In 2019, a divided federal government managed to pass new tax legislation in June with the Taxpayer First Act, and the IRS kept practitioners busy with an abundance of guidance on several key provisions of the Tax Cuts and Jobs Act of 2017 (TCJA). In addition, the fiscal year 2020 appropriations package passed by Congress, and signed into law by President Trump on December 20, contained three dozen tax extenders and numerous other tax law changes. The following is a summary of the most important tax developments of 2019.
IRS Issues Extensive Guidance to Help Clarify Calculation of the Section 199A Deduction
In January, the IRS issued eagerly anticipated guidance on the qualified business income (QBI) deduction under Code Sec. 199A in final regulations (T.D. 9847), proposed regulations (REG-134652-18), and Rev. Proc. 2019-11.
Code Sec. 199A generally provides a 20 percent deduction for qualified business income (QBI) from sole proprietorships, S corporations, partnerships, and LLCs taxed as partnerships. Thus, the calculation of QBI and, therefore, the benefits of Code Sec. 199A, are limited to taxpayers with income from a trade or business. Reg. Sec. 1.199A-1(b)(14) defines “trade or business” as a trade or business under Code Sec. 162 other than the trade or business of performing services as an employee. The final regulations also extend the definition of a trade or business beyond the Code Sec. 162 definition by treating the rental or licensing of tangible or intangible property to a related trade or business as a trade or business if the rental or licensing activity and the other trade or business are commonly controlled. The final regulations also included guidance regarding when a rental real estate enterprise qualifies as a trade or business for purposes of Code Sec. 199A (see below).
The proposed regulations in REG-134652-18 addressed several issues, including (1) the treatment of previously suspended losses that constitute QBI and (2) the determination of the Code Sec. 199A deduction for taxpayers that hold interests in regulated investment companies, charitable remainder trusts, and split-interest trusts. In Rev. Proc. 2019-11, the IRS provided guidance on the calculation of W-2 wages for purposes of Code Sec. 199A(b)(2), which limits the QBI deduction for some taxpayers whose taxable income exceeds a threshold amount ($160,700 for single filers; $321,400 for joint filers for 2019).
An issue of major concern for practitioners was determining whether a taxpayer’s rental real estate activity qualified as a trade or business for purposes of the Code Sec. 199A deduction. The final regulations in T.D. 9847 set forth a list of nonexclusive factors to consider in determining whether rental real estate enterprises qualify for the Code Sec. 199A QBI deduction. The preamble to T.D. 9847 states that, in determining whether a rental real estate activity is a Code Sec. 162 trade or business, the relevant factors include, but are not limited to, (1) the type of rented property (commercial real property versus residential property), (2) the number of properties rented, (3) the owner’s or the owner’s agents day-to-day involvement, (4) the types and significance of any ancillary services provided under the lease, and (5) the terms of the lease (for example, a net lease versus a traditional lease and a short-term lease versus a long-term lease). But the IRS concluded in the preamble that a bright line rule on whether a rental real estate activity is a trade or business for purposes of Code Sec. 199A was beyond the scope of the final regulations.
Safe Harbor Provided for Rental Real Estate Activities. Recognizing the difficulties taxpayers faced in determining whether a taxpayer’s rental real estate activity is sufficiently regular, continuous, and considerable for the activity to constitute a trade or business for purposes of the Code Sec. 199A deduction, the IRS issued Rev. Proc. 2019-38. Rev. Proc. 2019-38 provides a safe harbor under which a rental real estate enterprise may be treated as a trade or business. Under Rev. Proc. 2019-38, each rental real estate enterprise will be treated as a single trade or business if the taxpayer satisfies three requirements: (1) the taxpayer maintains of separate books and records to reflect income and expenses for each enterprise; (2) for enterprises in existence less than four years, the taxpayer performs at least 250 hours of services per year, and for enterprises in existence for at least four years, the taxpayer performs 250 hours of services per year in any three of the five previous years; and (3) the taxpayer maintains contemporaneous records documenting the services performed.
Further, Rev. Proc. 2019-38 provides that rental real estate services include, but are not limited to, (1) advertising to rent or lease the real estate; (2) negotiating and executing leases; (3) verifying information contained in prospective tenant applications; (4) collecting rent; (5) daily operation, maintenance, and repair of the property, including the purchase of materials and supplies; (6) management of the real estate; and (7) supervision of employees and independent contractors.
