All business owners other than corporations, including landlords, are now able to take the Qualified Business Income (QBI) Deduction, also known as the Section 199A Deduction. Starting with tax year 2018, the Tax Cut and Jobs Act of 2017, passed into law December 22, 2017, reduced rates for corporate and non-corporate businesses. Corporations received a reduction in their tax rate from 35% to 21%. Non-corporations received the QBI deduction.
Which Landlords Qualify for the QBI Deduction
All non-corporate landlords can qualify. The QBI was worded to cover a broad range of trades and businesses: sole proprietors, owners of S-Corporations and pass-through LLC’s, partnerships, estates, and trusts. Rental income declared on Schedule E and business income declared on schedule K-1 can both qualify.
Certain businesses are phased out of the QBI above certain income levels. A so-called “specified service trade or business” (SSTB) cannot take the full QBI deduction if the taxpayer’s income is above $315,000 married filing jointly or $157,500 for all others.
You have an SSTB subject to phase-out if your trade or business performs “services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, investing and investment management, trading, dealing in certain assets or any trade or business where the principal asset is the reputation or skill of one or more of its employees.”
Even if you do have an SSTB, you can still take the QBI deduction until your income hits the above limits, and then it is phased out to higher limits.
Rental real estate is neither an SSTB nor subject to the phase-out.
What Exactly is the QBI Deduction?
Sadly, as with all tax law, the QBI is difficult to parse. There are two parts that you add up. If you have neither qualified business income nor cooperative dividends, then these amounts are both zero and there will be no Section 199A QBI deduction.
Inside each part, they are making you pick the smaller of two numbers. If you are primarily a passive investor making lots of capital gains, and you don’t own REIT’s or PTP’s, then these amounts will be zero and there will be no Section 199A QBI deduction.
The QBI allows all taxpayers other than corporations to deduct the sum of:
- the lesser of:
- the combined qualified business income, defined below, OR
- your taxable income, minus your net capital gain, minus your qualified cooperative dividends, PLUS
- the lesser of:
- 20% of your qualified cooperative dividends, OR
- your taxable income, minus your net capital gain.
If you are primarily a passive investor taking capital gains, and you don’t own REIT’s or PTP’s, you will be screened out by bullet points “b”. For the sake of this article, we will assume you are a landlord and you don’t participate in a cooperative business, so we can ignore bullet point “2”. This leaves us with bullet point 1a.
The intent behind “combined qualified business income” is to reward business owners who have either W-2 employees or capital invested.
The combined qualified business income is the sum of:
- 20% of your real estate investment trust (REIT) dividends, PLUS
- 20% of your publicly traded partnership (PTP) income, PLUS
- the lesser of
- 20% of your qualified business income for your trade or business, OR
- the greater of
- 50% of the W-2 wages that business paid to all employees, OR
- 25% of the W-2 wages that business paid to all employees PLUS 2.5% of the unadjusted basis immediately after acquisition of qualified property.
The intent of the first two bullets is to maintain the tremendous tax advantages available to real estate investors, particularly senior investors who exited direct management through 1031 conversion to REIT’s and PTP’s. These are the only passive investments that qualify for the Section 199A QBI deduction.
The intent of the wage calculation is to discourage business owners from reducing their own W-2 wages as a tax avoidance strategy, and to encourage job creation by paying other W-2 employees.
The intent of the unadjusted basis calculation is to offer some deduction even for small businesses who don’t have W-2 employees but who nevertheless have made capital investments.
A business that has neither W-2 employees nor invested capital will not qualify for the QBI deduction.
Example: Sole Prop, Part-Time Landlord with no Employees and a Day Job
Suppose you have a $300,000 rental property that you are still depreciating, $80,000 W-2 income from your day job, $10,000 of Schedule D capital gains from sale of stock, and $2,000 of Schedule E net rental income. You will deduct the lesser of:
- your QBI, which is the lesser of
- 20% of $2,000 = $400, or
- 2.5% of $300,000 = $7,500.
- 20% of $70,000 = $14,000.
In this case, you will deduct $400 from your personal taxes.
Example: Full Time, Pass-Through LLC Landlord
Suppose your LLC paid $500,000 for real estate that is still being depreciated, paid $100,000 in W-2 wages to all employees in 2018 including yourself, and issued you a K-1 for additional net income equal to $80,000. You will deduct the lesser of:
- 20% of your qualified business income = 20% of $80,000 = $16,000, OR
- the greater of
- 50% of the W-2 wages that business paid = 50% of $100,000 = $50,000, OR
- 25% of the W-2 wages that business paid PLUS 2.5% of the unadjusted basis immediately after acquisition of qualified property = $25,000 + $12,500 = $37,500.
In this case, you will deduct $16,000 from your personal taxes.
Example: Landlord with a REIT
Suppose you sold most of your portfolio three years ago and operate just one last building that is fully depreciated, with no other depreciable improvements remaining, either. Your Schedule E net rental income will be $2,000. Your REIT income will be $100,000. You will deduct:
- 20% of $100,000 = $20,000, PLUS
- The lesser of
- $2,000, OR
- The greater of
- $0 W-2 wages, OR
- $0 remaining depreciable assets
In this case, the fully depreciated property eliminates the rental portion of your QBI deduction, but you will be able to deduct $20,000 from your REIT income.
The QBI deduction is available for US businesses, REIT’s, and PTP’s only. The QBI is not a credit and cannot be used to get a refund. If a business loss is carried over into a subsequent tax year, that carryover loss reduces the net income available for the QBI in that year.
Members can ask experienced landlords for advice over email and Facebook message boards, and can search our directory for accountant referrals.