Since the passage of the Tax Cuts and Jobs Act (TCJA) during the Trump Administration, the Section 199A QBI deduction has been a boon to debt funds and small businesses alike. It created a trend towards private, non-traded REITs within the private lending industry. However, many fund managers are concerned about the future of Section 199A because it has a sunset provision that takes place at the end of 2025, thereby eliminating the 20% pass-through deduction.
What is Section 199A?
Section 199A of the Internal Revenue Code provides a 20% pass-through deduction for qualified business income (QBI) earned by pass-through entities such as sole proprietorships, partnerships, S corporations, trusts, and estates. This deduction is available to businesses in various industries, including private lending, real estate, and investment funds. The TCJA made several changes to the tax code, including the Section 199A AI deduction, which was enacted to provide a tax break to small businesses and stimulate growth.
Since the enactment of Section 199A, there has been a trend toward private, non-traded REITs within the private lending industry. This is because REITs are pass-through entities that can take advantage of the QBI deduction, which allows investors to deduct up to 20 of their REIT dividends from their taxable income. This has led to increased interest in private REITs and other investment funds that can utilize the QBI deduction.
However, many fund managers are concerned about the future of Section 199A, given that it has a sunset provision. A sunset provision is a clause in a law that provides for the automatic expiration of a particular provision or law on a specific date unless further action is taken to extend or make it permanent. In this case, it is set to expire at the end of 2025.
Possible Outcomes Post-Sunset
There are three possible outcomes for Section 199A: extension, sunset, or permanence. The outcome will depend on the results of the 2024 Presidential and Congressional Elections. Objectively, this bill has a higher likelihood of being extended or made permanent if Republicans were to take control of Congress. If they take control of the White House, it would be a foregone conclusion. However, even if this were not to occur, the bill may be extended as part of an omnibus extension of various parts of the tax code or budget.
If Section 199 were to sunset and the QBI deduction were to go away forever, existing REITs would still benefit from other ancillary benefits of being a REIT, including UBTI blocking, state withholding/return blocking, and ECI blocking. UBTI blocking refers to the ability of a REIT to avoid paying unrelated business taxable income (UBTI), which is a tax that applies to certain types of income generated by tax-exempt organizations. State withholding/return blocking refers to the ability of a REIT to avoid having to file tax returns in multiple states, which can be a time-consuming and costly process. ECI blocking refers to the ability of a REIT to avoid having to pay taxes on income generated from sources outside the United States.
For these reasons, it is imperative that we engage with our lawmakers to explain to them that Section 199A supports small businesses (of which a vast majority are pass-through entities) and supports the private lending industry, which creates thousands of units of new housing inventory every day.
The private lending industry has been instrumental in providing funding for real estate developers and investors who may not qualify for traditional bank financing. This has resulted in the creation of new housing units and the revitalization of distressed properties in many communities. However, the industry has faced many challenges, including increased regulatory scrutiny and the potential loss of the Section 199A QBI deduction. If the deduction were to sunset, it could have a significant impact on the industry, which relies heavily on pass-through entities to structure their investments. This could result in reduced funding for real estate projects and a slowdown in the creation of new housing inventory, which would have a negative economic consequence for communities across the country.
To avoid this outcome, industry leaders should work to educate lawmakers on the importance of the Section 199A QBI deduction and the impact that it could have on small businesses should it expire. This includes advocating for the extension or permanence of the provision and engaging in discussions with lawmakers on ways to improve and expand the benefits of the deduction.
In conclusion, the Section 199A QBI deduction has been a critical tool for small businesses and the private lending industry since its enactment as part of the TCJA. However, the provision’s sunset creates uncertainty for the industry and could have significant economic consequences if it is not extended or made permanent. For this reason, industry leaders must work to educate lawmakers on the importance and advocate for its continuation to ensure that the private lending industry can continue to support the creation of new housing inventory and economic growth in communities across the country.