IRS issues final QBI real estate safe harbor rules

Earlier this year, the IRS published a proposed safe harbor giving owners of certain rental real estate interests the opportunity to take advantage of the qualified business income (QBI) deduction. The QBI write-off was created by the Tax Cuts and Jobs Act (TCJA) for pass-through entities. The IRS has now released final guidance (Revenue Procedure 2019-38) on the safe harbor that clearly lays out the requirements that taxpayers must satisfy to benefit.

QBI in a nutshell

The TCJA added Section 199A to the Internal Revenue Code. It generally allows partnerships, limited liability companies (LLCs), S corporations and sole proprietorships to deduct as much as 20% of QBI received. QBI equals the net amount of income, gains, deductions and losses — excluding reasonable compensation, certain investment items and payments to partners for services rendered. The deduction is subject to several significant limitations.

Many taxpayers involved in rental real estate activities were uncertain whether they would qualify for the deduction, which prompted the proposed safe harbor. The final guidance leaves no doubt that individuals and entities that own rental real estate directly or through disregarded entities (entities that aren’t considered separate from their owners for income tax purposes, such as single-member LLCs) may be eligible.

Covered interests

The safe harbor applies to qualified “rental real estate enterprises.” For purposes of the safe harbor only, the term refers to a directly held interest in real property held for the production of rents. It may consist of an interest in a single property or multiple properties.

You can treat each interest in a similar property type as a separate rental real estate enterprise or treat interests in all similar properties as a single enterprise. Properties are “similar” if they’re part of the same rental real estate category (that is, residential or commercial). In other words, you can only hold commercial real estate in the same enterprise with other commercial real estate. The same applies for residential properties.

Bear in mind that, if you opt to treat interests in similar properties as a single enterprise, you must continue to treat interests in all properties of that category — including newly acquired properties — as a single enterprise as long as you use the safe harbor. If, however, you choose to treat your interests in each property as a separate enterprise, you can later decide to treat your interests in all similar commercial or all similar residential properties as a single enterprise.

Notably, the guidance provides that an interest in mixed-use property may be treated as a single rental real estate enterprise or bifurcated into separate residential and commercial interests.

Safe harbor requirements

The final guidance clarifies the requirements you must fulfill during the tax year in which you wish to claim the safe harbor. Requirements include:

Keeping separate books and records. You must maintain separate books and records reflecting income and expenses for each rental real estate enterprise. If the enterprise includes multiple properties, you can meet this requirement by keeping separate income and expense information statements for each property and consolidating them.

Performing rental services. For enterprises in existence less than four years, at least 250 hours of rental services must be performed each year. For those in existence at least four years, the safe harbor requires at least 250 hours of rental services per year in any three of the five consecutive tax years that end with the tax year of the safe harbor.

The rental services may be performed by owners or by employees, agents or contractors of the owners. Rental services include:

• Advertising to rent or lease the property,

• Negotiating and executing leases,

• Verifying tenant application information,

• Collecting rent,

• Performing daily operation, maintenance and repair of the property, including the purchase of materials and supplies,

• Managing the property, and

• Supervising employees and independent contractors.

Financial or investment management activities, studying or reviewing financial statements or reports, improving property, and traveling to and from the property don’t qualify as rental services.

Maintaining contemporaneous records. For all rental services performed, you must keep contemporaneous records that describe the service, associated hours, dates and the individuals who performed the service. If services are performed by employees or contractors, you can provide a description of them, the amount of time employees or contractors generally spent performing those services, and time, wage or payment records for the individuals.

This requirement doesn’t apply to tax years beginning before January 1, 2020. The IRS cautions, though, that taxpayers still must establish their right to any claimed deductions in all tax years, so be prepared to document your QBI deduction.

Providing a tax return statement. You must attach a statement to your original tax return (or, for the 2018 tax year only, on an amended return) for each year you rely on the safe harbor. If you have multiple rental real estate enterprises, you can submit a single statement listing the requisite information separately for each.

