Land is arguably a farmer's most important asset. Land provides the farmer with the canvas on which he uses his skills to grow crops or raise livestock. It is also the primary tool for transition and retirement planning. Often, the next generation comes into the farm operation by renting or purchasing their parent's land. Alternatively, the retired farmer rents or sells the land to an unrelated party. It is dirt that sustains the farmer and his family both during and after farming.
Recently, the new tax law threw a curveball at the farming community by way of the "grain glitch," also known at Section 199A. Section 199A provides up to a 20% deduction on farm profits subject to certain limitations.
One important question arose regarding Section 199A in connection with active farming. Many famers put the land in a separate partnership, and the farming operation rents the land. This "self-rental" avoided self-employment tax on rental income. Could we aggregate self-rental with the farming operation to maximize the Section 199A deduction?
The proposed regulations says that as long as the farm and the land rental are part of a common group and the entities have the same taxable year, the rent would be aggregated with the farm income. So farmers get the best of both worlds: self-employment tax avoidance and increased Section 199A deduction.
What if you are a retired farmer and renting the land: Is there any way to get the Section 199A deduction?
The proposed regulations say the deduction is only for qualified business income. The IRS normally does not consider rental as business income. There is some authority in the tax code to say that if the landlord provides services or incurs significant costs related to the rental, it may rise to the level of a trade or business.
The problem in agriculture is that a cash-rent landlord almost never performs sufficient services to rise to the level of a trade or business. In a cash rental, it is rare for the landlord to incur significant operating costs. Thus, no 199A deduction.
That could change if the land owner enters into a crop-share arrangement. There is some authority to say that if the landlord shares in income and expense and has some management authority, the crop share could rise to the level of a trade or business and would qualify for Section 199A.
Does this mean a retired farmer should jump into a crop share? It's not that simple. First, these are proposed regulations, and nothing is certain yet. Second, crop share is a riskier option since you share in profits and losses of the farming operation. If you need a fixed amount of rent for living, a traditional rental may provide more stability and comfort. Also, if your taxable income is over the threshold amounts (tentative taxable income over $157,500, or $315,000 for married couples filing a joint return), little or no deduction may be available due to other limitations.
Whether you are passing on land, renting or considering crop sharing, Section 199A offers some opportunities. Consider your timeline carefully, as well as your security needs. And remember, elements of this rule may still be subject to change.
Editor's Note: Tax Columnist Rod Mauszycki is a CPA and tax partner with the accounting firm of CliftonLarsonAllen, in Minneapolis, Minnesota. Send questions to firstname.lastname@example.org
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