With the recent changes in tax law through the Tax Cuts and Jobs Act, there have been many questions regarding how these changes will affect taxpayers and businesses. The intent of this blog is to shed some light on the Section 199A deduction, which has confused a fair number of people. Specifically, this blog will address the definition and applicability of the phrase “unadjusted basis of qualified business property.”
To set the stage, the 199A deduction is only limited if you are above the income threshold of $315,000 for married filing joint and $157,500 for all other taxpayers. If your income is under these amounts, you get the full 20% deduction, if your business qualifies.
So, what happens when you are above these threshold amounts you ask? Well, your deduction may be phased out, limited or eliminated depending on three factors:
- Whether your business is a specified service trade or business,
- The W-2 wages paid by the business, and
- The unadjusted basis of certain property used by the business, which is defined below
The basis of qualifying property is calculated as the unadjusted basis immediately after the acquisition of that property. Qualifying property means (1) tangible, (2) depreciable property (3) held by, and available for use in, the business at the close of the tax year, (4) used in the production of QBI (qualified business income) at any time during the year, and (5) for which the “depreciable period” has not ended before the close of the tax year (Sec. 199A(b)(6)).
The depreciable period starts on the date the property is first placed in service and ends on the later of (1) 10 years after the beginning date, or (2) the last day of the last full year of the applicable recovery period under Sec. 168 (ignoring Sec. 168(g)). This rule allows “qualified property” to include property that has exhausted its modified accelerated cost recovery system (MACRS) depreciation period if it is still in its first 10 years of service.
Once this amount is determined, 2.5% of the unadjusted basis of the qualified property is used in one of the 199A limitation calculations.
Note: The IRS recently clarified that the unadjusted basis of qualified property is determined before any bonus depreciation or Section 179 expensing.