The qualified business income deduction in section 199A applies to income from a trade or business. Whether a rental property is a trade or business is a facts and circumstances question. Revenue Procedure 2019-38 offers a safe harbor: if the client meets its tests for the year, each rental real estate enterprise is treated as a single trade or business for section 199A. For the deduction itself, see the QBI deduction after the 2025 legislation. This guide covers the safe harbor tests and the file that supports them.
The four requirements
The determination to use the safe harbor is made annually. For each rental real estate enterprise, all of the following must hold during the taxable year:
- Separate books and records. Income and expenses are maintained separately for each enterprise. If an enterprise has more than one property, property-level statements may be kept and then consolidated.
- 250 hours of rental services. For an enterprise in existence less than four years, 250 or more hours of rental services must be performed per year. For an enterprise in existence at least four years, the 250-hour test must be met in any three of the five consecutive taxable years ending with the current year.
- Contemporaneous records. The taxpayer keeps time reports, logs or similar documents covering the hours of all services, a description of the services, the dates performed and who performed them. For services by employees or contractors, the taxpayer may instead describe the services, the time generally spent, and keep time, wage or payment records. The records must be available for IRS inspection.
- A statement with the return. A statement is attached to a timely filed original return for each year the safe harbor is relied on. It lists the properties in each enterprise by address and rental category, describes properties acquired and disposed of during the year, and represents that the revenue procedure's requirements are satisfied.
What is a rental real estate enterprise
Section 3.02 defines it as an interest in real property held for the production of rents, in one property or several. The taxpayer must hold each interest directly or through an entity disregarded as separate from its owner. Properties can be combined only within the same category: residential with residential, commercial with commercial. A taxpayer may treat each property as its own enterprise or combine all similar properties into one. Once similar properties are combined, the taxpayer must keep treating all similar properties, including newly acquired ones, as one enterprise for as long as the safe harbor is relied on. A taxpayer that treats each property separately may combine them in a later year. A single building with both residential and commercial units is mixed-use; it can be one enterprise by itself or be split into residential and commercial interests, but a mixed-use interest treated as a single enterprise cannot be combined with other properties.
What counts as rental services
The revenue procedure lists advertising to rent, negotiating and executing leases, verifying tenant applications, collecting rent, daily operation, maintenance and repair including purchasing materials and supplies, managing the real estate, and supervising employees and independent contractors. The services can be performed by owners, employees, agents or contractors. Financial or investment management, such as arranging financing, procuring property, reviewing financial statements, improving property under the capitalization rules, and travel time, do not count.
Arrangements that do not qualify
The following cannot be included in an enterprise, so the safe harbor is not available for them:
- Real estate used by the taxpayer as a residence under section 280A(d).
- Real estate rented under a triple net lease, which the revenue procedure describes as one requiring the tenant to pay taxes, fees and insurance, and to pay for maintenance, in addition to rent and utilities.
- Real estate rented to a trade or business conducted by the taxpayer that is commonly controlled.
- The entire rental interest if any portion is treated as a specified service trade or business.
Worked example one: the 250-hour count
A client owns a four-unit building and a duplex, grouped as one residential enterprise in existence for two years. The property manager's invoices show 180 hours of maintenance and tenant management. The client logs 40 hours on rent collection, lease renewals and vendor supervision, plus 25 hours on tenant screening.
- Total rental services: 180 plus 40 plus 25, or 245 hours.
- Result: below 250, so the safe harbor fails for the year.
Five more logged hours, for example advertising a vacancy, would meet the test. The same facts pass or fail on records, which is why the log must exist before the year ends. Under section 3.01, failing the safe harbor does not preclude the client from showing the activity is a trade or business under general rules.
Worked example two: the three-of-five test
A commercial enterprise has been in existence for six years, so the four-year rule applies. Logged rental service hours for the last five years, ending with the current year, are 260, 240, 255, 180 and 270.
- Years at 250 or more: 260, 255 and 270, which is three years.
- Result: the test is met for the current year, because three of the five consecutive years qualify.
If the current year's hours had been 245 instead of 270, only two years would qualify and the safe harbor would fail for that year. A commercial lease is eligible only if it is not a triple net lease, so confirm the lease terms before counting the hours.
Common errors
- Counting hours for financing, property searches, reviewing financial statements, capital improvements or travel.
- Combining residential and commercial properties in one enterprise.
- Attaching no statement, or attaching it to a late return. The statement goes with a timely filed original return.
- Keeping one set of books for all properties when the enterprises are separate.
- Including a triple net lease or a property the owner uses as a residence in the enterprise.
- Relying on year-end estimates, when the revenue procedure requires contemporaneous records of hours, services, dates and who performed them.
Frequently asked questions
Does the safe harbor apply to a triple net lease?
No. Section 3.05 excludes real estate rented under a triple net lease, defined as a lease that requires the tenant to pay taxes, fees and insurance, and to pay for maintenance, in addition to rent and utilities.
Do the owner's hours have to be the ones that count?
No. Section 3.04 says rental services may be performed by owners, or by employees, agents or independent contractors of the owners.
What if the client fails the safe harbor?
The enterprise may still be a trade or business for section 199A if it meets the general definition in Treas. Reg. 1.199A-1(b)(14). The rental safe harbor is not the exclusive route.
Is the choice made once?
No. The determination is made annually.
File checklist
- Enterprise definition by property and rental category.
- Separate income statements per enterprise.
- Hour logs and manager reports, with the manager's description of services.
- The attached statement, copied to the file.
- A note on any property excluded for triple net leases or residential use.
Sources
- Internal Revenue Service, Revenue Procedure 2019-38: https://www.irs.gov/pub/irs-drop/rp-19-38.pdf
- Internal Revenue Service, Qualified business income deduction: https://www.irs.gov/newsroom/qualified-business-income-deduction
CORAA prepares ready-to-review audit files for US CPA firms from QuickBooks books; you review and sign. See /us.
Part of CORAA University · Tax and compliance for CPA firms: related guides, calculators and templates.
AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error