over the years, we have been stressing that these entities need to form organizations to hold and manage their real properties. Part of the reason for that is related to the IRS definition that a real estate professional had to devote 750 or more hours a year to qualify for all the salient tax benefits that such an enterprise may qualify.

If the enterprise only deals with real estate management it is by definition a real estate professional. (Remember, the government considers businesses to be equivalent to humans when it comes to the rights and privileges of citizenship.) However, we have always known that there needs to be a minimum hour requirement, even if the government may not so stipulate. 250 hours (about 20 hours a month or 5 hours a week) was a number we chose to recommend to our clients.

But, we were on pins and needles about the Qualified Business Income (QBI) benefits that may accrue to such businesses.

Let’s review what QBI is. When the new tax law (Tax Cut & Jobs Act, PL97-115) was signed into law, one of the provisions (termed 199A) afforded the ability to shield 20% of the profits from taxes in a pass-through (sole proprietorship, partnership, limited liability corporation (LLC), and/or S entities), as long as their income was below certain levels. (There are provisions that extend that amount, based upon investments and payrolls, but for all intents and purposes, the ceiling is $ 315K for married folks and $ 157.5K if one is not married.)

During the furlough (18 January 2019), the IRS promulgated a set of regulations to explain how the service will handle the new Qualified Business Income (QBI) deductions for pass-through entities. So, now, we can feel secure filing taxes- since we finally have some guidance!

In particular, the IRS has cleared up one of the biggest confusions (better known as a hornet’s nest)- we knew what was what for most businesses, but those involved in real estate rental businesses were not sure if or how they would be included. The IRS solved that problem by issuing a ‘safe harbor” definition. (A Safe harbor is a provision of a statute or regulation that stipulates that certain conduct will be in compliance with a given rule, usually in connection with a vague, encompassing standard.) A business can still qualify for the provisions, if not covered by the safe harbor- but it will have to argue its case using a more complex set of rules.

The safe harbor stipulates that a rental real estate business can qualify for the 20% pass-through if a single piece of real estate (or multiples thereof) is held to produce rental income. Said property cannot serve as a residence for any of the principals. Moreover, the “owner” must hold the properties directly or via an entity separate from the owner (like the LLC’s we have been setting up for clients to protect their legal interests). Each property can be treated as a separate entity or combined as a single enterprise. Not surprisingly, the IRS demands that the financial records must be separate and apart from the other records of the taxpayer.

There is a time component requirement, as well. Until 1 January 2023, 250 hours of work must be effected to qualify for Section 199A consideration. Thereafter, that time requirement will only have to be met for 3 out of every 5 years. Not for 2018 tax year filing, but thereafter, the taxpayer must be keeping records that substantiate the hours of service (and what service performed) including the date and person(s) involved with those efforts.

To qualify for those 250 hours, the following activities apply: advertising, lease issues, tenant background verification, rent collection, daily operations and repairs, purchase of materials, management of the actual property, and supervision of employees and independent contractors. (The 250 hours may be effected by owners, employees, agents, or independent contractors!)

Thank you, IRS!