The Section 199A qualified business income (QBI) deduction has driven significant structural decisions in the private lending industry since its 2017 enactment. As private lenders navigate tax planning in 2025, understanding how this provision affects REIT utilization—and the broader benefits REITs provide—remains essential.
Understanding Section 199A
Section 199A of the Internal Revenue Code provides a 20% pass-through deduction for qualified business income earned through pass-through entities. This includes:
- Sole proprietorships
- Partnerships
- S corporations
- Trusts and estates
- Real Estate Investment Trusts (REITs)
For private lenders, this deduction has significant implications. REIT dividends qualify for the QBI deduction, allowing investors to deduct up to 20% of their REIT dividend income from taxable income.
The REIT Trend in Private Lending
Since Section 199A’s enactment, private lending has seen increased utilization of private, non-traded REITs as investment vehicles. The tax advantages compound with other REIT benefits:
Section 199A Status and Considerations
The Tax Cuts and Jobs Act (TCJA) provisions, including Section 199A, were enacted with sunset provisions. Understanding the current status helps lenders plan appropriately:
REIT Benefits Beyond QBI
Even without Section 199A’s QBI deduction, REITs offer compelling advantages for private lending operations:
UBTI Blocking
Unrelated Business Taxable Income (UBTI) creates tax complications for tax-exempt investors like pension funds and IRAs. When these investors hold debt investments directly, they may face UBTI exposure.
REITs provide UBTI blocking. Tax-exempt investors can invest in mortgage REITs without triggering UBTI on the underlying lending activities, making the investment more attractive for a broader investor base.
State Withholding and Return Blocking
Direct investment in multi-state lending operations creates administrative burdens for investors. Each state where the fund holds investments may require:
- Withholding on investor distributions
- State income tax return filings by investors
REITs simplify this significantly. Investors typically need only file in their home state and any states where they have direct presence, regardless of where the REIT makes loans.
ECI Blocking
Effectively Connected Income (ECI) creates complications for foreign investors in U.S. lending operations. Foreign investors receiving ECI may face U.S. tax filing obligations and withholding requirements.
REITs can provide ECI blocking for foreign investors, making the investment structure more attractive for international capital.
Structural Considerations for Fund Managers
When evaluating REIT structures, fund managers should consider:
Qualification Requirements
REITs must satisfy specific requirements:
- 75% asset test (majority of assets in real estate or real estate-related investments)
- 75% income test (majority of income from qualifying sources)
- 95% income test (nearly all income from qualifying sources plus other specified categories)
- Distribution requirements (90% of taxable income annually)
- Shareholder requirements (minimum 100 shareholders, no five shareholders owning more than 50%)
Operational Complexity
REIT compliance requires ongoing attention:
- Quarterly asset testing
- Annual income testing
- Distribution planning
- Shareholder tracking
- Specialized tax reporting
Formation and Maintenance Costs
REIT structures involve:
- Legal formation costs
- Ongoing compliance costs
- Specialized accounting requirements
- Additional administrative burden
When REITs Make Sense
REITs typically benefit private lending operations when:
Alternative Structures
Not every private lending operation requires REIT treatment:
Industry Advocacy and Legislative Engagement
The private lending industry has engaged actively in legislative discussions about Section 199A and pass-through taxation generally. Key messages include:
Best Practices for 2025 Planning
1. Monitor Legislative Developments: Tax law continues evolving. Stay informed about Section 199A status and related provisions.
2. Evaluate Structure Periodically: Business growth may change optimal structure. Reassess whether current entity form remains appropriate.
3. Quantify Tax Benefits: Work with tax advisors to model the actual benefit of various structures given current investor composition.
4. Consider Non-Tax Factors: Liability protection, operational flexibility, and investor preferences also affect structure selection.
5. Plan for Multiple Scenarios: Given legislative uncertainty, maintaining flexibility for multiple outcomes protects against adverse changes.
Conclusion
REITs remain valuable structures for private lending operations in 2025, whether or not Section 199A provides the QBI deduction. The UBTI blocking, state return simplification, and ECI benefits create meaningful value for various investor types.
Fund managers should evaluate whether REIT structures suit their specific operations based on investor composition, scale, and strategic objectives. Working with legal and tax professionals experienced in both private lending and fund structuring ensures optimal entity selection.
