Favorable UBIA Rules Under IRC Sec. 199A for Real Estate Industry
One of the most talked about items for the real estate industry in the Tax Cuts and Jobs Act has been the qualified business income (“QBI”) deduction under IRC Sec. 199A. Taxpayers with QBI who have taxable income above the thresholds of $157,500 ($315,000 for joint filers) are allowed a deduction of 20% of QBI subject to the lesser of --
- Greater of:
- 50% of W-2 wages or
- 25% of W-2 wages, plus 2.5% of the unadjusted basis immediately after acquisition (“UBIA”) of all “qualified property”
- 20% of taxable income not including net capital gain
The UBIA limitation will allow many taxpayers with real estate investments, which often have minimal or no W-2 wages, to take advantage of some or all of the QBI deduction. The unadjusted basis will not be reduced by IRC Sec. 179 expensing, bonus depreciation or regular depreciation.
Qualified property includes depreciable tangible property under IRC Sec. 167(a), which is:
- Available for use in a trade or business at the end of the tax year,
- Used during the year in the production of QBI, and
- The depreciable period of which has not ended before the end of the tax year.
The depreciable period is defined under IRC Sec. 199A(b)(6)(B) as the period beginning on the date the property was first placed in service by the taxpayer and ending on the later of the date that is ten years after such date or the last day of the last full year in the applicable recovery period that would apply to the property under IRC Sec. 168 (determined without regard to the alternative depreciation system (“ADS”) under IRC Sec. 168(g)).
Furniture placed in service in June, 2010 with a seven-year life would be included in the UBIA calculation for all calendar-year taxpayers through the 2019 tax year. In 2020, the ten-year anniversary would occur before year-end, so it is not includible for UBIA purposes.
A building placed in service in 2000 with a 39-year life that is sold on December 30, 2018 would not be includible in the UBIA calculation for 2018 even though it was in service for all but the last day of the year. If the building was not sold and assuming IRC Sec. 199A does not sunset, then the building could be used in the UBIA computation through the 2038 calendar year.
The UBIA of qualified property is generally defined as the basis on the placed in service date of that property. For example --
- Purchase – cost under IRC Sec. 1012.
- Contribution to a corporation in an IRC Sec. 351 transaction – carryover basis under IRC Sec. 362.
- Distribution from a corporation – fair market value (“FMV”) under IRC Sec. 301.
- Contribution to a partnership – carryover basis under IRC Sec. 723.
- Non-liquidating distribution from a partnership to a partner – adjusted basis to the partnership immediately before the distribution under IRC Sec. 732 (not to exceed the adjusted basis of such partner’s interest in the partnership reduced by any money distributed in the same transaction).
In addition, under Treas. Reg. Sec. 1.199A-2(a)(3)(iv), property subject to an IRC Sec. 743 adjustment will create additional UBIA equal to the difference between the FMV utilized for the IRC Sec. 743 adjustment and the UBIA of the related assets on an asset-by-asset basis. This adjustment can be negative if the FMV is less than the UBIA.
Assume a 50% partner in a partnership sold its partnership interest for $1,200. The partner had an adjusted basis of $650 in its partnership interest. The partnership owns two properties (assume no other assets or liabilities):
Building A - UBIA $800, adjusted tax basis $700, FMV $1,900
Building B - UBIA $800, adjusted tax basis $600, FMV $500
Total IRC Sec. 743 adjustment $550 ($1200 - $650);
Building A - $600
Building B - ($50)
Total UBIA adjustment - $0
Building A - $150
Building B - ($150)
There would be a net increase in UBIA from building A of $150, which would have a placed in service date based on the sale date while the $400 carryover UBIA from building A and $250 ($400 - $150) from building B would keep the original placed in service date.
Additional UBIA items:
- Property acquired through an IRC Sec. 1031 exchange will utilize the original UBIA of the property exchanged plus any excess purchase price above the surrendered property’s FMV. The excess of any money or the FMV of other property received in the exchange over the appreciation in the relinquished property will reduce the UBIA of the property sold. The carryover UBIA will have the same placed-in-service date as the property sold while any excess purchase price will have a different placed-in-service date, which will be the purchase date of the new property. This carryover rule has been extended to other non-recognition transactions including those under IRC Sec. 721, IRC Sec. 1033 and IRC Sec. 351.
- UBIA will be allocated to partners and shareholders on K-1s proportional to current-year book depreciation. If the asset was fully depreciated, then the allocation would be based on IRC Sec. 704(b).
- If a pass-through entity fails to report the UBIA on the K-1, then the partner or shareholder is presumed to have zero UBIA from that entity.
- Property acquired within 60 days of the end of the taxable year and disposed of within 120 days of acquisition is not treated as qualified property unless it was used for at least 45 days or a business purpose is demonstrated.
The UBIA provisions of IRC Sec. 199A will allow real estate developers and investors to achieve significant tax savings as compared to the rules in place for 2017. However, it does create added complexity in making the annual calculations as well as including IRC Sec. 199A considerations when doing tax planning for potential transactions.