Tax reform Q&A Thread 1 - Pass-through and 20% deduction

22 Replies

Colleagues and friends, 

The original GOP reform thread started by @Brandon Hall is well over 200 posts by now. This is one of the follow-up threads specifically for discussion of pass-through entities (Sch C / Sch E sole proprietorships, LLCs, partnerships, S-corps) that will enjoy a 20% deduction under the tax reform. PLEASE POST OTHER QUESTIONS IN THE OTHER TAX REFORM THREADS.

As of today, we have a consensus on several points.

1. All forms of doing business (aka business entities) EXCEPT C-corporations and trusts will be treated the same way, as pass-through entities:

  • no entity / sole proprietorship / single-member LLC using Schedule C for non-rental business
  • no entity / sole proprietorship / single-member LLC using Schedule E for rental business
  • partnerships and LLCs filing as partnerships
  • S-corporations and LLCs filing as S-corporations

2. All of them are eligible for a 20% deduction from their net profit - i.e. after all deductions

Example 1: Susan the wholesaler makes $150k in assignment fees - gross profit. She deducts $50k marketing, driving, and whatnot - resulting in $100k net profit. 20% of that amount - or $20,000 - is Susan's new "freebie" deduction.

Example 2: Brad the apartment guy collects $300k rent from his property. He deducts $150k for property taxes, mortgage interest and insurance (they are not limited in the reform!) He deducts another $50k for maintenance, repairs and depreciation. Brad is left with $100k net rental income. He also gets a 20% freebie deduction equal to $20,000.

Note: if your business or rental properties show a net loss - there is no 20% deduction. 20% of zero is zero, sorry.

3. This deduction is "under the line" - meaning it is NOT subtracted from the AGI. 

4. This deduction is per business. If you have multiple businesses - each one calculates its own deduction. They will eventually add up on your tax return.

5. This deduction is not limited as long as your total taxable income (including W2s and everything else) is under the threshold:

  • $315,000 for a jointly filing couple
  • $157,500 for everybody else

6. Once you cross the threshold, your 20% deduction becomes limited. You can choose between two ways to figure the limitation, whichever is best.

  • 50% of all W2 salaries paid by the business - or -
  • 25% of all W2 salaries plus 2.5% of initial basis of all depreciable business assets

Example 1: ABC Flip-Flopping, a one-owner S-corp, generated $650k in income (after deductions) and paid $150k in salaries, resulting in $500k net income. The 20% deduction would be $100k. However, it is limited by 50% of the $150k salaries, or $75k. Only $75,000 is deductible. The company has no assets, so it cannot benefit from the alternative limit.

Example 2: XYZ Slumlords, an LLC-partnership, owns an apartment complex that they purchased for $2.5 mil. It generates $500k net income (after all expenses and depreciation) and pays no salaries. 20% deduction would be $100k. Since there're no salaries - we have to use 2.5% of depreciable basis. Let's say that $0.5 mil was allocated to land - which leaves $2 mil depreciable basis. 2.5% of $2 mil is $50k - which is our limit. Only $50,000 is deductible.

7. If you're a "service business" AND over the threshold mentioned in #5 above - then your 20% deduction gets phased out and completely disappears at:

  • $415,000 for a jointly filing couple
  • $207,500 for everybody else

The definition of service business is "where the principal asset of the business is the reputation or skill of 1 or more of its employees" - which is not totally clear. It looks like Realtors and brokers are considered service businesses.

There're lots of questions left, and nobody has all the answers. We all expect more rules from the IRS that will change the game. Meanwhile - let's debate it here. As long as it's on topic, please. There are other threads for other tax reform topics.

I own 2 rental in my personal name but I have tenants sent rent payment to my LLC property management company. Will I qualify for the 20% deduction?

Also, I currently take 100% of my property management income as personal wages for my 1 employee LLC. Does this allow me to take the larger 50% of W2 wage benefit instead of the 20% deduction?

@Joe R.

Unfortunately, no. 50% of W2 is not "a larger option." It is a limitation on the 20% deduction. Since you remaining net profit is $0, your 20% is $0, and 50% of W2 does not matter. 

You could extract some 20% deduction by lowering your W2, but I would not do it without discussing with a tax expert first.

@Michael Plaks @Brandon Hall Any idea if income from REITS qualifies for the 20% deduction? The Wall Street Journal thinks yes:

https://www.wsj.com/articles/reit-investors-to-gai...

