Section 199A dividends are distributions from the profits of domestic real estate investment trusts (REITs) that qualify for a special 20% tax deduction. Investing in Section 199A dividends can provide a valuable tax deduction for investors, and income limits don’t apply to Section 199A income from REITS. Understanding the ins and outs of this tax break requires some study, but the effort can produce useful information to guide investing activities. Consulting with a financial advisor can help you determine whether investments like REITs and their Section 199A dividends fit into your overall financial plan.
Section 199A Dividend Background
Section 199A dividends get their name from Section 199A of the tax code. This section was created by the 2017 Tax Cuts and Jobs Act to provide a tax deduction for pass-through business income. One element of Section 199A is that it allows a 20% deduction for dividends paid out from the profits of domestic REITs.
When you receive Section 199A dividends, they will be reported on Form 1099-DIV in Box 5. These dividends are a subset of the total ordinary dividends reported in Box 1a. You don’t need to itemize deductions to qualify for the 199A deduction. The deduction does not reduce your adjusted gross income.
Section 199A Dividend Tax Deductions
The tax deduction for Section 199A dividends is generally 20% of the amount reported in Box 5 of 1099-DIV. This percentage deduction is not phased out at higher income levels like it is for some other sources of qualified business income (QBI), such as profits from self-employment. Taxpayers at any income level can take the full 20% deduction for their Section 199A dividends.
The Section 199A deduction for dividends is claimed on Form 8995 or Form 8995-A and then flows through to Line 13 of your Form 1040. This deduction does not lower your marginal tax bracket or income-based phaseouts on things like Roth IRA contributions. But it does directly lower your taxable income.
Section 199A Dividend Deduction in Action
Here’s a hypothetical example of how a typical taxpayer who invests in domestic REITs might use the Section 199A dividend deduction:
This investor earns $50,000 in W-2 income from his job. He also gets $5,000 in ordinary dividends from a mutual fund that includes domestic REITs in its portfolio. His Form 1099-DIV shows $3,000 of that amount as Section 199A dividends in Box 5. Only part of the $5,000 in ordinary dividends is classified as Section 199A dividends in this example because the other components of the mutual fund’s portfolio are not REITs. In this case, his Section 199A deduction would be the lesser of:
- 20% of $3,000 Section 199A dividends = $600 or
- 20% of his taxable income = 20% x ($50,000 + $5,000 – $12,950 standard deduction for 2023) = $8,230
The investor in this example could claim a $600 Section 199A deduction. That’s 20% of his $3,000 in Section 199A dividends.
Section 199A Dividends for Investors
For investors, the main advantage of Section 199A dividends is the tax deduction without income limits. The tradeoff is that ordinary REIT dividends don’t qualify for the lower qualified dividend tax rates like corporate stock dividends might.
Investors will generally find Section 199A dividends within mutual funds or ETFs holding REIT stocks. Individual REIT stocks also may pay Section 199A dividends. The presence of this potential deduction can be a significant factor to consider when selecting REIT investments.
Limitations of the Section 199A Dividend Deduction
While the 199A deduction for dividends has some attractive features, including that it lacks income phaseouts, it comes with limitations. Here are some to keep in mind:
- It doesn’t reduce your adjusted gross income or marginal tax bracket.
- It expires at the end of 2025 unless Congress extends Section 199A.
- The dividends themselves are taxed as ordinary income, not at the lower qualified dividend rate.
- The deduction only applies to dividends attributable to domestic REIT ownership.
The Section 199A dividend deduction can directly lower tax bills for REIT investors. Taxpayers can claim the deduction even if they don’t itemize, although it doesn’t lower adjusted gross income and can’t move them to a lower tax bracket. The deduction may not last forever and can be tricky, but the opportunity to save on taxes can make learning about it and using it a worthwhile exercise.
Tips for Tax Planning
- Meeting with a financial advisor can help identify the best tax savings opportunities for your situation. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Forecast your future tax bill with SmartAsset’s federal income tax calculator.
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