Under the “Tax Cuts and Jobs Act” of 2017, eligible small business owners are entitled to a deduction of up to 20 percent of qualified business income (QBI).
Under the “Tax Cuts and Jobs Act” of 2017, eligible small business owners are entitled to a deduction of up to 20 percent of qualified business income (QBI). However, the statute, as originally drafted, seemed to exclude real estate agents from this category if they earned more than $157,500 as single filers or $315,000 as joint filers. This was a huge disappointment to the local industry.
However, the final IRS enforcement guidelines, published just before tax season, greatly expanded the applicability of the QBI deduction. Now most real estate agents, regardless of income, will earn some form of additional deduction.
The QBI deduction was one of the biggest and most attractive parts of the 2017 tax reform law. But it was technically not supposed to apply to the “personal service industries,” including the real estate sales industry. A carve out exception was made at the last minute for real estate agents making beneath certain thresholds. But it was generally understood that agents making more than the stated thresholds would be excluded from taking QBI deductions.
Immediately prior to the start of the tax season, the IRS changed course and reinterpreted the statute so that one’s status as a real estate agent is no longer a barrier. The earning thresholds still apply, but they no longer prevent a deduction. Rather, they simply change the math for high earning agents.
What This Means
Agents making less than $157,500 in commissions and filing single or agents making less than $315,000 in commissions and filing jointly get a general 20% deduction. Obviously, the deduction applies to taxable income and excludes income earned outside the independent contractor space (like additional wages and tips from a part-time job).
Agents making more than $157,500 in commissions and filing single or agents making more than $315,000 in commissions and filing jointly may get a deduction as well provided they own property or employ an assistant for their business. This deduction is generally worth the LESSER of 20% their total commissions and the GREATER of either 1) 50% their wage expense or 2) 25% their wage expense plus 2.5% the original cost of all property (cars, buildings, hardware, ext.) they own and use for business.
That may seem sound hard to understand, but it doesn’t have to be. If a single agent makes $500,000 a year in commissions, and she pays an assistant $50,000 a year in wages, and she owns a car and a copier originally worth a combined $150,000 to conduct her business, then she can now expect an additional deduction worth approximately $25,000. The math is simple: her QBI is $100k (20% of $500k). But she makes too much money, so she only gets to deduct her QBI if it is less than half her wage expense or a quarter her wage expense plus 2.5% of the business property she owns. Here, 25% the amount of her total wages paid ($12,500) plus 2.5% of the cost of property she owns for business ($3,750) is $16,250. Furthermore, 50% her total wages paid is $25,000. So, she won’t get the $100k QBI deduction because it is higher than both equations, but she will get a deduction she otherwise might not have been entitled to get. Here, she gets to deduct an additional $25k (half her total wage expense), because that amount is greater than the value of 25% her wage expense plus 2.5% her business property.
Note, if the same agent owns significantly more property, or pays significantly more wages, she could have a much larger deduction and could conceivably get the full QBI. However, if the same agent with the same production has no business property or employees at all, she likely won’t get a deduction because the lesser of her QBI and nothing is…nothing. But even high producing agents with no employees and very limited business property, perhaps nothing more than a car they use for work, should now be able to deduct an additional 2.5% the car’s original value according to the IRS’s final rule.
Obviously, how the new tax law works specifically for you, and the question of whether or not it is a net benefit, hinges on numerous variables that change person to person. But these recent changes in the IRS’s interpretation and enforcement of the law are a clear win for everyone in the industry.
NAR has prepared a detailed analysis of the tax law, including five good examples of how real estate professionals might be able to take advantage of this deduction. For more information, please refer to NAR’s website.
Disclaimer: This information is provided generally for purposes of discussion. No warranty is made to its accurateness and it is not intended to provide specific tax or legal advice to any person or group. Readers should consult their own tax adviser for appropriate advice about their specific circumstances.