Untangling tax reform: final section 199A regulations

The IRS recently released final section 199A regulations for the 20 percent pass-through deduction enacted under the Tax Cuts and Jobs Act (TCJA). This deduction provides a break to business owners who pay the related income taxes on their respective returns, similar to the relief for corporations that reduced the corporate rate to 21 percent.

For taxable years beginning after Dec. 31, 2017, and before Jan. 1, 2026, noncorporate taxpayers (individuals, trusts and estates) may take a deduction of up to 20 percent of qualified business income (QBI) from partnerships, S corporations and sole proprietorships, plus 20 percent of qualified REIT dividends and publicly traded partnership income. For individual taxpayers in the maximum bracket, if the deduction is allowed at the full 20 percent, it effectively reduces their tax rate to 29.6 percent. This Tax Alert discusses the key elements of the final regulations.

Key takeaways

• The regulations provide a safe harbor for rental real estate to be treated as a trade or business solely for purposes of section 199A. See our previous Tax Alert on this issue.
• They allow for an increase for the purchase price of a partnership interest attributable to the appreciation of such property as part of the qualified property amount.
• The regulations permit aggregation at the entity level, in addition to aggregation at the individual level. The proposed regulations only allowed aggregation at the individual level.

Definition of a trade or business for section 199A purposes

In order to be eligible for the 20 percent QBI deduction, a taxpayer’s activities must first rise to the level of a “trade or business.” The new regulations do not define trade or business but generally rely on existing case law. In short, the taxpayer must demonstrate, based on all the facts and circumstances, that they are involved in activity on a regular, continuous and substantial basis with the primary purpose of making a profit.

• Self-rentals (where the taxpayer rents or leases its real estate or other assets to its operating business) will be treated as a trade or business if the rental is to a trade or business conducted by the individual or to a commonly controlled pass-through entity.