One of the most significant aspects of the Tax Cuts and Jobs Act passed late last year was the addition of the Section 199A deduction that provides a 20% deduction on “qualified business income.” Our Summer/Fall 2018 issue contained an overview of the deduction. Recently, the IRS has provided guidance on whether farm rent income is qualified business income. Depending on the landlord’s level of involvement, even the rental of one piece of property can qualify for the deduction.
The key determination to make is whether the rental activity qualifies as a “trade or business” as defined by the Internal Revenue Code. If so, the rental income may qualify for the deduction (assuming the other requirements discussed in our last issue are met). There is no clear rule for determining whether renting out farmland is a trade or business. Instead, the IRS guidelines state:
Within the scope of a section 162 (the section providing for deduction of ordinary business expenses) determination regarding a rental activity, key factual elements that may be relevant include, but are not limited to, the type of property, the number of properties rented, the day-to-day involvement of the owner or its agent, and the type of rental. Therefore, due to the large number of factual combinations that exist in determining whether a rental activity rises to the level of a section 162 trade or business, bright-line (unambiguous) definitions are impractical and would be imprecise.
The IRS guidelines go on to state the determination is based on whether the landlord engages in rental activity for the purpose of earning a profit with sufficient “continuity and regularity.” Since whether renting farmland amounts to a trade or business has been of little consequence prior to the deduction, there have been few court decisions to flesh out what this means. The few that have been issued, however, make clear that the landlord must be more involved in managing the property than simply collecting a rent check.
The Iowa State University Center for Agriculture Law and Tax has provided several examples of rental activity that likely will or will not qualify for the deduction.
Cash Rent Lease: ISU contrasts two landlords:
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.
And:
Landowner B, owns 1,800 acres of farm land, 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.
Landowner B is more likely to qualify for the deduction, but maintaining documentation of these activities will be important.
Non-farmer receiving Conservation Reserve Program payments: Maintaining property in the CRP program has been held to be a trade or business by one US Court of Appeals Circuit.
Wind Tower: Under a lease agreement with typical terms, the landowner renting a site for a wind tower would not qualify.
Since there is not a clear rule regarding the deduction, careful review is warranted to determine if you qualify for the deduction on your 2018 taxes, and if not, whether adjustments can be made to qualify in future years. The attorneys and CPAs at Plager, Krug, Bauer & Rudolph, Ltd. have the experience and knowledge to assist you in making this decision.