By a slim margin of 51-48, the Senate passed the tax reform bill on December 19th. Included among the provisions is a hidden benefit for real estate developers. The bill contains a 20% deduction for qualified business income (QBI) from pass-through entities under new Code §199A. QBI generally is defined as all domestic business income other than certain investment income, investment interest, and capital gains. Until the final conference agreement, it was unclear whether this provision would benefit real estate developers, because the Senate version only applied a wage test to determine the limitation on the deduction. A “capital” test was added to the final agreement, which will allow real estate investors to take advantage of some or all of the new 20% deduction.
For those with taxable income greater than $415,000, the deduction is limited to the greater of 50% of W-2 wages from the pass-through entity or the sum of 25% of W-2 wages, plus 2.5% of the unadjusted basis of all qualified property immediately after acquisition. “Qualified property” generally is defined as tangible property subject to depreciation under §167 (e.g., office buildings, shopping centers, residential rental property, etc.) used in the production of QBI.
For example, if a building cost $1 million and there is no W-2 wage income from a real estate venture, the deduction equals the lesser of “qualified business income” (i.e., real estate income-interest-depreciation) or $25,000 (2.5% of $1 million).
I will have more observations on the new tax bill in the coming days and weeks. Stay tuned!