199A Deduction: What Commercial Real Estate Investors Need to Know About Section 199A Deductions

An Introduction to Section 199A Deductions for Commercial Building Owners

Section 199A is a provision of the Tax Cuts and Jobs Act. It is effective from January 1, 2018, to December 31, 2025. In mid-January 2019, the IRS released a 274-page supplement to the Act. These additional Regulations help to interpret the Act. Specifically, Section 199A consists of three separate deductions:

  • 20% Passthrough Deduction
  • 20% Deduction for REIT Dividends and PTP Income
  • Deduction for Agricultural and Horticultural Cooperatives

In this article, we’ll focus on the most relevant deduction to this discussion, the 20% Passthrough Deduction.

The Section 199A deduction is commonly referred to by its initials QBI (Qualified Business Income).

What is Qualified Business Income (QBI)

QBI provides a business deduction on the following terms:

  • 20% of Taxable income
  • Limited to Passthrough Entities
  • Only available to specified business types
  • Limited by the taxpayers income

QBI Basics

The Rationale Behind QBI

One of the initial questions raised by this deduction is why did Congress provide for this beneficence? The answer lies in other provisions of the Act that provided substantial tax benefits to C Corporations. Congress attempted to provide a similar benefit for non-C corporation small business. Yet this attempt was not entirely successful. Currently, C corporations have significant tax and tax planning advantages not shared by their pass-through counterparts.

Business Income

The difficulty is determining how much activity and for what purpose?

The deduction only applies to businesses. For the purpose of defining what a business is, the IRS refers to Section 162 of the Tax Law. In general, any regular activity carried on for a profit is classified as a business. The difficulty is determining how much activity and for what purpose?

As a result, the answer depends on an assessment of each individual case. For example, depending on the circumstances, Residential Property Leasing may or may not qualify as a business.

The Deduction is 20% of QBI

The amount of the deduction is calculated on a separate form and the result is then transferred to the taxpayers 1040.

Limited to Passthrough Entities

This deduction is limited to the following taxpayer entities:

  • Sole Proprietors
  • LLC’s
  • Partnerships
  • S Corporations
  • Certain Trusts and Estates

Applied to the Owners

An important part of the regulations defines the benefit as applying to the owners of the business, not the business itself. In other words, this not a deduction on the business return. Instead, it is part of the K-1 and becomes a deduction on the business owners personal return. It should be noted that this deduction only applies to US taxpayers. Consequently, a foreign partner in an LLC doesn’t qualify for the deduction.

The 199A is not a deduction on the business return.

Limited to Certain Business Types

Some business types are specifically excluded from the benefit, including:

  • Any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, OR
  • Any trade or business where the principal asset of such trade or business is the reputation or skill of one more of its employees or owners

Limited by the Taxpayers Income

If the Taxpayer’s income exceeds $207,000 ($415,000 if married and filing jointly), then no benefit is available.

If the Taxpayer’s income exceeds $207,000 ($415,000 if married and filing jointly), then no benefit is available. At the same time, this can produce an unusual situation – one member of an LLC qualifies for the deduction, while the other does not. For example, if the wife’s W-2 income pushes their joint income over the $415,000 limit, they are ineligible for this deduction.

Calculating QBI

Calculating QBI is complicated. However, the text box (at right) offers an illustration which includes a step by step calculation provided for the primary benefit of CPA’s.
Since these calculations are quite complex, it is strongly recommended that you discuss this topic with your CPA at tax time. In general, maintain low expectations about QBI deductions. According to CXRE’s CFA, over 80% of their small business clients do not qualify for the deduction. The primary reason is that they exceed the taxable income threshold.

IRS Final Regulations’ Effect on NNN Leases

On January 18, the IRS released Final Regulations on Section 199A. These regulations have a direct impact on investors and landlords who lease property under triple net (NNN) leases. Under these regulations, the IRS won’t consider many landlords to be active trades or businesses. As a result, many won’t qualify for the 20% deduction available to the majority of active landlords.

Originally, Section 199A didn’t clearly define trade or business. Yet now, the IRS doesn’t consider passive investors to be active trades or businesses. Specifically, to qualify for the deductions, these landlords must become active. In some cases, landlords may opt to fulfill the 250-hour per year work hour requirement. At the same time, others may choose to renegotiate lease terms to become eligible for the deductions.

Understand the Real Benefits of QBI

Without a doubt, the QBI deduction has produced a good deal of hype. However, the substance of this deduction complex, calculation bound, and temporary benefit to small business that will only remain in effect for eight years.

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