However when I scanned the bill for reit I saw this:

‘‘(c) QUALIFIED BUSINESS INCOME.—For purposes

4 of this section—

5 ‘‘(1) IN GENERAL.—The term ‘qualified busi6

ness income’ means, for any taxable year, the net

7 amount of qualified items of income, gain, deduc8

tion, and loss with respect to any qualified trade or

9 business of the taxpayer. Such term shall not include

10 any qualified REIT dividends, qualified cooperative

11 dividends, or qualified publicly traded partnership

12 income.

@Michael Plaks

So if I pay myself only 25% of business income as a salary, then can I take a 20% deduction on the remaining 75% of business income???

@Michael Plaks

If I pay myself 100% profits at year end as a member of the LLC instead of a W2 as an employee monthly do I then qualify for the 20% deduction on the income?

Thanks for providing all the info @Michael Plaks .  Just to confirm I'm reading your post correctly, does the line in your post that reads "no entity / sole proprietorship / single-member LLC using Schedule E for rental business" mean that no entity is required to get the 20% deduction? In other words, a landlord operating without a LLC will still get a 20% deduction on their net passive rental income profit?

Seems almost too good to be true, but that's great if that's how it will work.

And also to be clear, from my understanding, the 9% domestic production deduction will go away, so for those of us that use that, this is really an 11% bump.

@Jeff Kehl - sorry, I do not know the answer on REITs. Will have to research.

@Joe R. - correct. If you pay 25% as salary, you qualify for 20% on the remaining 75%. And if you pay $0 salary - you qualify for 20% deduction on the entire profit, as long as you're under the threshold. However, you still must comply with the reasonable salary requirement for S-corps. 

The 20% deduction creates an additional incentive to minimize S-corp salary, on top of the incentive to reduce SE tax. The IRS is likely to address this unintentional consequence, especially since the entire Sch C income qualifies for 20% - which creates a disparity in treatment. Stay tuned for more IRS rules and more understanding from us, tax guys.

LLC is normally disregarded, reporting 100% on Schedule C and eligible for a 20% deduction on the entire profit. No need for the end-of-year distributions.

@Kyle J. - correct. Landlord without an LLC gets the 20% on his net income. It does sound too good to be true, I agree. But it is the fundamental feature of the tax reform: all forms of business except C-corps are treated as pass-throughs. Can I promise the IRS will not alter these rules? No, I cannot.

@Chase Gochnauer - yes, DPAD is out. You can indeed consider the 20% deduction as a replacement. 

@Brandon Hall I report my rental income on my Schedule E. My accountant, and some articles, say I may not be able to claim the 20% deduction on my rental income because it is passive income, and I don't pass the test of a Section 162 "trade or business". The forbes article also articulates this.

ttps://www.forbes.com/sites/anthonynitti/2017/12/26/tax-geek-tuesday-making-sense-of-the-new-20-qualified-business-income-deduction/#c98b7df44fda

"Section 199A, however, is in its infancy. We don't have regulations. We only have a blanket reference to a "trade or business," which without further clarity, I would think HAS to be interpreted to mean a Section 162 trade or business. Which means, yes, certain rental activities may not meet this definition -- for example, a triple-net lease where the owner has almost no regular involvement -- thereby denying the owner a 20% deduction."

Can you clarify if someone who owns single family rental properties and reports passive income on a schedule E will qualify for this 20% deduction? If the answer is yes, how are you interpreting this issue with Section 162?

I haven't seen any mention of husband and wife qualified joint venture where 1 schedule E and 2 schedule C's are filed, married filing jointly.  This would be a residential real estate rental business.  I presume any business filing schedule C is entitled to the 20% deduction based on income guidelines. I wonder on which schedule or form this 20% will be deducted.  Thank you,  Mark

I am a landlord with a 6fam, 3fam and 5 condo units. All are set up in seperate LLC's. I do all of the management work myself and don't have any employees. I get about $215k per year in gross rents. About $100k is income. About $85k of this is cash flow. I believe my taxable income is about $60k.

As a passive landlord who passes rental income through but works as the sole manager of the rentals I am hoping that I am eligible for the 20% deduction.  Can anyone confirm?

@Terry Fox   I'm interested to hear what my colleagues think. My impression is that, strictly from the bill, this provision is debatable and will be eventually (hopefully, sooner rather than later) clarified in Regulations. Until then, I choose to interpret it as all Schedule Es qualify. You know - ask for forgiveness, not permission.