Excluded real estate arrangements

The safe harbor isn’t available for all rental real estate arrangements. The guidance excludes:

• Real estate used as a residence by the taxpayer (including an owner or beneficiary of a pass-through entity),

• Real estate rented or leased under a triple net lease that requires the tenant or lessee to pay taxes, fees, insurance and maintenance expenses, in addition to rent and utilities,

• Real estate rented to a commonly controlled business, or

• The entire rental real estate interest if any part of it is treated as a specified service trade or business (SSTB) for purposes of the QBI deduction. (SSTBs with taxable income above a threshold amount don’t qualify for the deduction.)

The guidance states that taxpayers that don’t qualify for the safe harbor may still be able to establish that an interest in rental real estate is a business for purposes of the deduction.

Next steps

The final safe harbor rules apply to tax years ending after December 31, 2017, and you have the option of instead relying on the earlier proposed safe harbor for the 2018 tax year. Plus, you must determine annually whether to use the safe harbor. We can help you determine whether you’re eligible for this and other valuable tax breaks.

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Tax Implications of a Company Vehicle

The use of a company vehicle is a valuable fringe benefit for owners and employees of small businesses. This benefit results in tax deductions for the employer as well as tax breaks for the owners and employees using the cars. (And of course, they get the nontax benefits of driving the cars!) Even better, recent tax law changes and IRS rules make the perk more valuable than before.

Here’s an example

Let’s say you’re the owner-employee of a corporation that’s going to provide you with a company car. You need the car to visit customers, meet with vendors and check on suppliers. You expect to drive the car 8,500 miles a year for business. You also expect to use the car for about 7,000 miles of personal driving, including commuting, running errands and weekend trips with your family. Therefore, your usage of the vehicle will be approximately 55% for business and 45% for personal purposes. You want a nice car to reflect positively on your business, so the corporation buys a new luxury $50,000 sedan.

Your cost for personal use of the vehicle will be equal to the tax you pay on the fringe benefit value of your 45% personal mileage. By contrast, if you bought the car yourself to be able to drive the personal miles, you’d be out-of-pocket for the entire purchase cost of the car.

Your personal use will be treated as fringe benefit income. For tax purposes, your corporation will treat the car much the same way it would any other business asset, subject to depreciation deduction restrictions if the auto is purchased. Out-of-pocket expenses related to the car (including insurance, gas, oil and maintenance) are deductible, including the portion that relates to your personal use. If the corporation finances the car, the interest it pays on the loan would be deductible as a business expense (unless the business is subject to business-interest limitation under the tax code).

In contrast, if you bought the auto yourself, you wouldn’t be entitled to any deductions. Your outlays for the business-related portion of your driving would be unreimbursed employee business expenses that are nondeductible from 2018 to 2025 due to the suspension of miscellaneous itemized deductions under the Tax Cuts and Jobs Act. And if you financed the car yourself, the interest payments would be nondeductible.

And finally, the purchase of the car by your corporation will have no effect on your credit rating.

Administrative tasks

Providing an auto for an owner’s or key employee’s business and personal use comes with complications and paperwork. Personal use will have to be tracked and valued under the fringe benefit tax rules and treated as income. This article only explains the basics.

Despite the necessary valuation and paperwork, a company-provided car is still a valuable fringe benefit for business owners and key employees. It can provide them with the use of a vehicle at a low tax cost while generating tax deductions for their businesses. We can help you stay in compliance with the rules and explain more about this prized perk.

Volunteering for charity: Do you get a tax break?

If you’re a volunteer who works for charity, you may be entitled to some tax breaks if you itemize deductions on your tax return. Unfortunately, they may not amount to as much as you think your generosity is worth.

Because donations to charity of cash or property generally are tax deductible for itemizers, it may seem like donations of something more valuable for many people — their time — would also be deductible. However, no tax deduction is allowed for the value of time you spend volunteering or the services you perform for a charitable organization.

