Sale of CRP Land - Is it Subject to the 3.8% Tax?

Published on: 21:06PM Nov 12, 2013

We had a reader ask the following question:

"Hey Paul, Is farmland with current CRP Income subject to the additional 3.8% NII tax if sold in 2013. Assuming all other income thresholds are met."

This is one of those questions with multiple answers depending on the facts and circumstances of the taxpayer. As previously discussed, the 3.8% tax will apply beginning in 2013 on net investment income on income over $200/$250,000 adjusted gross income. Rent income is part of the definition of investment income (the IRS proposed Regulations use a very broad interpretation of rent income).

Prior to the Morehouse case decided this summer, most taxpayers reported CRP income as rent income assuming they were no longer a farmer. This income would not be subject to self-employment tax. Farmers most likely reported it as part of their farm income, but in many cases they would report it on schedule E as rent income. If rent income did not rise to the level of a trade or business, the income would normally be subject to the extra 3.8% tax. Gain from selling land that was in CRP and was not part of the farming operation would most likely be subject to the 3.8% tax.

However, with the Morehouse decision, the Tax Court has determined that any taxpayer receiving CRP income is in a trade or business and thus subject to self-employment tax (taxpayers receiving both CRP and social security do not pay the tax by law). Since the income is now subject to SE tax it falls out of the definition of investment income subject to the tax on the ongoing income. However, this trade or business is probably still passive for the non-farmer. Even though self-employment tax was paid, the sale of the land remains a sale of property used in a passive activity. The taxpayer must meet the material participation test on the business income in order to avoid the 3.8% tax on the sale. And if the Morehouse
case is overturned on appeal and the CRP is treated as rents, the land sale will also be subject to the 3.8% tax.

Since the Morehouse case is on appeal and the IRS has not issued final Regulations and this type of gain has not been tried in Court, it may be several years before we have any final conclusions on this subject. If this situation applies in your case, you MUST review your facts with your tax advisor before selling and there may be conflicting conclusions.