What Are Section 199A Dividends? Reduce Your Taxable Income

Section 199A dividends are dividends paid by REITs (real estate investment trusts) and funds holding REITs. They are taxed as ordinary income, but they may qualify for a 20% deduction under Section 199A of the 2017 Tax Cuts and Jobs Act. They are reported in Box 5 of Form 1099-DIV, and they require a minimum holding period of 46 days for the deduction.

Section 199A of the Tax Cuts and Jobs Act (TCJA) allows certain individuals and entities to deduct up to 20% of qualified business income (QBI) from their taxable income. One of those entities are real estate investment trusts (REITs), which often pay out up to 90% of their income to investors in the form of dividends. These dividends are classified as Section 199A dividends.

In this article, we will explain what Section 199A is, examine how it pertains to dividends paid out by REITs, and highlight what you need to be aware of when reporting Section 199A dividends.

What is Section 199A?

Section 199A refers to a part of the United States Internal Revenue Code (IRC) that was introduced as part of the Tax Cuts and Jobs Act in 2017. It addresses the deduction for qualified business income for pass-through entities like sole proprietorships, partnerships, S corporations, and certain qualified real estate investment trusts.

Under Section 199A, eligible taxpayers can deduct up to 20% of their qualified business income from a pass-through entity. The deduction is subject to various limitations and depends on the taxpayer’s income and type of business. This deduction provides significant tax savings for many small business owners and individual taxpayers who have qualified income from eligible sources.

“For any individual, estate, or trust, the Section 199A deduction in a tax year is equal to 20% of QBI plus 20% of qualified REIT dividends and qualified publicly traded partnership income. Negative QBI in a tax year results in no deduction for the business portion of that equation.” – An excerpt from the Congressional Research Service (CRS) report

Section 199A primarily focuses on business income rather than dividends from investments. The deduction applies to qualified business income generated from eligible sources, such as income from operating a business, rental real estate activities, or certain qualified dividends from domestic REITs.

It is worth noting that the IRC Section 199A deduction is temporary – if no changes are made, it will remain in effect until 2025.

Also, there are several types of income that don’t apply for the deduction under Section 199A, namely wage income, reasonable compensation received by an S corporation shareholder for services provided to the business, guaranteed payments to a partner for services provided to a partnership, and investment income unrelated to a trade or business.

For a better understanding of how Section 199A deductions might apply in practice, check the official lower and upper-income thresholds by year for both single and married persons.

Lower and upper-income thresholds for wage and qualified property limitation (WQP) and specified service trade or business (SSTB) limitations under Section 199A. Image source: CRS

What are Section 199A dividends?

Section 199A dividends are paid by REITs, which are investment vehicles that own, operate, or finance income-generating real estate. They pool capital from numerous investors to invest in a diverse portfolio of real estate properties, such as office buildings, shopping malls, residential apartments, hotels, warehouses, and more. They are a popular investment type since they pay unusually high dividends to their investors, often up to 90%. For context, some of the most lucrative dividend stocks, like Coca-Cola and IBM, pay 3-5% of their earnings in the form of dividends and are generally considered to have one of the highest and most consistent dividend rates around.

According to the Congressional Research Service report, there are limits that apply to the deduction under Section 199A. Here’s the relevant excerpt from the report:

The unavoidable limitation is an overall cap on the deduction a business owner may take in a tax year, a cap that can be thought of as the maximum deduction. It is the lesser of:

• the sum of 20% of an owner’s QBI and (if applicable) 20% of any REIT dividends and PTP income the owner receives, or 
• 20% of a taxpayer’s taxable income, less any net capital gain, which is equivalent to an owner’s taxable ordinary income.

The eligibility to claim the Section 199A qualified business income deduction for Section 199A dividends is not restricted by any income limit, whether it’s taxable income, Modified Adjusted Gross Income (MAGI), or any other criteria.

Do I need to report Section 199A dividends?

Yes, you need to report Section 199A dividends on your tax return. To do so, you should follow these steps:

• Report the total ordinary dividends from Form 1099-DIV Box 1a on Form 1040 Line 3b. Section 199A dividends are a component of Box 1a total ordinary dividends and are reported on Line 3b.
• Report the Section 199A dividends from Form 1099-DIV Box 5 on either Line 6 of Form 8995 or Line 28 of Form 8995-A. You can file the simpler Form 8995 to report qualified business income and Section 199A dividends. The amount from the last line of Form 8995 should be copied to line 13 of Form 1040. Alternatively, you can report the dividends in Box 6a of Schedule K and Box 20 with a code of AC.
• Section 199A dividends are not reported on Line 3a of Form 1040. They are not qualified dividends and are taxed as ordinary income subject to your ordinary income tax rates.

To report Section 199A dividends, enter the total amount of dividends (including 199A dividends) under Box 1A on Form 1099-DIV, and then fill out the relevant amount for Section 199 dividends under Box 5.

What is Section 199A on K-1?

Section 199A on K-1 refers to the information that a partnership provides to its partners about their share of income, deductions, credits, and other items that may qualify for the QBI deduction under Section 199A of the TCJA. 

This deduction allows eligible taxpayers to deduct up to 20% of their QBI plus 20% of their qualified REIT dividends and qualified PTP income from their taxable income. The partnership will report the Section 199A information in Box 20 of Schedule K-1 using various codes. The partner will use this information to complete Form 8995 or Form 8995-A and claim the deduction on their tax return.

The bottom line: Section 199A dividends allow investors to claim a 20% tax deduction

The provisions introduced with the TCJA allow taxpayers to deduct up to 20% of their qualifying income. One of the benefits is the ability to deduct income earned from REIT dividends. It is worth noting that the Section 199A deduction is only temporary and is slated to phase out by 2025.

If you are looking for other dividend investment opportunities besides REITs, feel free to parse through our selection of “Dividend Aristocrats”, which are companies that have been paying and increasing their dividend for 25 consecutive years.