Section 199A Deduction: 2019 Tax Year Implications for Real Estate, Service Businesses and Partnerships

The Section 199A deduction was rolled out in December 2017 as part of the Tax Cuts and Jobs Act. Almost as soon as it was introduced, it was met with claims that it was convoluted and needed significant clarification. In response to the feedback of CPAs and other tax professionals, the IRS released Regulation 107892-18 in August to attempt to clear up areas of confusion, specifically regarding to defining which trades or businesses qualified for the deduction. Three of these main areas centered around the treatment of service business, real estate professionals, and partnerships.

Clearing up the Confusion Around 2019 Tax Implications for Specified Service Trade or Business

Initially, a qualified trade or business was any business with the following exceptions:

1. A specified service trade or business (SSTB), which is “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 1 or more of its employees or owners.”
2. Performing services as an employee

While some of these areas seem easy to define, there are exceptions to each service industry leaving much up to interpretation by individuals owning SSTBs and tax professionals. To clear up some of the confusion, the IRS released proposed regulations specifically clarifying which businesses are SSTBs within the health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services and brokerage services fields.

Specific Section 199A Tax Implications for SSTBs

Each trade or business must be evaluated separately, and tax preparers and individuals should take care to correctly categorize each trade or business to qualify for the deduction. Below are the specific tax implications for SSTBs under the Sec 199A threshold, between the threshold amounts, and over the threshold:

Married filing joint

• • Under $315,000 of taxable income: full deduction can be taken
  • Deduction phase out starts: $315,000 of taxable income
  • Deduction phase out ends (no deduction allowed): Over $415,000 of taxable income

All other taxpayers (married filing separate, head of household, single, etc.)

• • Under $157,500 of taxable income: full deduction can be taken
  • Deduction phase out starts: $157,500 of taxable income
  • Deduction phase out ends (no deduction allowed): $207,500 of taxable income

Real Estate Professionals

Two areas were specifically excluded from the “brokerage service” category of the definition of an SSTB: real estate agents and brokers and insurance agents and brokers. Under the investment management category, real estate management was also specifically excluded. This means real estate and real estate management companies are not considered service trades or businesses (SSTBs) and qualify for the Section 199A deduction. However, there are specific limitations on how the deduction can be applied to real estate businesses, the most significant of which is that a real estate business must be a “qualified trade or business.”

Individuals who own real estate investments don’t necessarily qualify as owning a trade or business unless they actually run the investments like a business. Revenue Procedure 2019-7 clears up some of this confusion with a “safe harbor” for real estate investments and businesses, noting that rental activity will be considered a section 162 trade or business if separate books and records are kept and specific business activities are performed and logged. Real estate investment or businesses meeting these requirements will fall under the “safe harbor” category and will be considered a section 162 qualified trade or business and qualify for the Section 199a deduction.

Specific Section 199A Tax Implications for Real Estate Professionals or Investors

Since real estate companies and real estate management companies are not considered SSTBs, they calculate their portion of the deduction only subject to the income thresholds:

Married filing joint

• • Under $315,000 of taxable income: full deduction can be taken
  • Deduction phase out starts: $315,000 of taxable income
  • Over $415,000 of taxable income limitations on deduction: 50% of the owner’s share of the W-2 wages paid by the business, or 25% of the owner’s share of the W-2 wages paid by the business, plus 2.5% of the unadjusted basis immediately after acquisition (UBIA) of qualified property.

All other taxpayers (married filing separate, head of household, single, etc.)

• • Under $157,500 of taxable income: full deduction can be taken
  • Deduction phase out starts: $157,500 of taxable income
  • Over $207,500 of taxable income limitation on deduction: 50% of the owner’s share of the W-2 wages paid by the business, or 25% of the owner’s share of the W-2 wages paid by the business, plus 2.5% of the unadjusted basis immediately after acquisition (UBIA) of qualified property.

Partnerships

The second, sometimes overlooked, component of the Qualified Business Income Deduction is the potential 20% deduction for qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income. Unlike the first component of Section 199A, the second component is fairly straightforward. Taxpayers calculate 20% of qualified REIT dividends and qualified PTP income. Once this amount is calculated, it is added to the first component of the Section 199A deduction and subject to an overall limitation, which is 20% of the excess of:

1. The taxpayer’s taxable income for the year, over
2. The sum of net capital gain

While partnerships are not taxpayers, partners can determine their qualified income through their K-1 to calculate their related Section 199a deduction.

Guaranteed Payments vs Distributive Share of Partnership Income

Under Section 199A, guaranteed payments to partners for services provided and use of capital are not included in qualified business income (QBI) for determining the deduction. However, a partner’s distributive share of the partnership’s income may qualify for the deduction. Partnerships who currently distribute income to partners as guaranteed payments should consider reducing the guaranteed payment and increasing the distributive share of the partnership income to maximize his or her deduction.

Moving Into 2019 With the New Regulations

To get an in-depth look into how Section 199A may affect your clients, check out Surgent’s CPE course “Section 199A NEW Developments: What You Need to Know to Prepare 2018 Tax Returns in Light of the IRS’ Final Regulations (S19U),” which provides even more clarification regarding the recent updates and how they affect the Section 199A deduction.