On Jan. 18, the U.S. Department of the Treasury and the IRS released final IRC Section 199A regulations and three related pieces of guidance. Section 199A, enacted as part of the Tax Cuts and Jobs Act, provides a deduction of up to 20 percent of income from a domestic business operated as a sole proprietorship or through a partnership, S corporation, trust, or estate.
For taxpayers with taxable income exceeding a statutorily defined threshold amount, the deduction may be limited based on the type of trade or business engaged in by the taxpayer, the amount of W-2 wages paid with respect to the trade or business, or the unadjusted basis immediately after acquisition (UBIA) of qualified property. The deduction also is limited to 20 percent of the excess (if any) of taxable income of the taxpayer for the taxable year over the net capital gain of the taxpayer for the taxable year.
To qualify for the safe harbor, at least 250 hours of rental services must be performed per year with respect to the rental enterprise, among other requirements. These rental services may be performed by owners or by employees, agents, or independent contractors of the owners. Thus, in contrast to the passive activity rules under Section 469, these rules appear more focused on the activity of the real estate enterprise and not necessarily on the involvement of the owner.
For purposes of the safe harbor, taxpayers may treat all similar properties held for the production of rents as a single enterprise. The safe harbor does not apply to any real estate used by the taxpayer as a residence for any part of the year or for real estate rented or leased under a triple net lease. According to the notice, taxpayers might still qualify for the deduction even if they do not meet the safe harbor as long as they otherwise meet the requirements of Section 199A.
The first method (the unmodified box method) allows for a simplified calculation but might not result in the maximum amount of potential W-2 wages for the tax year. The second and third methods (the modified box 1 method and the tracking wages method) provide greater accuracy and might result in a higher amount of W-2 wages, but might be more burdensome to use.
For taxpayers with taxable income exceeding a statutorily defined threshold amount, the deduction may be limited based on the type of trade or business engaged in by the taxpayer, the amount of W-2 wages paid with respect to the trade or business, or the unadjusted basis immediately after acquisition (UBIA) of qualified property. The deduction also is limited to 20 percent of the excess (if any) of taxable income of the taxpayer for the taxable year over the net capital gain of the taxpayer for the taxable year.
Final regulations
Proposed Section 199A regulations were published in August 2018. The final regulations generally adopt the proposed regulations with several important clarifications. For instance, the final regulations permit relevant pass-through entities (RPEs), in addition to individuals, to aggregate trades or businesses and provide clearer guidance regarding what constitutes a specified service trade or business (SSTB) and how the rules apply to them. The final regulations also clarify the definition of “net capital gain” and provide rules for allocation of UBIA to partners or shareholders of an RPE. Last, the final regulations provide taxpayers and their advisers additional time to work through these new rules by allowing initial decisions about aggregating multiple trades or businesses on amended 2018 returns and permitting RPEs to report Section 199A items to owners using a Schedule K-1 filed with an amended or late filed return for any open tax year.Notice 2019-07
There has been much uncertainty regarding whether a rental real estate enterprise is a trade or business for purposes of claiming the deduction under Section 199A. To help mitigate this uncertainty, the IRS released Notice 2019-07, which contains a proposed revenue procedure providing a safe harbor to determine whether rental real estate qualifies as a trade or business solely for purposes of Section 199A.To qualify for the safe harbor, at least 250 hours of rental services must be performed per year with respect to the rental enterprise, among other requirements. These rental services may be performed by owners or by employees, agents, or independent contractors of the owners. Thus, in contrast to the passive activity rules under Section 469, these rules appear more focused on the activity of the real estate enterprise and not necessarily on the involvement of the owner.
For purposes of the safe harbor, taxpayers may treat all similar properties held for the production of rents as a single enterprise. The safe harbor does not apply to any real estate used by the taxpayer as a residence for any part of the year or for real estate rented or leased under a triple net lease. According to the notice, taxpayers might still qualify for the deduction even if they do not meet the safe harbor as long as they otherwise meet the requirements of Section 199A.
Revenue Procedure 2019-11
In many cases, eligibility to claim the deduction under Section 199A is limited to a percentage of W-2 wages. Revenue Procedure 2019-11 provides three methods for calculating the total amount of W-2 wages for these purposes.The first method (the unmodified box method) allows for a simplified calculation but might not result in the maximum amount of potential W-2 wages for the tax year. The second and third methods (the modified box 1 method and the tracking wages method) provide greater accuracy and might result in a higher amount of W-2 wages, but might be more burdensome to use.