Mid-Year Sec. 199A Prop. Regs Provide Guidance for Cooperatives. In June, the IRS issued proposed regulations (REG-118425-18) which provide guidance to cooperatives and their patrons on calculating the Code Sec. 199A QBI deduction, as well as guidance to specified agricultural or horticultural cooperatives (specified cooperatives) and their patrons regarding the deduction for domestic production activities under Code Sec. 199A(g). The proposed regulations also (1) provide guidance on Code Sec. 199A(b)(7), relating to the rule requiring patrons of specified cooperatives to reduce their deduction for QBI under Code Sec. 199A(a); (2) provide a single definition of patronage and nonpatronage under Code Sec. 1388; and (3) remove the final regulations, and withdraw the proposed regulations that have not been finalized, under former Code Section 199. The IRS also issued a proposed revenue procedure in Notice 2019-27 that contains computational guidance for specified cooperatives on methods and appropriate sources of data, for calculating W-2 wages for purposes of Code Sec. 199A(g). Notice 2019-27 provided three methods for calculating W-2 wages for purposes of Code Sec. 199A(g)(1)(B)(i), which limits the amount of the deduction available to specified cooperatives to 50 percent of such cooperative’s W-2 wages for the tax year.
Final Regs and Related Guidance Clarify Computations of 100 Percent Bonus Depreciation
Another important area where the IRS provided a significant amount of guidance to practitioners in 2019 was with respect to the additional first-year depreciation deduction (i.e., bonus depreciation) under Code Sec. 168(k). The TCJA increased the bonus depreciation deduction from 50 percent to 100 percent.
In September, the IRS issued final bonus depreciation regulations in T.D. 9874 along with proposed regulations in REG-106808-19. The final regulations reflect and clarify the increase of the bonus depreciation benefit and the expansion of the universe of qualifying property, particularly to certain classes of used property authorized by the TCJA. The final regulations contain rules regarding used property, substantially renovated property, and rules applicable to partnerships. The final regulations also address the date of acquisition of depreciable property, the computation of the bonus depreciation deduction, and the elections provided in Code Secs. 168(k)(5), 168(k)(7), and 168(k)(10). The proposed regulations addressed several issues including (1) certain property not eligible for bonus depreciation, (2) a de minimis use rule for determining whether a taxpayer previously used property; (3) components acquired after September 27, 2017, of larger property for which construction began before September 28, 2017; and (4) other aspects not dealt with in the previous proposed regulations.
The IRS also issued two important bonus depreciation safe harbor rules in 2019. In February, the IRS issued Rev. Proc. 2019-13 to provide a safe harbor method of accounting for determining bonus depreciation deductions for passenger automobiles that are subject to the luxury automobile depreciation limitations under Code Sec. 280F(a) (as amended by the TCJA). In general, the Code Sec. 179 and depreciation deductions for passenger automobiles are subject to dollar limitations for the year the taxpayer places the passenger automobile in service and for each succeeding year. For a passenger automobile that qualifies for the bonus depreciation deduction, the TCJA increased the first-year limitation amount by $8,000. If the depreciable basis of a passenger automobile for which bonus depreciation is allowable exceeds the first-year limitation, the excess amount is deductible in the first tax year after the end of the recovery period. The safe harbor method in Rev. Proc. 2019-13 allows depreciation deductions for the excess amount during the recovery period, subject to the depreciation limitations applicable to passenger automobiles. Thus, the safe harbor mitigates the anomalous result that occurs in the years after the placed-in-service year and before the first year succeeding the end of the recovery period.
In July the IRS issued Rev. Proc. 2019-33 to allow late elections or revocation of elections under Code Sec. 168(k)(5) (the election to deduct the cost of a specified plant in the year it was planted or grafted), Code Sec. 168(k)(7) (the election not to apply bonus depreciation), and Code Sec. 168(k)(10) (the election to deduct 50 percent, rather than 100 percent, of the cost of all qualified property) for property acquired by the taxpayer after September 27, 2017, and placed in service or planted or grafted during the taxpayer’s tax year that includes September 28, 2017. The IRS explained that when it issued the proposed regulations under Code Sec. 168(k) in August of 2018 (which were later finalized in T.D. 9874), some taxpayers had already filed their tax returns or did not have sufficient time to analyze the proposed regulations before filing returns due in September or October of 2018.
