This article has been updated to include revised limits for 2020.
The Tax Cuts and Jobs Act (TCJA) was signed into law on December 22, 2017, by President Donald Trump. The TCJA made significant changes to the United States Tax Code by lowering corporate and individual tax rates, increasing the standard deduction, limiting certain itemized deductions, eliminating personal exemptions, and vastly expanding the child tax credit.
Perhaps the most profound change in the TCJA is a section of the law that benefits the vast majority of small business owners in the United States, including Real Estate Agents. The TCJA created Internal Revenue Code Section 199A, which allows a twenty-percent income deduction for qualifying businesses.
IRC §199A allows qualifying business owners to deduct 20% of Qualified Business Income (QBI) before calculating income tax due on their individual income tax return, Form 1040. Although referred to as a pass-through deduction for entities such as partnerships and S Corporations, sole proprietorships (including commission-paid real estate agents) may also qualify for the deduction. This article will discuss how the Qualified Business Income deduction impacts real estate agents who are sole proprietors.
Qualified Business Income
Every business owner who’s taxable income (in italics because §199A involves a few technical adjustments) falls below a certain threshold (discussed below) qualifies for the 20% deduction. When an owner’s income exceeds these thresholds, however, the source of business income becomes relevant. Taxpayers who operate Specified Service Trades or Businesses will not qualify for the QBI deduction when their income exceeds these levels. A specified service trade or business is a for-profit activity whose principal asset is the reputation or skill of its employees or owners. As a result, many owners that practice law, accounting, healthcare, consulting, and investing do not qualify for the deduction.
Real Estate Agents Rejoice:
Real Estate Agents were initially considered a Specified Service Trade. After all, what is a real estate agent’s primary asset if not his or her skill or reputation? Fortunately, some heavy-duty lobbying by professional associations encouraged lawmakers to create a special carve-out and remove real estate agents and brokers from the specified service definition.
As mentioned above, there are income limits that determine whether or not a business owner automatically qualifies for the full Qualified Business Income Deduction. These limits are adjusted for inflation and change each year. For 2022, the thresholds are $170,050 for single taxpayers (and married individuals filing separately) and $340,100 for married taxpayers who file jointly.
If a business owner’s taxable income falls below these levels, they receive the full 20% deduction! The type of business is not a consideration. If their taxable income exceeds these thresholds, however, things become increasingly complex. There is an income phase-out range that will reduce and eliminate the deduction for Specified Service Business. There are also additional calculations for non-specified service businesses, such as Real Estate Agents, that pay wages and own property.
If a business owner’s taxable income falls below these levels, they receive the full 20% deduction. The type of business is not a consideration. If their taxable income exceeds these thresholds, however, things become increasingly complex. There is an income phase-out range that will reduce and eliminate the deduction for Specified Service Business. There are also additional calculations for non-specified service businesses, such as Real Estate Agents, that pay wages and own property.
Deduction Phase-Out (No Wages and No Assets):
Once taxable income exceeds the threshold listed above, several additional limits come into play. Two of these limits involve an income phase-out that will impact specified service business owners and real estate agents who do not pay wages to employees. For these owners, the QBI deduction begins to phases out, allowing a partial deduction for those whose taxable income falls within the phase-out range. For single taxpayers, the 20% deduction is reduced by 2% for every $2,500 taxable income exceeds $170,050 (2022). When taxable income exceeds $220,050 ($50,000 over the threshold), the deduction vanishes. For married taxpayers filing jointly, the 20% deduction is reduced by 2% for every $5,000 taxable income exceeds $340,100 (2022). Once taxable income exceeds $440,100 ($100,000 over the threshold), the deduction vanishes for specified service businesses.
Real Estate Agents are not specified service businesses, but those without employees and taxable income above these levels may find their deduction drastically limited.
Deduction Limit (Wage-Paying Real Estate Agents):
For owners and real estate agents who pay W2 wages to employees, calculating the deduction limit becomes even more complicated. For those whose taxable income exceeds $170,050 (single/MFS) and $340,100 (MFJ), the §199A deduction is limited to the greater of 1) The phase-out limits listed above, 2) Fifty-percent of Medicare wages (basically, Box 3 on form W3) paid to employees during the tax year, or 3) Twenty-Five percent of Medicare wages plus 2.5% of the unadjusted basis of depreciable property (basically, the asset’s purchase price) owned by the business.
For real estate agents and brokers who earn less than the phase-out limits calculating the QBI deduction is relatively simple. Congratulations! You get the deduction! For those in higher-earning households, however, planning-complexities abound. Those interested in maximizing this time-limited deduction need to make some serious decisions - decisions whose consequences may extend far beyond deduction’s 2025 sunset date.
Summary and Invite: We hope this article has helped you to better-understand the Qualified Business Income Deduction as it applies to Real Estate Agents. If you’d like some assistance in cutting a Real Estate Agent’s highest cost - taxes, please download our Real Estate Agent Tax Organizer. We also invite you will review and purchase our Real Estate Agent Tax-Cut Library - over eight hours of tax-cut training broken into twenty-nine searchable volumes. It covers every possible deduction a Real Estate Agent can take on their business tax return. Our Broker Version helps entire agencies cut their taxes! And don’t forget to browse our courses. You might find something you like!
All courses and articles are for informational purposes only and do not constitute tax advice. Taxes are complicated - do not act on course information without consulting a professional. Always refer to treasury regulation before making any tax decision. Read the full disclaimer.
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I haven’t practiced in the accounting field in quite some time and wanted a refresher. The Overnight Account course 1099-Misc Basics was very helpful! It was simple to follow along and understand each section. I would highly recommend this course! Staff were quick to answer my question as well. I love that I can review the modules again, if needed, at any time. I will definitely be using them again for more classes.- Tammy, Anchorage, AK, 1099-MISC Basics Course