It doesn’t matter if the services you provide require significant skills and experience, such as construction, which a charity would have to pay dearly for if it went out and obtained itself. You still don’t get to deduct the value of your time.

However, you potentially can deduct out-of-pocket costs associated with your volunteer work.

The basic rules

As with any charitable donation, to be able to deduct your volunteer expenses, the first requirement is that the organization be a qualified charity. You can check by using the IRS’s “Tax Exempt Organization Search” tool at   target="_blank">http://bit.ly/2KXWl5b.

If the charity is qualified, you may be able to deduct out-of-pocket costs that are unreimbursed; directly connected with the services you’re providing; incurred only because of your charitable work; and not “personal, living or family” expenses.

Expenses that may qualify

A wide variety of expenses can qualify for the deduction. For example, supplies you use in the activity may be deductible. And the cost of a uniform you must wear during the activity may also be deductible (if it’s required and not something you’d wear when not volunteering).

Transportation costs to and from the volunteer activity generally are deductible — either the actual expenses (such as gas costs) or 14 cents per charitable mile driven. The cost of entertaining others (such as potential contributors) on behalf of a charity may also be deductible. However, the cost of your own entertainment or meal isn’t deductible.

Deductions are permitted for away-from-home travel expenses while performing services for a charity. This includes out-of-pocket round-trip travel expenses, taxi fares and other costs of transportation between the airport or station and hotel, plus lodging and meals. However, these expenses aren’t deductible if there’s a significant element of personal pleasure associated with the travel, or if your services for a charity involve lobbying activities.

Recordkeeping is important

The IRS may challenge charitable deductions for out-of-pocket costs, so it’s important to keep careful records and receipts. You must meet the other requirements for charitable donations. For example, no charitable deduction is allowed for a contribution of $250 or more unless you substantiate the contribution with a written acknowledgment from the organization. The acknowledgment generally must include the amount of cash, a description of any property contributed, and whether you got anything in return for your contribution.

And, in order to get a charitable deduction, you must itemize. Under the Tax Cuts and Jobs Act, fewer people are itemizing because the law significantly increased the standard deduction amounts. So even if you have expenses from volunteering that qualify for a deduction, you may not get any tax benefit if you don’t have enough itemized deductions.

If you have questions about charitable deductions and volunteer expenses, please contact us.

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IRS wheels out additional guidance on company cars

The IRS has updated the inflation-adjusted “luxury automobile” limits on certain deductions taxpayers can take for passenger automobiles — including light trucks and vans — used in their businesses. Revenue Procedure 2019-26 includes different limits for purchased automobiles that are and aren’t eligible for bonus first-year depreciation, as well as for leased automobiles.

The role of the TCJA
The Tax Cuts and Jobs Act (TCJA) amended Internal Revenue Code (IRC) Section 168(k) to extend and modify bonus depreciation for qualified property purchased after September 27, 2017, and before January 1, 2023, including business vehicles. Businesses can expense 100% of the cost of such property (both new and used, subject to certain conditions) in the year the property is placed in service.

The amount of the allowable deduction will begin to phase out in 2023, dropping 20 percentage points each year for four years until it vanishes in 2027, absent congressional action. The applicable percentage for qualified property acquired before September 28, 2017, and placed in service in 2019, is 30%.

But 100% (or 30%) bonus depreciation is available only for heavier business vehicles that aren’t considered passenger automobiles. The maximum bonus depreciation amount for passenger automobiles is much smaller.

IRC Sec. 280F limits the depreciation deduction allowed for luxury passenger automobiles for the year they’re placed into service and each succeeding year. The TCJA amended the provision to increase the Sec. 280F first-year limit for qualified property acquired and placed after September 27, 2017, by $8,000. It increased the limit on first-year depreciation for qualified property acquired before September 28, 2017, and placed in service in 2019, by $4,800. These amounts are the bonus depreciation.

