Earlier this month, the U.S. Treasury and IRS issued final 199A regulations. Because they were released in 2019, taxpayers have the option of following the proposed regulations or the final regulations for taxable years ending in 2018. The new rules clarify some issues but leave others unanswered.
Iowa State University’s Center for Agricultural Law and Taxation provide some highlights from the final rules. Below, the final changes to farm rentals are outlined:
Rental Safe Harbor
The 199A deduction is available for “qualified business income” arising from a “qualified trade or business.” The final regulations continue to define “trade or business” as a trade or business under IRC § 162, other than the trade or business of performing services as an employee. Commenters asked for a regulatory definition, a bright-line test, or a safe harbor. The agencies maintain, however, that whether an activity rises to the level of a trade or business is inherently a factual question and specific guidance under § 162 is beyond the scope of the final regulations. The summary states that the courts have developed two definitional requirements for an activity to rise to the level of a trade or business:
- Good faith intention to make a profit
- Considerable, regular, and continuous activity (it is unclear where the word “considerable” arose. It does not appear in the Groetzinger[i] or Higgins[ii] cases)
In determining whether a rental real estate activity is a § 162 trade or business, the agencies state that relevant factors might include, but are not limited to, (i) the type of rented property (commercial real property vs. residential property), (ii) the number of properties rented, (iii) the owner’s or the owner’s agent’s day-to-day involvement, (iv) the types and significance of any ancillary services provided under the lease, and (v) the terms of the lease (net lease v. traditional; short-term v. long-term).
Recognizing the difficulties taxpayers and practitioners may have in determining whether a taxpayer’s rental real estate activities is sufficiently “regular, continuous, and considerable” for the activity to constitute a section 162 trade or business, the agencies concurrently released Notice 2019-07. This proposed revenue procedure details a proposed safe harbor under which a rental real estate enterprise may be treated as a trade or business for 199A purposes. The regulations specify that those taxpayers who treat a rental activity as a trade or business for purposes of 199A should be consistent and comply with the information return filing requirements of IRC § 6041 (filing 1099s).
The final regulations continue to provide that rental activity that does not rise to the level of an IRC § 162 trade or business is nevertheless treated as a trade or business for purposes of § 199A, if the property is rented to a commonly controlled trade or business. In other words, self-rental activities do not have to rise to the level of a trade or business for the rental income to qualify as QBI. Common control under the final regulations means that the same person or group of persons, directly or by attribution under IRC §§ 267(b) or 707(b), owns 50 percent or more of each trade or business. Notably, the final rule was written to exclude self-rental income received from a C corporation from this special treatment. The final rule does expand the family attribution rules to include siblings and grandparents.
By expanding the family attribution rules, this means that almost all sibling farming-rental operations will meet the common ownership definition.
Cash Rents Paid to Landlords
The final regulations did not specifically state that cash rent paid to a landlord will qualify as QBI. This type of rental arrangement will need to rise to the level of a trade or business in order to qualify. The safe harbor referred to above requires at least 250 hours of time on real estate management or related services by either the landlord or their agent(s). However, triple net leases are specifically excluded from the safe harbor provisions. It may be difficult for any cash rent landlord to have rental QBI unless they can meet the trade or business requirement.
Crop Share Rents Paid to Landlords
Since the safe harbor does not apply to triple net leases, net crop share rentals will also probably not rise to the level of a trade or business if the landlord has minimal time and/or a lesser amount of acres involved in crop share leases. Based upon how most crop share rental arrangements work the conversion of the crop by the landlord to cash will not likely be QBI unless the lease calls for the landlord to participate in crop expenses and enough involvement to create enough hours for it to qualify as QBI.
Need help navigating all the changes? Start here.
[i] Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987).
[ii] Higgins v. Commissioner, 312 U.S. 212 (1941)