Changes for Real Estate Professionals under the Tax Cut and Jobs Act

One of the more significant changes under the Tax Cut and Jobs Act, signed into law by President Trump in December 2017, relates to business owners of flow-through entities, such as partnerships, LLCs, sole proprietorships, and S corporations. This Flash will focus on how the new rules related to these flow through entities will affect real estate professionals.

For years after 2017, taxpayers that have qualified business income (QBI) flowing from these entities are entitled to a deduction to reduce income, which will be computed as the lesser of their QBI or 20% of taxable income from the activity. This deduction will have the effect of further lowering the top individual tax rate for income pertaining to these entities.

What is QBI?

Qualified business income (“QBI”) is defined as all domestic business income, other than investment income, with the exception of qualified REIT dividends, cooperative dividends, and interest income if the interest is properly allocable to the business. This deduction reduces taxable income and is not a reduction of adjusted gross income (“AGI”). The deduction is also available whether or not the taxpayer itemizes. The deduction is computed for each qualified trade or business, then combined to include all such qualified businesses.

For taxpayers with taxable income in excess of $157,500 (single filers) or $315,000 (joint filers), the deduction is generally limited to the greater of either:

1. 50% of the W-2 wages paid with respect to the qualified trade or business, or;
2. The sum of 25% of the W-2 wages with respect to the qualified trade or business plus 2.5% of the unadjusted basis, immediately after acquisition, of all qualified property.

Qualified property includes tangible property that is subject to depreciation and:

1. Is held by, and available for use in, the qualified trade or business;
2. Is used at any point during the tax year in the production of qualified business income; and
3. For which the depreciable period has not ended before the close of the tax year.

Marcum Observation

The inclusion of 2.5% of unadjusted basis immediately after acquisition allows a greater deduction for real estate professionals.

Limitations

For certain specified personal service businesses in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, and brokerage services, this deduction is not allowed for single taxpayers with taxable income above $157,500 (filing single) or $315,000 (married filing jointly). Real estate professionals are not considered a personal service business for purposes of this deduction.

What is a Real Estate Professional?

A real estate professional is someone who performs personal services involving real property trades or businesses, or in which the taxpayer’s spouse materially participates, constituting more than 50 percent of all services performed in a tax year and exceeding 750 hours in the year.

Individual rental real property is considered a separate activity unless the taxpayer elects to treat all interest in rental real estate as a single activity for the purposes of satisfying the material participation requirements. Previously made grouping elections may need to be revisited.

Please reach out to your Marcum tax advisor for further information.