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TAX PAY DIRT: Rented farmland is one of the easiest ways to maximize the 199A deduction, but there are important restrictions to remember.

Looking for a tax break? Look to the land

Tax brief: Income from renting land can qualify for the 199A deduction, but there are stipulations.

By Dario Arezzo

Now that the dust has settled on the 2019 tax season (for the most part!) it is time to continue fine-tuning tax strategies for 2020 and beyond.

One of the easiest ways to maximize the 199A deduction — it allows taxpayers other than corporations a deduction of 20% of qualified business income — is to ensure the farmland being utilized in the operation qualifies for the deduction.

There are three ways for farmland to qualify for the 199A deduction: The land can either be rented to a commonly controlled entity, fall under the safe harbor, or be considered a trade or business.

Let’s explore these three options.

Common control

The challenge in understanding common control is whether the farmland is rented to a trade or business conducted by the farmer, or to a flow-through entity that is commonly controlled by the farmer — i.e. a “self-rental.”

This begs the question: What exactly is common control? Essentially, this means that the same people, directly or indirectly, own 50% or more of each entity. Indirect ownership includes the following:

  • Ownership by a spouse, siblings, parents, grandparents and lineal descendants, such as kids.
  • Owning 50% or more of the issues and outstanding shares of an S-Corporation.
  • Owning 50% or more of the capital or profits of a partnership, or LLC taxed as a partnership.

Here is an example: Mom and Dad own Land LLC as 50/50 members. They rent that farmland for $150 an acre to Farm LLC, which is owned by Jr. and Dad at 10% and 90%, respectively. Since Land LLC is being rented to a commonly controlled entity, the rental payments will count as qualified business income (QBI) and will qualify for the 199A deduction.

Most family farm rentals should qualify as QBI under the common control test above.

Safe harbor clause

Another way a rental may qualify for QBI is through Notice 2019-07, which contains a safe harbor that requires the rental to meet all the following requirements:

  • Separate books and records are maintained for each rental, or the combined enterprise if grouped together.
  • 250 or more hours of rental services are performed; financial activities generally do not count.
  • The taxpayer maintains contemporaneous records.

Be considered a ‘trade’ or ‘business’

If the two methods above do not get the taxpayer to QBI, the rental may still qualify for the deduction by being considered a trade or business, as defined in the tax code. This is a fact-specific inquiry that requires a profit motive that is “considerable, regular and continuous.” Generally speaking:

  • Material participation farm rentals, reported on schedule F, will qualify.
  • Schedule E triple net leases are not likely to qualify.
  • Form 4835 crop share leases may or may not qualify, depending on the circumstances.

S corporation consideration

One of the important rules of the updated tax law excludes C corporations from the “self-rental” scenarios described above. What this means is that the rental arrangement would have to qualify under the safe harbor, or as its own trade or business to be considered QBI.

The conversion from a C corporation to an S corporation is quite nuanced and requires guidance from an experienced agricultural tax professional. But most farmers have found the conversion to be advantageous.

Final take-away

The 199A deduction on farmland is a great tax benefit. However, there are situations that require adequate planning and documentation to optimize the deduction. For those situations, especially those C corporate rentals, now is the time to optimize the situation for the 2020 tax season.

Arezzo is a senior tax consultant with Farm Credit East.
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