Annual depreciation caps
The new guidance includes three depreciation limit tables for purchased autos placed in service in calendar year 2019. The limits for automobiles acquired before September 28, 2017, that qualify for bonus depreciation are:

• 1st tax year: $14,900

• 2nd tax year: $16,100

• 3rd tax year: $9,700

• Each succeeding year: $5,760

The limits for autos acquired after September 27, 2017, that qualify for bonus depreciation are:

• 1st tax year: $18,100

• 2nd tax year: $16,100

• 3rd tax year: $9,700

• Each succeeding year: $5,760

The limits for autos that don’t qualify for bonus depreciation are:

• 1st tax year: $10,100

• 2nd tax year: $16,100

• 3rd tax year: $9,700

• Each succeeding year: $5,760

Other restrictions
The bonus depreciation deduction isn’t available for automobiles for 2019 if the business:

• Didn’t use the automobile more than 50% for business purposes in 2019,

• Elected out of the deduction for the class of property that includes passenger automobiles (that is, five-year property), or

• Purchased the automobile used and the purchase didn’t meet the applicable acquisition requirements (for example, the business cannot have used the auto at any time before acquisition).

Limits on leased automobiles
The new guidance also includes the so-called “income inclusion” table for passenger automobiles first leased in 2019 with a fair market value (FMV) of more than $50,000. The FMV is the amount that would be paid to buy the car in an arm’s-length transaction, generally the capitalized cost specified in the lease.

Taxpayers that lease a passenger automobile for use in their business can deduct the part of the lease payment that represents business use. Thus, if the car is used solely for business, the full cost of the lease is deductible. (Alternatively, you could just deduct the standard mileage rate — 58 cents for 2019 — for business miles driven.)

But Sec. 280F requires the deduction to be reduced by an amount that’s substantially equivalent to the limits on the depreciation deductions imposed on owners of passenger automobiles. The idea is to balance out the tax benefits of leasing a luxury car vs. purchasing it. That’s where the table comes into play.

Lessees must increase their income each year of the lease to achieve parity with the depreciation limits. The income inclusion amount is determined by applying a formula to an amount obtained from the IRS table. The latter amount depends on the initial FMV of the leased auto and the year of the lease term. Although the $50,000 FMV threshold for 2019 is unchanged from 2018, many of the other values in the new table have changed since then.

For example, let’s say you leased a car with an FMV of $56,500 on January 1, 2019, for three years and placed it in service that same year. You use the car for business purposes only. According to the table, your income inclusion amounts for each year of the lease would be as follows:

• Year 1: $26

• Year 2: $59

• Year 3: $86

The annual income inclusion amount may seem small compared to the depreciation deduction limits, but it represents a permanent tax difference that affects the effective tax rate but not book or taxable income. The depreciation limits, on the other hand, represent a timing difference that affects book and taxable income in the same way but at different times and doesn’t change the effective tax rate. The business will recover the timing difference through depreciation deductions or when it disposes of the auto.

Drive carefully

The new tax rules for vehicles used in business generally are favorable but aren’t easily navigable. We can help steer you toward the best strategy given your current circumstances.
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IRS updates rules for personal use of employer-provided vehicles

The IRS recently announced the inflation-adjusted maximum value of an employer-provided vehicle under the vehicle cents-per-mile rule and the fleet-average value rule. Employers can use the rules to value an employee’s personal use of such a vehicle for income and employment tax purposes. 

The new values reflect vehicle-related amendments in the Tax Cuts and Jobs Act (TCJA) and the IRS’s intent to make the rules more widely available to employers. The IRS is also temporarily loosening some of the consistency requirements for 2018 and 2019.

Valuation methods for personal use

When an employer provides an employee with a vehicle that’s available for personal use, it must include the value of the personal use in the employee’s income. Employers generally have four methods available to value an employee’s personal use of a company car:

1. General valuation rule. This involves the fair market value (FMV), which is defined as the amount the employee would have to pay a third party to lease the same or similar vehicle on the same or comparable terms in the geographic area where the employee uses the vehicle.

