The IRS and Treasury are unlikely to make significant changes to guidance for landlords and small real estate ventures seeking to take the 2017 tax law’s 20 percent write-off for pass-through businesses.
Accountants and tax lawyers have pushed for guidance to more easily allow casual property owners and small landlords to take the new deduction for pass-through businesses, which are taxed at the individual owner level, under tax code Section 199A.
But Internal Revenue Service and Treasury officials indicated that any changes as the guidance—a proposed revenue procedure (Notice 2019-07) containing a safe harbor meant to help smaller-scale real estate outfits figure out whether they qualify—becomes finalized will involve clarifications rather than a relaxing of standards and requirements.
“I don’t think there’s anything in particular other than, as I noted, clarifying the definition of triple-net lease,” said Audrey Ellis, an attorney-adviser in Treasury’s Office of Tax Policy.
Triple-net leases, in which the property owners are minimally involved in upkeep, weren’t included in the safe harbor.
Ellis and Vishal Amin, a docket attorney in the IRS Associate Chief Counsel Office (Passthroughs and Special Industries) and one of the principal authors of the guidance, also said that the government planned to clarify the definition of a triple-net lease in the guidance. But they also said they didn’t plan on loosening any particular standards.
Both also emphasized that triple-net leases aren’t excluded from the 20 percent deduction simply because they don’t fit the safe harbor.
Need for Proof
“There’s nothing that we’ve designated that we’re going to change,” minus the triple-net lease definition, Amin said.
One of the standards of the safe harbor, a requirement that the real owners document at least 250 hours of real estate service work annually, may be burdensome to taxpayers, but necessary for the government, he said. He and Ellis also noted that one commenter had said 250 hours isn’t enough.
“Obviously that’s not easy to get taxpayers to do,” Amin said, referring to the documentation requirements. But from an auditing standpoint, he continued, “they need to at least show or have some proof that the work has been done with respect to that enterprise.”
Regulations (REG-107892-18) issued in January barred multiple industries from taking the new 20 percent deduction above certain income thresholds, but gave real estate agents and brokers the go-ahead. (The write-off comes with other restrictions based on the wages paid by the business and capital it owns.)
Those rules, however, were murky on whether a real estate outfit is an “active” enterprise—a foundational requirement for the tax perk. The text leaned on a definition of an active trade or business found in Section 162, which is somewhat ambiguous on the subject.
Running a real estate business can entail active involvement, but can also take the form of a passive investment. For small landlords, people renting out their homes or using apps like Airbnb, and those who use a triple-net lease, whether or not they could reduce the amount of their income from the real estate subject to tax by up to one-fifth was unclear.
The IRS issued the proposed revenue procedure in January. It received roughly a dozen comments—public or otherwise—as of May 9, and those commenters weren’t particularly pleased.
The American Institute of CPAs, for instance, said in an April 10 letter to Treasury Department and IRS officials that the latter restriction would be problematic for mixed-use properties. The group also called on the IRS to reduce the 250-hour threshold to 100 hours, calling the requirement excessive. The requirement that real estate owners document those hours of service starting with the taxable years that begin in 2019 “is unduly burdensome to the taxpayer as well as the taxpayer’s agents and independent contractors,” the letter continued.
The New York State Bar Association’s Tax Section had sent those same officials a letter dated two days earlier with its own similar list of asks, calling the distinction between residential and commercial real estate “ill-defined” and the 250-hour requirement an inadequate measure of businesses’ activities.
Individuals have voiced their criticisms as well. One commenter wrote that time spent traveling to and from properties ought to count toward the 250 required hours, pointed to the difficulty of documenting the work of various third-party contractors, such as janitors, that fit into that 250-hour total, and called the need for record retention “unrealistic.”
A Tucson-based attorney wrote that the safe harbor served large rental enterprises rather than his smaller clients. Another joined the chorus of voices demanding that triple-net leases not be excluded from the safe harbor.