@Mark Zingale   There is nothing in the law that would indicate a different treatment for h/w QJVs. They are not, in fact, a different business structure, just a designation for SE Tax purposes. Until the IRS says otherwise, I assume they are treated just like all other pass-throughs and are eligible for the 20% deduction.

@Daniel McFadden   Nobody can "confirm" assertively at this early point. But our current understanding (I dare to speak on behalf of my peers) is that yes, you are eligible.

I have a question, I am planning the living trust now, and I plan to transfer the Rental properties from my name to the living trust, my question is: for the tax point of view, the rental properties under my name vs under the Trust name, is there any difference? I mean do I still can deduct all expenses, repairs, mortgage Interests. property tax, and the freebie 20% of the net income?

Thanks

Originally posted by @Gary Li :

I have a question, I am planning the living trust now, and I plan to transfer the Rental properties from my name to the living trust, my question is: for the tax point of view, the rental properties under my name vs under the Trust name, is there any difference? I mean do I still can deduct all expenses, repairs, mortgage Interests. property tax, and the freebie 20% of the net income?

Thanks

 No change for taxes

I have a question regarding renting out a room in your primary residence.  Say that I want to rent out one of my rooms, and this generates 10,000 in income each year (net of depreciation and other expenses).  Would I be allowed to apply this 20% deduction on this 10,000 and effectively only pay the taxes on the 8,000 remaining?

@Ryan Ouderkirk

Renting one room for $10k after all expenses? Damn, I may need to move into your neighborhood. 

As to your question, nobody has a firm answer at this point. The law is not clear, and we tax pros simply guess on how it will be applied. We hope that the answer is yes, but we don't know for sure.

First BP post so please be kind to the newb.

I have been reading and reading about how to move my FLIP property to my LLC for the sole reason of the 20% deduction...hey I'm being positive that I will turn a profit...why not.

Being that I have a conventional loan, moving title to the LLC looks to be difficult at best.

In this thread, it was mentioned that rental income may be eligible for the 20%  deduction even if the property is not held by a business entity.

What are the thoughts on flip income on a personally held property and the 20%?

Much thanks.

RT

@Michael Plaks @Jeff Kehl

I have been through the weeds on this provision in particular. As Michael said, there is no real guidance in tax reform. Although this provision and the new interest limitation under section 163(j) are both high priority for treasury to issue guidance, which is not expected until next year.

IRC Section 199A(b)(1)(B) includes 20% of Qualified REIT Dividends - a defined term, which excludes section 857(b)(3) capital gain dividends and section 1(h)(11) qualified dividends - in the definition of “combined qualified business income amount”. Assuming this is the appropriate deduction amount (i.e you are not limited under section 199A(a)(1)(B) for taxable income in excess of net capital gains and qualified cooperative dividends) you get the 20% deduction for these qualified REIT dividends. Furthermore, this amount is not subject to the limitations based on W-2 wages and/or unadjusted basis of all qualified property found in section 199A(b)(2).

@Ryan Thompson

Hi, neighbor! :)

You do not need an LLC to claim the 20% deduction for flipping. Do the deal in your own name.

And stop reading random articles from non-experts, you can drive yourself crazy. And broke.

@Andrew Reyes thanks, it made sense to me that REITS would get the 20% deduction since they are not really any different than any other real estate investment. But sense and the tax code don't necessarily go hand in hand...

If true, REITS are theoretically a bit more valuable than they were before tax reform but they've done nothing but fall in price this year because of rising interest rates...

Originally posted by @Michael Plaks :

@Ryan Thompson

Hi, neighbor! :)

You do not need an LLC to claim the 20% deduction for flipping. Do the deal in your own name.

And stop reading random articles from non-experts, you can drive yourself crazy. And broke.

 Awesome.  Thank you.

Learning the industry is tough enough.  Learning tax code is a whole other league.

One more rookie question along similar lines.  Let's use this example.

I leave the house in my name, no LLC, as you mentioned. I sell the house and "net" $40k.

However, I spent $20k in repairs, etc. BUT I did so with my LLC. Let's assume I did nothing else with the LLC.

Since the LLC is a pass through, do those expenses land in the same spot as my $40k "profit" yielding a 20k profit, when tax time comes?

I realize I could just pay the expenses with my personal funds but I would really like to keep them as separate as possible. And I already have the LLC and associated business accounts.

I hope this is not too dumb of a question.

Thanks and have a great weekend!

RT

@Ryan Thompson

Short answer to your example - yes.

Longer answer: your LLC will be completely ignored by Uncle Sam. Everything done by the LLC is considered as done by you.

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