Category: Tax Planning and Preparation
Author: Derek Northup
Most of what we have heard to this point relating to the new 20 percent Sec 199A QBI deduction1 has centered on taxpayers with operating businesses. However, there is also a QBI deduction available for real estate investment trust (REIT) dividends.
Distributions from REITs are usually some combination of return of capital, capital gain distribution and ordinary dividend. Ordinary REIT dividends are taxed at ordinary rates as opposed to the lower qualified dividend rates.2 The new Sec 199A rules allow a taxpayer to deduct 20 percent of the dividend amount against itself. For example, if a taxpayer has REIT dividends of $10,000, they will receive a deduction of $2,000. This is pretty simple if the taxpayer has standard investment income and REIT dividends. It becomes more complex if the taxpayer also invests in publicly traded partnerships (PTPs).3
If a taxpayer also invests in publicly traded partnerships, their REIT dividends must be netted with their income/loss from those PTPs first. Once the income is netted, the 20 percent QBI deduction is calculated. For example, if you have the same $10,000 in REIT dividends, but you also invest in PTPs that have combined net losses of $5,000 for the year, you must net those losses against the REIT dividends, then calculate the 20 percent deduction. Your net income from REITs and PTPs is $5,000, so your QBI deduction is $1,000.
You could therefore have a situation where your PTP losses are greater than your REIT dividends, and you would receive no QBI deduction. In that scenario, that net loss is carried forward and used the following year when determining if you will receive a QBI deduction against your REIT income. The other downside to this netting is you may lose your entire QBI deduction, and since losses from PTPs are suspended, you pay tax on the full REIT dividend with no benefit from the PTP losses or QBI deduction. Additionally, there is no interplay between the QBI calculation for REIT dividends and ordinary income. The two calculations are completely separate.
The REIT deduction is beneficial especially when compared to a direct passive investment in real estate. If you are directly invested in real estate through a partnership, the income earned is not eligible for the QBI deduction. Therefore, you will always pay at your full marginal rate. Assuming you had no PTP investments, the same income from a REIT would benefit from the 20 percent deduction.
In summary, there is a benefit to investing in REITs under the new tax law, but it gets more complicated if you have a more complex investing strategy that includes PTPs. If you have additional questions, please reach out to your Exencial advisor or feel free to contact me directly at dnorthup@ExencialWealth.com.
1. IRS – Tax Cuts and Jobs Act, Provision
11011 Section 199A - Qualified Business Income Deduction FAQs
2. The Motley Fool – What is the difference between qualified dividends and ordinary dividends?
3. Investopedia – Publicly Traded Partnership (PTP)
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