One of the most impactful changes from the Tax Cuts and Jobs Act (TCJA) was the limitation of state and local tax (SALT) deductions to $10,000 on individual returns. For real estate professionals operating through pass-through entities like partnerships and S corporations, this created a significant tax burden. Fortunately, many states have created workarounds, and as I discussed with Rich Hedley, our state and local tax leader, these Pass-Through Entity Tax (PTET) elections can provide substantial federal tax savings.
The TCJA limited state and local tax deductibility for individuals, which primarily affects pass-through entity owners. Here's why: if you own a partnership or S corporation, the income from that business is taxed on your individual tax return. The state taxes paid by the business are treated as distributions to you as the owner, and you deduct those state taxes on Schedule A of your Form 1040.
This is where the $10,000 limitation hits hard. If your business generates significant income across multiple states, your state tax liability can easily exceed $10,000, leaving you with non-deductible taxes that increase your overall tax burden.
Many states recognized this problem and created what's called a "workaround" through Pass-Through Entity Tax elections. Interestingly, Connecticut was the first state to implement this solution back in 2018, initially making it mandatory (though they've since made it elective like most other states).
Virginia created their PTET option in 2021, and the IRS has blessed these arrangements through official notices, confirming that they're legitimate tax planning strategies.
The mechanics are actually quite elegant:
The Election: States allow you to elect into this regime—it's your choice, not mandatory. The election process varies by state, but many states make it as simple as checking a box when you file your tax return or make estimated tax payments.
The Deduction: Once you make the election, state taxes attributable to the business become deductible by the business itself, rather than flowing through to your individual return.
The Result: This creates lower federal taxable income that passes through to you on your Schedule K-1.
A Simple Example
Let me illustrate with a straightforward example:
Without PTET Election:
With PTET Election:
The federal tax savings on that $10,000 difference can be substantial, especially for high-income earners.
While PTET elections are generally beneficial, there are important nuances to understand:
Varying State Rules: Just like other state tax laws, the specific rules for making PTET elections vary significantly by state. Some states make it as simple as checking a box, while others have more complex procedures.
Timing Matters: The timing of elections and payments can be crucial. Some states require the election to be made with estimated payments, while others allow it to be made with the return.
Professional Guidance Recommended: Given the varying rules and potential complexity, it's important to work with tax professionals who understand the specific requirements in each state where you have nexus.
There's currently legislation working through Congress (the "One Big Beautiful Act" or OBBA) that could increase the SALT cap from $10,000 to potentially $40,000. While this could reduce the benefit of PTET elections, it's still uncertain whether this legislation will pass and in what form.
Even if the SALT cap increases, PTET elections will likely remain valuable planning tools, especially for high-income real estate professionals with significant multi-state tax liabilities.
PTET elections represent one of the most effective responses to the SALT cap limitation. For real estate professionals operating through pass-through entities with significant state tax liabilities, these elections can provide substantial federal tax savings.
The key is understanding your specific situation and the rules in each state where you have tax obligations. While the concept is straightforward, the implementation requires careful attention to state-specific requirements and timing.
If you haven't explored PTET elections for your real estate business, it's worth having that conversation with your tax advisor. The potential savings make it a strategy that most pass-through entity owners should at least consider.