A safe harbor for rentals in Section 199A?

The new regs on Code Section 199A (the 20 percent deduction available to passthrough entities) contain a safe harbor for owners of rental properties. If the taxpayer qualifies for the safe harbor, the rental activity is considered a trade or business and the income from the activity is considered qualified business income for purposes of the deduction. If the rental activity does not meet the safe harbor requirements, it may still qualify if it “rises to the level of a business.” Triple net leases and vacation homes are excluded from the safe harbor test, which includes aggregation rules, minimum hours of service rules, a definition of rental services, and rules for contemporaneous records.

There’s an inconsistency in the final regulations, according to Roger Harris, president of Padgett Business Services: “The regs say that the proposed safe harbor also requires that separate books and records and separate bank accounts be kept for rental enterprises, but in the safe harbor itself there’s no reference to bank accounts. Will the IRS hold a gun to your head because of the inconsistency? No, I think they’ll work with you.”

“The first thing the service had to do was to get the guidance out,” he continued. “Now we all have to deal with the real world with its questions and challenges. The service recognizes this and they have indicated their willingness to understand that there’s still another phase to go through. The world doesn’t fit neatly into the way the regs are written.”

A taxpayer whose activity satisfies the safe harbor rules attaches a statement to the return stating that the requirements of Section 3.03 of Revenue Procedure 2019-7 have been met. The statement must be signed under penalty of perjury by the taxpayer or the authorized representative of the passthrough entity.

Harris believes the signature requirement is redundant, given the fact that the taxpayer is already consenting to everything contained on the electronic return by signing Form 8879. Moreover, it poses a burden on both the preparer and the taxpayer, he indicated.

For rent sign for summer rental
A home rental sign is displayed on a front lawn Belmar, New Jersey, U.S., on Sunday, June 1, 2008. U.S. Photographer: Jin Lee/Bloomberg News

In a letter to the IRS dated Feb. 11, 2019, he suggested that the safe harbor election be made without requiring a taxpayer’s signature. “Because many tax software programs allow the election to be electronically filed without the signature, what is the service’s position if the election gets filed without a signature, or with just one signature if the taxpayer is filing jointly?” he asked. “Will the return still be processed? Will the taxpayer receive a notice to allow an opportunity for the statement to be signed so the election is valid? If the election is omitted in error, can the election be attached post filing with an amended return?”

“It might create more problems for the service than for practitioners,” he observed. “”We’re not perfect, and we’ll make mistakes. What will they do about it? The fewer ways they allow us to make mistakes, and the more they can minimize the impact of those mistakes, the better for all of us.”

“Is double perjury worse than single perjury? I’ve already signed and said that everything is correct, now you want me to do it again?” he added, suggesting that, if the service believes the signature is necessary, they might reduce the burden by treating the election similar to that of the signature requirement on Form 8879. “Perhaps the election statement could be attached to the return without a signature, but the signed copy received prior to filing and held at the tax preparer’s office along with the signed Form 8879,” he said.

“The letter hasn’t received a response yet, because the comment period [for the regulations] hasn’t ended,” Harris noted.

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