At the same time the IRS issued final regulations on the business interest deduction limitations under IRC §163(j), the agency issued a proposed Revenue Procedure in Notice 2020-59 to provide a safe harbor for a trade or business that manages or operates a qualified residential living facility to be treated as a real property trade or business solely for the purposes of qualifying as an electing real property trade or  business under IRC §163(j)(7)(B).[1]

An electing real property or business is exempted from the business interest limitations under IRC §163(j) but is required to use the alternative depreciation system (ADS) methods to depreciate any real property.

The IRS explains the reason why they are proposing this safe harbor in Notice 2020-59:

The Treasury Department and the IRS are aware that taxpayers have uncertainty about whether residential living facilities that include the provision of supplemental assistive, nursing, or routine medical services qualify as electing real property trades or businesses under section 163(j)(7)(B).

To mitigate this uncertainty, the proposed revenue procedure in section 6 of this notice provides a safe harbor under which a qualified residential living facility, as defined in section 3.01 of the proposed revenue procedure, is treated as eligible to be an electing real property trade or business under section 163(j)(7)(B).[2]

Although the procedure is issued as a draft, the IRS provides that taxpayers may rely on the procedure until the date a final revenue procedure is published:

Until the date on which the proposed revenue procedure is published as a revenue procedure in the Internal Revenue Bulletin, taxpayers may rely on the safe harbor described in the proposed revenue procedure for purposes of determining whether a qualified residential living facility, as defined in section 3.01 of the proposed revenue procedure, is eligible to be an electing real property trade or business solely for purposes of section 163(j).[3]

The proposed Revenue Procedure defines a qualified residential living facility as a facility that:

• Consists of multiple rental dwelling units within one or more buildings or structures that generally serve as primary residences on a permanent or semi-permanent basis to individual customers or patients;

• Includes the provision of supplemental assistive, nursing, or other routine medical services; and

• Has an average period of customer or patient use of the individual rental dwelling units that is 90 days or more.[4]

The proposed revenue procedure provides the following guidance on determining the average period of customer use:

The average period of customer or patient use is determined by dividing (i) the sum of the total number of days in the taxable year that each customer or patient resides in a rental dwelling unit of the residential living facility (which may be determined by reference to a rental contract or other formal written lease agreement); by (ii) the total number of individual residential customers or patients that reside in all of the rental dwelling units of the facility for the taxable year. For this purpose, a married couple residing in a single rental dwelling unit of the residential living facility will be counted as one individual customer or patient, unless each spouse is separately properly treated as an individual customer or patient of the residential living facility that receives supplemental assistive, nursing, or other routine medical services from or on behalf of the residential living facility.[5]

The proposed procedure provides the following example:

Example, Proposed Revenue Procedure, Notice 2020-59

Facility has 100 rental dwelling units. Of the 100 units, 60 units are occupied by the same customer or patient for the entire year, 25 units are occupied by each customer or patient for three months (90 days) of the year, and 15 units are occupied for only 10 months (300 days) of the year (for a total of 100 customers for the year). Of the 15 units occupied for only 10 months of the year, 10 units are occupied by customers or patients for 5 months (150 days) each (for a total of 20 customers for the 10-month period). For the remaining 5 of 15 units that are occupied for only 10 months of the year, 5 customers or patients occupy the units for 8 months (240 days) of the year, and 5 other customers or patients occupy the units for 2 months (60 days) of the year. The average period of customer or patient use is determined by dividing the sum of the total number of days in the taxable year that each customer resides in a rental dwelling unit, by the total number of individual residential customers or patients that reside in all of the rental dwelling units for the taxable year. The total number of days in the taxable year that the customers or patients reside in the rental dwelling unit is 35,400 days [21,900 days (60 units that are occupied for the entire year x 365 days per year) + 9,000 days (25 units that are occupied for 90 days each x 90 days x 4 90-day periods in a year) + 4,500 days (15 units that are occupied for only 10 months x 300 days)]. The total number of individual residential customers or patients is 190 [60 customers or patients occupying a unit for the entire year + 100 (25 customers or patients occupying units for 90 days each x 4 90-day periods in a year) + 20 customers or patients that occupy a unit for a 5-month period + 5 customers or patients that occupy a unit for a 8-month period + 5 customers or patients that occupy a unit for a 2-month period]. Accordingly, the average period of customer or patient use is approximately 186 days (35,400/190).

