Late last week, the U.S. Treasury Department and Internal Revenue Service issued final regulations regarding the new 20 percent deduction on qualified business income.
Americans are now preparing for the 2018 tax filing season, and while real estate professionals understood that the new deduction offered benefits, the specific extent of those benefits was unclear pending the government’s final regulations.
Friday’s ruling from Treasury and the IRS, however, “signaled a significant victory for the real estate industry and for many of the National Association of Realtors®‘ (NAR) 1.3 million members,” according to NAR.
“Friday’s ruling is a result of several months of advocacy and collaboration between NAR, our members and the administration,” says NAR President John Smaby. “These final guidelines will allow real estate professionals to benefit from the Section 199A 20 percent pass-through deduction, a move that will empower Realtors to expand their operations and provide improved services to consumers and potential homebuyers across the country.”
Smaby says NAR is “grateful for the openness and transparency encouraged by Treasury and the IRS, and we thank them for their hard work to ensure the real estate community was heard throughout this rulemaking process.”
A central component of the new tax law is a reduction of the corporate tax rate – from 35 to 21 percent. However, since nine out of 10 American businesses are structured as pass-through entities rather than corporations, the Section 199A provision provides critical tax deductions for small businesses and self-employed independent contractors, which includes many real estate professionals.
Within the 247-page rule issued last Friday, three major provisions for real estate professionals stood out as critical victories for members, according to NAR:
1. Impacted real estate professionals
Most importantly, the regulation clarifies that all real estate agents and brokers who are not employees but operate as sole proprietors or owners of partnerships, S corporations or limited liability companies are eligible for the new deduction, which can be as high as 20 percent. This includes those whose income exceeds the threshold of $157,500 for single filers and $315,000 for those filing a joint return.
2. Rules to follow for rentals
The rule simplifies the process rental-real estate property owners must follow to claim the new deduction. As written in the Tax Cuts and Jobs Act, only income from a “trade or business” qualifies for the 20 percent write-off. However, this distinction was not clearly defined by Congress when crafting the law, and various court rulings and prior IRS guidance have caused confusion among tax professionals. NAR strongly urged Treasury and the IRS to simplify the rules in order to give millions of rental real estate owners clarity, and Friday’s final regulations included a bright-line safe harbor test requiring at least 250 hours per year spent on maintaining and repairing property, collecting rent, paying expenses and conducting other typical landlord activities.
3. 1031 exchanges
Within the proposed regulation released last August, those who had exchanged one parcel of real estate under Section 1031 for another parcel were unfairly denied deduction eligibility. However, NAR and multiple additional trade groups concerned with commercial real estate highlighted this shortcoming. As a result, Treasury and the IRS recognized the initial ruling was misguided and corrected the policy in Friday’s final guidance.
“NAR maintained consistent and coordinated communication with Treasury and the IRS throughout this rulemaking process,” says Shannon McGahn, NAR senior vice president of government affairs. “The finalized ruling, which represents a tremendous win for real estate professionals across the country, is a direct result of that engagement. We are thrilled to see our members emerge from this process so favorably, and we thank Treasury and the IRS for all of their hard work in ensuring consistency and clarity within these policies as America’s 1.3 million Realtors begin filing their 2018 tax returns in the coming weeks.”
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