By Jeff Talley, LBMC Tax Shareholder, and Tori Farmer, LBMC Senior Tax Manager
Key Takeaways
- Your rental income does not automatically qualify for the Section 199A deduction. You must either establish that the activity rises to the level of a trade or business or meet the IRS safe harbor requirements.
- The 250-hour threshold is not optional. If you plan to rely on the safe harbor, you need to track qualifying services and keep contemporaneous records that support your position.
- Lease structure can determine the outcome. Properties under triple net arrangements and homes used for personal purposes typically fall outside the safe harbor.
Real estate owners often assume their rental income qualifies for the Section 199A deduction. In reality, eligibility depends on whether the activity rises to the level of a trade or business. Many portfolios fall into a gray area.
To address that uncertainty, the IRS created a safe harbor. When the requirements are met, rental activity is treated as a trade or business solely for purposes of claiming the 20% qualified business income deduction.
The rules are specific. Property owners must meet a 250-hour service threshold and maintain detailed, contemporaneous records. For families with multiple properties or complex ownership structures, documenting operational involvement is just as important as generating the income itself.
When Rental Real Estate Qualifies for Section 199A
The 199A deduction is only available for “qualified business income” arising from a “qualified trade or business.” QBI is the sum of qualified items of income, expenses, gains, and losses from a trade or business that is effectively connected to the conduct of business within the United States and included or allowed in determining taxable income. A qualified trade or business must be:
- considerable, regular, and continuous, and
- intended to make a profit.
Rental real estate activity that does not rise to the level of a trade or business under the existing tax code is nevertheless treated as a trade or business for purposes of Section 199A, and it can still produce qualified business income if it satisfies the safe harbor considerations outlined below. This means that there are two methods to choose when determining if your rentals qualify for the 20 percent deduction:
- Claim that the rental is a trade or business under existing law.
- Choose to use the safe-harbor rules.
If you meet the safe harbor for Section 199A, your rental is deemed a trade or business and net rental profits are considered qualified business income. Keep in mind that this safe harbor applies only to the Section 199A deduction and it does not qualify a rental enterprise as a trade or business for any other purpose.
Section 199A Safe Harbor Requirements for Rental Property
Exclusively for the purposes of Section 199A, a rental enterprise will be treated as a trade or business if the following requirements are satisfied during the taxable year with respect to the rental enterprise:
- Separate books and records are maintained to reflect income and expenses for each rental enterprise.
- 250 or more hours of rental services are performed per year with respect to the rental enterprise. For rental enterprises in existence at least four years, the 250-hour requirement must be met in any three of the five consecutive taxable years ending with the current year.
- Taxpayer maintains contemporaneous records, including time reports, logs, or similar documents, regarding the following:
- Hours of all services performed,
- Description of all services performed,
- Dates on which such services were performed,
- Who performed the services.
The IRS has emphasized the importance of documentation in this area. Failure to maintain adequate records may result in disqualification from the safe harbor.
What is a Rental Real Estate Enterprise Under Section 199A?
A rental enterprise is an interest in real property held for production of rents. In simple terms, it is the ownership of the real estate for renting or leasing. The rental enterprise may consist of an interest in multiple properties. The owner must either:
- Treat each property as a separate enterprise, or
- Treat all similar properties as a single enterprise
Commercial and residential real estate may not be part of the same enterprise. Deciding whether to group properties as a single enterprise or maintain them separately requires careful consideration as taxpayers may not vary this treatment from year-to-year unless there has been a significant change in facts and circumstances.
For example, Bill owns five rental properties. Three of the properties are residential, and two are commercial. Grouping allows Bill to have two real estate enterprises: one residential and one commercial.
What Counts as Rental Services for the 250-Hour Test?
Qualifying rental services for the purpose of this safe harbor include:
- advertising to rent or lease the real estate,
- negotiating and executing leases,
- verifying information contained in prospective tenant applications,
- collection of rent,
- daily operation, maintenance, and repair of the property,
- management of the real estate,
- purchase of materials,
- supervision of employees and independent contractors.
These rental services may be performed by owners or by employees, agents, and/or independent contractors of the owners. Additionally, the term rental service does not include:
- financial or investment management activities, such as arranging financing, producing property reports, studying and reviewing financial statements or reports on operations,
- planning, managing or constructing long-term capital improvements, or
- hours spent traveling to and from the real estate.
