The U.S. tax code may come across as dull and unexciting. Yet, recent developments have paved the way for businesses to save and channel substantial tax-free sums into their operations. IRC 199A, the Qualified Business Income Deduction [QBID], is a ground-breaking change to the tax code. U.S. pass-through or sole-proprietorships offering a "qualified trade or business" can exclude the first 20% of their net taxable income from taxation, dramatically reducing their tax burden.
To grasp the Qualified Business Income Deduction, it's essential to understand the intent behind its creation. The legislation was designed to benefit retirees and real estate investors primarily. The Tax Cuts & Jobs Act [TCJA] limits state and local property tax deductions, inadvertently affecting wealthy individuals and genuine estate professionals.
The TCJA created the QBID, a significant tax break for qualifying taxpayers to address this. This legislation benefits real estate professionals due to a safe harbor rule detailed in IRS Notice 2019-07. Although there are several requirements to meet, the potential benefits of the QBID are significant and worth exploring.
In essence, a qualifying business can deduct the lower of two calculations from their taxable income, with both focused on excluding 20% of that qualified income. This deduction benefits firms looking to maximize their profit margins and strategically reinvest funds into the business.
Moreover, real estate professionals can qualify for this benefit by investing in a Real Estate Investment Trust [REIT] or securing income from a Publicly Traded Partnership [PTP]. This aspect of QBID offers an expanded window of opportunity for real estate professionals, making investments in property and partnerships even more attractive due to the possibility of significant tax relief.
Eligibility for the QBI Deduction bears significant restrictions. The taxpayer cannot be an employee, the entity cannot be a C-Corp, and the entity cannot be a specified service trade or business (SSTBs). SSTBs encompass health, law, accounting, actuarial science, performing arts, consulting, athletics, and more. Taxpayers can receive QBID benefits by filing jointly with a spouse despite these restrictions.
Generally speaking, the first 20% of net income generated from many trades and businesses is tax-excluded if they qualify. The challenge is not falling into the SSTB zone. This financial powerhouse was primarily created for real estate management services.
This can include income from a REIT or even shares of a publicly traded partnership that qualify. Granted, one is active income, and the other is passive income, but the IRS groups them, for the most part, when figuring out your allocable deduction.
Achieving a Qualified Business Income Deduction requires a combination of strategic decisions and careful adherence to specific regulations. Here are some of the best tips on how to navigate this process and successfully claim your deduction:
Attain Real Estate Professional Status (RPS): You don't need to become a licensed realtor to achieve this status. You just need to meet the requisite business service criteria.
Stay actively engaged: Actively participate in the real estate management business and maintain a detailed log of your working hours. This is important to validate that you've spent the necessary time actively managing the property.
Utilize the BRRRR Method: This acronym is for "Buy, Renovate, Rent, Refinance, Repeat." It harnesses the power of compounded growth and can significantly bolster your real estate portfolio.
Hire a 1031 exchange specialist: The rules surrounding 1031 exchanges can be complex. Hiring a professional to navigate through this process can save you from costly mistakes.
Network extensively: Contact individuals, business owners, lawyers, and others closely allied with real estate transactions. A strong network can provide valuable leads and partnerships.
While these tips can boost your eligibility for QBID, consult a qualified tax professional or financial advisor to ensure you remain compliant with ever-evolving tax laws and regulations.
Calculating your Qualified Business Income Deduction is easy. According to the IRS, the deduction is the lesser of:
20% of the taxpayer’s QBI (QBI Component), 20% of the taxpayer’s qualified REIT dividends, and qualified PTP income (REIT/PTP Component).
20% of the taxpayer’s taxable income after subtracting any net capital gain.
This is a relatively straightforward Internal Revenue Service formula. Most people will fall into the second category if they fail to use a 1031 exchange, which avoids capital gains taxation issues.
The Qualified Business Income Deduction is a potent tool for reducing a qualifying taxpayer's tax liability. While it's particularly suited to real estate professionals, it can also benefit retirees and stay-at-home parents. To maximize the QBI deduction, consider speaking with a knowledgeable business expert, such as an attorney, financial advisor, or consultant.
Brad Biren is a proud autistic professional, writer, and advocate for neurodiverse people within the business community. He is a tax & elder law attorney with a passion for estate planning and crisis Medicaid planning. His favorite part of his job is Special Needs Planning — a financial and legal roadmap to help families of diversely-abled people cultivate greater opportunities for their loved ones. Biren also assists startups and nonprofits with optimization challenges through his innovative and novel use of synergies between tax, law, finance, science, and technology.