There has been much discussion of late, over the recent federal tax overhaul and it's sec. 199A QBI deduction, particularly in the small business and real estate investment communities.

This is due in large part, to one of the more important provisions in the Tax Cuts and Jobs Act. More specifically, the Sec. 199A deduction for qualified business income (QBI).

Under the new code section, a deduction for up to 20% of qualified business income may be allowed. The deduction itself applies to income taxes only, but nonetheless may prove quite beneficial. Businesses which qualify, include sole proprietorships, partnerships, limited liability companies (LLCs), S corporations and trusts.

Income qualifying for the deduction must be “effectively connected with the conduct of a trade or business within the United States (within the meaning of §864(c)”. Consequently, for purposes of the §199A deduction, a U.S. business entity or resident, or even a foreign company or non-resident alien may qualify, so long as they are not specifically excluded and are conducting business within the U.S. as required. It is worth noting that “Qualified Business Income”, also includes interest received which is related to business activities. Dividends, as well as capital gain(s) or losses, do not affect the computation for QBI. It should also be mentioned, that current year business losses, are required to be carried forward to offset QBI in the subsequent year. A penalty for losing money!

The deduction is equal to the sum of 20% of the qualified Business Income (QBI) of each of the taxpayer's qualified businesses. QBI is determined separately for each business activity of the taxpayer.

In the simplest scenario, a small business would determine business activity gross income, subtract normal and necessary business deductions and thus obtain their QBI. They would then calculate twenty percent of the determined QBI, to figure their deduction. As with most deductions and credits however, there are several limitations which can come into play.

For example, various income thresholds can determine the amount of deduction allowed. Once the applicable income threshold has been reached, the deduction begins to be phased out and is eventually eliminated at the highest income levels.

Another limitation applies to what the code defines as a “specified service trade or business”. The nature of your business activities, if related mostly to professional services, may limit or even eliminate your QBI deduction. Further limitations may also apply to businesses involved in the manufacturing and sale of goods, agricultural and horticultural cooperatives and those operating within the Commonwealth of Puerto Rico. For businesses with employees, limitations factoring in wages and/or ownership of the business, also must be considered.

It is not only small businesses who are asking questions about the new deduction. One of the more widely asked questions is coming from owners of rental real estate. While we know that real estate professionals such as property managers, real estate brokers and developers may be able to take advantage of the deduction, landlords and owners of more passive real estate activities, want to know if the new deduction is available to them. Presently, most professionals agree that the intent of the legislation, seems likely to include these more passive rental activities. The new law however, does not directly address this specific issue in clarity. Moving forward, we are all looking to further clarification on this issue, from the U.S. Treasury.

Another hot question among the real estate community, has to do with how real estate is owned and the impact of the ownership structure on the QBI deduction. While §199A does specifically exclude some types of business entities, such as corporations and publicly traded partnerships, it does not state that real estate assets must be held within any specific entity type. Consequently, as before, many factors should still be taken under consideration, when deciding how to hold title to real property.

Certainly however, an allowance of a QBI deduction for landlords and owners of investment real estate, would be most welcome.

If you would like to learn about the how the new deduction may apply to you specifically, we would love to help. We are offering no-cost seminars to the local community, aimed to educate small business owners and real estate investors on these issues. We also offer one-on-one assistance. We invite you to call or email us at any time to learn more.

By Christopher Jacquez & David Jacquez