2. Commuting valuation rule. This is the amount of each one-way commute, from home to work or from work to home, multiplied by $1.50. (This method’s availability is subject to stringent requirements, including having a written policy limiting the employee’s use to commuting and “de minimis” personal use.)

3. The cents-per-mile rule. Employers can use the business standard mileage rate (58 cents for 2019, less up to 5.5 cents if the employer doesn’t provide fuel) multiplied by the total miles the employee drives the vehicle (including cars, trucks and vans) for personal purposes.

4. The automobile annual lease valuation rule. With this method, employers use the annual lease value of the automobile (including trucks and vans) — as specified by an IRS table that bases annual lease value on an automobile’s FMV — multiplied by the percentage of personal miles out of total miles driven by the employee. This amount also is subject to a fuel adjustment.

The fleet-average value rule allows employers operating a fleet of 20 or more qualifying automobiles to use an average annual lease value for every qualifying vehicle in the fleet when applying the automobile annual lease valuation rule.

The fleet-average value rule or the simple cents-per-mile rule isn’t available, though, if the FMV of the vehicle exceeds a certain base value, adjusted annually for inflation, on the first date the vehicle is made available to the employee for personal use. In 2017, the maximum value for the cents-per-mile rule was $15,900 for a passenger automobile and $17,800 for a truck or van. The maximum value for the fleet-average value rule that year was $21,100 for a passenger automobile and $23,300 for a truck or van.

The role of the TCJA

The base values were raised significantly earlier this year, in IRS Notice 2019-08, to reflect amendments made by the TCJA. The law changes the price inflation measure for automobiles (including trucks and vans). It also substantially increases the maximum annual dollar limitations on the depreciation deductions for passenger automobiles, basing the latter on the depreciation of a passenger automobile with a cost of $50,000 (up from $12,800), inflation adjusted annually, over a five-year recovery period. 

The IRS announced in the guidance that it intended to amend the tax regulations to incorporate a base value of $50,000 for both the cents-per-mile and the fleet-average value rules, effective for the 2018 calendar year. It also intended to amend the regulations to provide that the base value will be adjusted annually for 2019 and future years using the new price inflation measure. 

The latest news

Now, in Notice 2019-34, the IRS has announced the adjusted values for 2019. For vehicles and automobiles first made available to employees for personal use in calendar year 2019, the maximum value under both rules is $50,400. Under planned amendments to the applicable regulations, these maximum values will be the same as the maximum standard automobile cost that determines eligibility to set reimbursement allowances under a fixed and variable rate (FAVR) plan — an alternative to the business standard mileage rate.

The IRS also shared its intention to amend the tax regulations to provide relief to employers that previously didn’t qualify for the cents-per-mile rule because, under the earlier rules, the vehicle’s FMV exceeded the permissible maximum value. Under amended regulations, the employer may first adopt the cents-per-mile valuation rule for 2018 or 2019 based on the maximum value of a vehicle for 2018 or 2019. 

Note, though, that employers that adopt the cents-per-mile rule generally must continue to use it for all subsequent years in which the vehicle qualifies for it. An employer can, however, use the commuting valuation rule for any year the vehicle qualifies.

Similarly, employers that didn’t qualify for the fleet-average value rule before 2019 because of the pre-2018 maximum value limit can adopt the rule for 2018 or 2019 if it falls under the applicable maximum value.

The new notice confirms that employers can use the flexible guidelines in Announcement 85-113 to determine the timing for when personal use income is deemed paid. That means employers may use the rules in that guidance, the adjustment process, or the refund claim process to correct any overpayment of federal employment taxes resulting from application of the notice’s transition relief.

Additional requirements

Satisfying the maximum value limit isn’t enough for an employer to use the cents-per-mile rule or the fleet-average value rule to value an employee’s personal use of a vehicle. Both rules come with other requirements that can prove difficult to meet. For example, the cents-per-mile rule generally is available only if the employer reasonably expects the vehicle to be regularly used in its trade or business throughout the calendar year or the vehicle meets the mileage test. We can help you determine the appropriate valuation method for your circumstances.
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