The proposed revenue procedure defines supplemental assistive, nursing or other routine medical services as:

Supplemental assistive, nursing, or other routine medical services are personal and professional services that are customarily and routinely provided to individual residential customers or patients of nursing homes, assisted living facilities, memory care residences, continuing care retirement communities, skilled nursing facilities, or similar facilities, as needed, on a day-to-day basis. Such services generally do not include surgical, radiological, or other intensive or specialized medical services that are usually only provided in emergency or short-term in-patient or out-patient hospital or surgical settings.[6]

The proposed revenue procedure defines permanent or semi-permanent basis as:

The rental dwelling units of a residential living facility serve as primary residences on a permanent or semi-permanent basis to customers or patients whose use of the units is generally long-term (more than 90 days) in nature, even though some customers or patients may arrive at the residential living facility with significantly shortened life expectancies due to advanced age or terminal medical conditions, and some customers or patients otherwise may be expected to periodically reside away from the residential living facility (such as at the primary residence of a spouse or other relative) for short periods or durations of time.[7]

Under the proposed revenue procedure, a taxpayer that manages or operates a qualified residential living facility may, solely for the purpose of the election to be treated as an electing real property business under IRC §163(j), treat the operation as a real property trade or business.  Meeting the tests to qualify under the safe harbor does not establish that the business is engaged in a real property trade or business for the passive activity rules found at IRC §469.[8]

The proposed revenue procedure provides the following information on the effect of the election and how it should be made:

If a taxpayer makes the election pursuant to this safe harbor, the provisions in § 1.163(j)-9 of the regulations apply, and the taxpayer must use the alternative depreciation system of section 168(g) of the Code to depreciate the property described in section 168(g)(8). The taxpayer makes the election at the time, and in the manner prescribed by § 1.163(j)-9(d). See also Rev. Proc. 2020-22.[9]

The proposed revenue procedure imposes the following requirements for keeping books and records:

A trade or business that manages or operates a residential living facility to which this revenue procedure applies must retain books and records to substantiate that all the requirements of this section 4 have been met in accordance with section 6001 of the Code.[10]

The proposed revenue procedure also contains the following broad anti-abuse rule applicable to this procedure:

Arrangements entered into with a principal purpose of avoiding the rules of section 163(j) of the Code or the regulations under section 163(j) may be disregarded or recharacterized by the Commissioner of Internal Revenue to the extent necessary to carry out the purposes of section 163(j). See § 1.163(j)-2(j).[11]

The proposed revenue procedure applies to tax years beginning after December 31, 2017.[12]

[1] Notice 2020-59, July 28, 2020 https://www.irs.gov/pub/irs-drop/n-20-59.pdf (retrieved August 6, 2020)

[2] Notice 2020-59, Section 2

[3] Notice 2020-59, Section 4

[4] Notice 2020-59, Proposed Revenue Procedure Section 3.01

[5] Notice 2020-59, Proposed Revenue Procedure Section 3.02(1)

[6] Notice 2020-59, Proposed Revenue Procedure Section 3.03

[7] Notice 2020-59, Proposed Revenue Procedure Section 3.04

[8] Notice 2020-59, Proposed Revenue Procedure Section 4.01

[9] Notice 2020-59, Proposed Revenue Procedure Section 4.02

[10] Notice 2020-59, Proposed Revenue Procedure Section 4.03

[11] Notice 2020-59, Proposed Revenue Procedure Section 4.04

[12] Notice 2020-59, Proposed Revenue Procedure Section 5