Rental Properties That Do Not Qualify for the Safe Harbor
While this deduction will benefit a vast majority of real estate investors, this safe harbor has also outlined certain rental real estate arrangements that are not eligible for the Section 199A deduction:
- Real estate used by the taxpayer as a residence, including vacation and second homes, for any part of the year.
- Triple net lease real estate, where a lease agreement requires the tenant or lessee to pay taxes, fees, and insurance, and to be responsible for maintenance activities for a property in addition to rent and utilities.
Because triple net lease structures continue to receive scrutiny, taxpayers should carefully review lease terms to determine whether they fall within this exclusion.
Examples of Rental Activities That Often Meet the Safe Harbor
Multi-family rentals, self-storage, and hospitality rental arrangements will often meet the requirements of the safe harbor. For multi-family rentals, property owners have various responsibilities and incur labor hours necessary to fulfill those responsibilities. Because the lease arrangements are not triple net lease, multi-family apartment rentals will fit within the scope of safe harbor requirements.
Self-storage facilities and hotels involve similar operational responsibilities, where the owner actively manages the property. As a result, these asset classes are often positioned to meet the safe harbor requirements.
Planning Considerations Before Claiming the Section 199A Deduction Meeting the safe harbor requirements requires careful tracking of rental services and consistent documentation.
Remember that you have a choice to use the following:
- Safe harbor as described in this article.
- Existing tax code trade or business rules to prove that your rental is a trade or business.
If you are considering using the new safe harbor, contact your tax advisor to discuss before making the choice between the two methods. At LBMC, we work with our clients to review and compare their rental enterprise activities to factors established by the IRS. We help them document their support when it comes to filing their tax return and taking the QBI deduction. If a client does not qualify for the deduction under current rules, we evaluate alternative structuring strategies that may provide long-term tax efficiency.
Meeting the Section 199A safe harbor requires more than generating rental income. LBMC’s tax professionals help real estate owners evaluate qualification requirements, document rental activities, and identify strategic tax planning opportunities. Contact our team to discuss your rental real estate portfolio and Section 199A strategy.
Content provided by Jeff Talley, Shareholder, Tax, and Tori Farmer, Senior Manager, Tax. Contact them at jeff.talley@lbmc.com and tori.farmer@lbmc.com.
LBMC tax tips are provided as an informational and educational service for clients and friends of the firm. The communication is high-level and should not be considered as legal or tax advice to take any specific action. Individuals should consult with their personal tax or legal advisors before making any tax or legal-related decisions. In addition, the information and data presented are based on sources believed to be reliable, but we do not guarantee their accuracy or completeness. The information is current as of the date indicated and is subject to change without notice.
Section 199A Rental Real Estate Safe Harbor FAQs
Does my rental automatically qualify for the Section 199A deduction?
No. Rental income only qualifies if the activity rises to the level of a trade or business under existing law or if you meet the IRS rental real estate safe harbor in Rev. Proc. 2019‑38.
Who can count toward the 250 hours of rental services?
Hours performed by you, your employees, agents, and independent contractors can all count toward the 250‑hour requirement, as long as the services are qualifying rental services and you maintain contemporaneous records showing who did what, when, and for how long.
What types of activities count as “rental services” for the safe harbor?
Qualifying services include tasks like advertising the property, negotiating and executing leases, screening tenants, collecting rent, handling repairs and maintenance, managing the property, purchasing materials, and supervising employees or contractors. Investment‑type activities (such as financing and reviewing financial statements), capital improvements, and travel time do not count.
Can I include all my rentals in one enterprise to meet the 250‑hour test?
You may group similar properties into a single rental real estate enterprise (for example, all residential rentals together and all commercial rentals together), or treat each property as a separate enterprise. However, you cannot combine residential and commercial properties in the same enterprise, and you generally must stick with your grouping method unless your facts and circumstances change significantly.
Do triple‑net leases or vacation homes qualify for the safe harbor?
Generally no. Properties rented under triple‑net lease arrangements and real estate used by you as a residence for any part of the year are specifically excluded from the rental real estate safe harbor, even if they generate rental income.
Is the safe harbor my only way to get the 199A deduction on rentals?
No. The safe harbor is optional and applies only for Section 199A. Even if you do not meet the safe‑harbor requirements, your rental may still qualify if it is a trade or business under general tax principles (regular, continuous, and profit‑motivated). Many taxpayers work with their advisors to evaluate both paths each year.
