Tax Treatment of Pass-Through Entities

Educational Article Series for Owners of Investment Real Estate

Austin Bowlin, CPA | Real Estate Transition Solutions, LLC

The Trump administration’s largest legislative victory of 2017 came to fruition days before the end of the year. The “Tax Cuts and Jobs Act of 2017” is receiving both applaud and outcry as attorneys, accountants, business owners, and individuals digest what the impact will be for both themselves and their clients.

One component of the act that has received significant attention and may have implications for the RHAWA community is the addition of a deduction for pass-through entities.

A bit of background: historically owners of pass-through entities (LLCs, S-Corps, Sole Proprietorships, etc.) have generally benefited from lower taxes than C-Corps. However, with the reduction in the corporate tax rate from 39% to 21%, the beneficial treatment of pass-through entities becomes less clear. In response, Congress decided to provide a deduction for pass-through entities of up to 20% of “Qualified Business Income” or QBI (subject to a threshold) — the remainder of which would be taxed at the new, lower, individual rate. Note, QBI does not include any investment related income such as dividends or capital gains — nor will those sources of income qualify for a deduction. The threshold amount is relatively high at $157,500 for individual taxpayers and $315,000 for married taxpayers. Therefore, if you are married and expect to earn $80,000 of QBI, then $16,000 would be deducted with the remainder taxed at your personal rate.

The public outcry that may have come to your attention is due to the fact that President Trump tucked in last-minute legislation that benefits his own real estate businesses and others who own high-value depreciable assets. Originally, the phase-out of the deduction could only be avoided if the amount of the deduction above the threshold QBI is less than 50% of W2 wages paid out by the entity during the year. The goal here was to incentivize and reward pass-through entities that employ workers and pay wages, however, most owners of investment real estate do not employ many, if any, employees, so this would not apply. A second calculation method was included at the 11th hour that is advantageous to large real estate owners. The second method allows for the deduction to be capped at 25% of W2 wages paid out plus 2.5% of the original basis of depreciable property owned by the entity. The second method allows for a hefty deduction for owners of high-value depreciable property such as apartment buildings, office buildings, airplanes, and machinery. A case can be made that investment in depreciable assets should be rewarded just like wages paid to employees, however support of this reasoning is no where near unanimous.

While most individual investment real estate owners do not have “Qualified Business Income” in excess of the $157,500 or $315,000 thresholds, it is worth noting that you will likely see a reduction in your 2018 tax bill compared to that of previous years. Furthermore, with the preservation of 1031 exchanges for real estate, there continues to be flexibility in re-positioning assets so that they fit with your financial and lifestyle objectives on a tax-deferred basis.

Real Estate Transition Solutions, LLC, provides exit strategy analysis, execution, income and equity replacement options for investment property owners. If you have questions relating to your investment property ownership, please email: RWBowlin@RE-Transition.com or call (206) 755–7068.

Please note this article is for informational purposes only and does not constitute tax or legal advice. Your personal advisor should be consulted when making any tax or legal decisions.