United States: Real Estate Structures Enabling Investors To Use The Section 199A Qualified Business Income Deduction

On December 22, 2017, H.R.1, commonly referred to as the Tax Cuts and Jobs Act, was signed into law. One of the most significant changes affecting the real estate industry is the new 20 percent business income deduction available to pass-through entities and real estate investment trusts. This article provides a brief analysis of the implications of the deduction and offers insights into structuring your real estate investment vehicle to reduce the income tax imposed on rentals and other business income.


The 20 percent deduction is available to non-corporate taxpayers for their qualified business income. REIT shareholders are eligible for the deduction with respect to dividends paid by the REIT other than capital gain dividends. As pass-through entities and REITs are typically the vehicles of choice for real estate transactions in the United States, the QBI deduction represents a significant opportunity for the industry.

QBI is the net amount of qualified items of income, gain, deduction and loss, to the extent such items are effectively connected with a qualified domestic trade or business, which generally includes real estate businesses. Interest, dividends (other than REIT dividends), capital gains, and other types of investment income are not treated as QBI.

As a result of the QBI deduction, the top marginal federal tax rate on QBI is potentially reduced from 37 percent to 29.6 percent.


The QBI deduction is subject to several limitations. The Tax Act generally limits the deduction attributable to a particular pass-through business to the greater of: (i) 50 percent of the individual's W-2 wages paid with respect to the qualified trade or business, or (ii) the sum of 25 percent of such W-2 wages plus 2.5 percent of the tax basis, immediately after its acquisition, of the business's qualified property (i.e., tangible property subject to depreciation or held by the business for less than 10 years and used, during the taxable year, to produce QBI).

Primarily due to the W-2 wage limitation, the full benefit of the QBI deduction is likely to be out of reach for many real estate businesses since they do not employ workers directly. Rather, these entities typically engage a third-party or related manager that employs the workers. In this circumstance, the QBI deduction is effectively limited to 2.5 percent of the purchase price of the depreciable real estate.

Another limitation is that the QBI Deduction is not a permanent fixture in the tax code and is set to expire on December 31, 2025.


In light of the QBI deduction limitations, we discuss below two possible restructuring techniques real estate businesses may implement to increase the QBI deduction available to the business's owners.

Increasing Direct Employment as a Means to Increase the QBI Deduction

A real estate holding company may consider taking steps to increase its W-2 wages by employing workers directly. Companies can also work with their accountants to explore whether commonly-owned companies or partnerships that are currently set-up as separate entities for tax purposes can be consolidated and reorganized such that their activities are more likely to be viewed as a single integrated business in an effort to put income and W-2 wages in the same business. This analysis will necessarily vary on a case-by-case basis.

The owners and managers of related entities will naturally have chosen to operate their businesses in separate legal entities for good reason (to avoid liability for employee claims and the obligation to maintain workers compensation insurance, for instance). While the increased risks associated with holding assets and liabilities under the umbrella of a single entity potentially make such restructuring undesirable, it may be possible to ring-fence certain liabilities in a limited liability company or limited partnership that is wholly owned by, and treated for tax purposes as part of, another entity that directly or indirectly owns the real estate.

Private REITs: QBI Deductions without Wage or Basis Limitations, but Beware of Higher Administrative Costs and Capital Reserve Limitations

A second option is to use a private REIT in the same way one would use an LLC as the real estate holding vehicle. REITs are generally not taxed at the corporate level, but in effect, are treated like quasi pass-through entities as at least 90 percent of a REIT's net income must be distributed annually to its shareholders, who are then taxed at their respective individual tax rates on such dividend distributions. Under the Tax Act, REIT shareholders may take advantage of the QBI deduction, treating dividends attributable to operating income ("ordinary REIT dividends") as QBI. Importantly, REIT shareholders are not subject to the wage or basis limitations discussed above, allowing them to more easily obtain the full benefit of the QBI deduction.

However, there are certain drawbacks that should be considered before making the decision to structure as a private REIT. Namely, the costs associated with forming a REIT and maintaining its tax status are typically significantly higher when compared to an LLC that is taxed like a partnership, for example.

The most costly of the formation requirements is the 100 shareholder rule. In order to qualify as a REIT, REITs must have a minimum of 100 shareholders by around the thirtieth day of their second taxable year. To accomplish this, private REITs will often look to a third-party private placement agent to locate a sufficient number of shareholders, usually preferred shareholders, and to provide administrative support related to those shareholders (e.g., issuing dividend checks, fulfilling IRS reporting requirements, etc.). For its shareholder placement services, agents will charge a number of fees. To illustrate, the proceeds from the issuance of shares having a face value of $1,000 to 115 preferred shareholders will be $115,000. For its administrative services, the agent will generally charge a funding fee of $11,500 plus an initial fee of $1,000, and annual fees between $5,000 and $9,000. Thus, the cost in the first year may exceed $20,000, and there may be recurring annual costs of up to $9,000.

In addition to the 100 shareholder requirement, REITs are also subject to other requirements in order to maintain their preferential tax status. Principal among these are the quarterly asset test and annual income test. The asset test requires that at least 75 percent of a REIT's assets consist of real estate assets (land, buildings, and other improvements), cash, shares of other REITs, debt securities of public REITs, and government securities. The first prong of the two-pronged income test requires that 75 percent of a REIT's gross income be derived from certain real estate related sources (including rents from real property, gains from the sale of real property and interest income from debt secured by real property). The second prong requires that 95 percent of a REIT's gross income be derived from the sources qualifying under the first prong, plus interest income, dividend income and gain from the sale or disposition of stocks and securities. The costs of complying with these tests, primarily stemming from audit and tax return preparation fees, will vary, but can exceed $75,000 each year.

Further, the annual distribution requirement poses a potentially significant burden for certain types of projects, namely redevelopment and other project types where significant ongoing capital expenditures are anticipated and there is positive cash flow that is reinvested in the project.

REITs generally are unable to accrue capital reserves to meet upcoming needs without the imposition of tax. Because of this, where a project is producing significant net cash flows which would otherwise be held for on-going capital needs, the private REIT structure may not be more efficient than a partnership structure.

Accordingly, where a project is large enough and currently stabilized, a REIT structure has the potential to result in significant tax savings.

The decision whether or not to restructure a real estate business to take advantage of the QBI deduction will necessarily call for a fact-specific inquiry into the needs and demands of both the project and its investors. For additional information relating to the impact of the QBI deduction in your particular circumstances, or any other real estate or tax question or concern, please contact any of the authors mentioned below.

Originally published by Real Estate Finance & Investment.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Similar Articles
Relevancy Powered by MondaqAI
In association with
Related Topics
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Mondaq Sign Up
Gain free access to lawyers expertise from more than 250 countries.
Email Address
Company Name
Confirm Password
Mondaq Newsalert
Select Topics
Select Regions
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions