The Tax Cuts and Jobs Act, TCJA, includes a 20% qualified business income (QBI) deduction, which at first glance, seems to be straight forward. However, upon further inspection into the deduction, there are many complexities that enter into computing what the deduction can mean for individual taxpayers.
One such complexity is whether farm rental income qualifies for the QBI deduction. There are many guidelines around what constitutes the trade or business of real estate rental and in most cases it is a fact-intensive determination made on a case-by-case basis. In a blog post from Iowa State University’s Center for Agricultural Law and Taxation (CALT), the following discussion examples with suggested answers are provided, noting that proposed regulations could change, and interpretations could vary:
Landowner A, who lives in Arizona, leases 80 acres of inherited Iowa farmland to a single tenant for a ten-year term. She collects the rent, but has little or no other contact with the tenant. She owns no other real property.
Under this bare fact pattern, Landowner A would likely not be involved in a trade or business so as to qualify for the IRC 199A deduction. This would likely be true even though the landlord paid the taxes and/or insurance on the property. Under the IRC §162 standard, the limited activities of this landlord do not seem to be engaged in “with sufficient continuity and regularity” to rise to the level of a trade or business. Rather, they are more akin to investment-related activities.
Landowner B, owns 1,800 acres of farmland, which she rents out to three different tenants for one-year lease terms under fixed rent leases. Each lease is terminated and renegotiated each year, and each lease requires the tenant to report yields, soil fertility, and conservation practices, which the landlord closely monitors. The landlord is responsible for repairing drain tile, fences, and outbuildings. She works closely with her tenants to ensure farming practices that best preserve the health and sustainability of the farmland. She meets with her tenants regularly throughout the year.
A good argument can be made that Landowner B’s activities are sufficiently continuous and regular so as to qualify her as being in the trade or business of renting property, so as to qualify for the 199A deduction. Documentation of this activity is important to establish eligibility for the deduction.
Landowner C has the same facts as Landowner B, except that he hires a farm manager to manage his farm rental business.
Landowner C should be in the same position as Landowner B because the law allows business owners to count the activity of their agents in determining whether their activity rises to the level of being a trade or business.
Landowner D is a non-farmer with 120 acres enrolled in CRP.
IRS’ non-acquiescence to Morehouse means that Landowner D’s CRP income should qualify for the 20 percent deduction, even though he is a non-farmer. IRB No. 2015-41 (2015). The Tax Court’s position in Morehouse was that the non-farmer was in the trade or business of “participating in the CRP.” The Eighth Circuit removed the trade or business question by deeming the CRP payments to be “rent.” Morehouse v. Commissioner, 769 F.3d 616 (8th Cir. 2014), rev’g 140 T.C. 350 (2013). The IRS did not agree with the Eighth Circuit and issued an Action on Decision in 2015 stating that it would continue to litigate its position, even with respect to taxpayers in the Eighth Circuit where payments were made after 2008. That is good news for non-farmers wanting to take the 199A deduction on these payments. But unless they are on social security or disability and enjoy a statutory exclusion, they should pay SE tax if they take a deduction to avoid taking an inconsistent position on this issue.
Landowner E is a crop share landlord who materially participates in a crop share arrangement.
Landowner E is in the trade or business of farming (not renting property) and will qualify for the 199A deduction.
Landowner F is a crop share landlord who does not materially participate in a crop share arrangement.
Landowner F’s eligibility for the deduction will depend upon whether his activities are sufficiently regular, systematic, and continuous to constitute a “trade or business.”
Landowner G receives a yearly rental payment from a wind tower that is housed on her property.
Landowner G would not be eligible for the 199A deduction for this payment because the landowner would have no related activity beyond receiving a check. This would not qualify for trade or business status.
The question of what rental income will qualify for the 199A deduction is a key issue that impacts many taxpayers. The 199A “qualified trade or business” requirement and the proposed regulations pointing taxpayers to IRC §162 leave lots of gray area for taxpayers and their tax advisors to navigate.
We will continue to monitor this issue and provide updates as they arise. Remember, these are proposed regulations. The final regulations could provide some clarity. Have questions? Start here!
What if Landlord A is renting this farm to a brother and nephew and they farm it. Would family attributions rules apply to this situation for meeting the 250 hour brightline test for the purpose of considering this a trade or business of the taxpayer and/or tax payer spouse?
I really enjoyed this article on farm rental income qualifying for 199A deduction. The Landowner B example was especially good and I thought the case you made for the deduction being applicable to her situation was solid. One additional item I thought could have been addressed that might be of interest. If Landowner B made this argument of being in the trade or business of renting property and qualified for the 199A deduction would that not also mean the rental income should be reported on Schedule C and therefore be subject to the self employment tax of 15.3% rather than… Read more »
Hi Mitchell, The term “trade or business” is not defined anywhere in the Internal Revenue Code (IRC). The term is used in IRC Section 199A and also in IRC Section 1402 which defines Net Earnings from Self-Employment. IRC Section 1402 excludes real estate rentals from earnings from self-employment with some exceptions. “There shall be excluded rentals from real estate and from personal property leased with the real estate”. The final regulations to IRC Section 199A expressly state that the rental of real estate to a pass-through entity (S-corporation or partnership) is considered trade or business income when there is enough… Read more »