Follow Up on Qualified Business Income
Sep 26, 2018
This post will be follow up on the previous post regarding Qualified Business Income (QBI). Under the proposed regulations, the IRS is indicating that rental income is not QBI unless it either meets the definition of being a trade or business under Code Section 162 or is part of a common group.
There is no bright-line test for rental income being Section 162 income. It is always based on facts and circumstances. Typically, to be a trade or business, you or your agent need to provide enough "services" to get it to that level. That may or may not create self-employment tax on the income, but typically it is always going to be more services than is ever done with a typical farm cash rent income lease.
Now, if the cash rent income lease is part of a common group, it then by default rises to the level of a trade or business under the proposed regulations (even if it does not qualify as a Section 162 trade or business, it will be QBI). This is true even if you can't aggregate that income due to the entity being a C corporation or not having the same year-ends, etc.
Income received by the common group that is not paid by a member of the common group likely will not be QBI, however, we could see where there may be cases where it is. One example, is a farmer that as part of their crop rotation rents some of their ground each year to a potato farmer. The landlord is required to maintain the irrigation system, perhaps pay for power, etc. This may be a enough "services" to arise to the level of QBI even though it would not otherwise qualify as part of the common group (the rent was paid by an unrelated third party).
Now, many farm landlords rent their ground under a crop-share lease. Historically much of crop-share income could arise to the level of a joint-venture which would likely qualify as QBI. However, these leases usually required the landlord to pay some share of many farm expenses such as seed, fertilizer and chemicals. Many of the new crop-share leases I am seeing call for a triple-net crop share lease where the landlord is receiving a percentage of the crop but paying no farm related expenses (other than interest, real estate taxes and perhaps crop insurance). In this case, the IRS could assert that this is simply similar to a cash rental lease and not QBI.
We know that many commentators are stating that "all" rental income qualifies for the Section 199A deduction. However, the proposed regulations state otherwise. The proposed regulations provide a "safe-harbor" with the common group situation. Outside of that, all rental income requires additional review to see if it qualifies as QBI. Make sure you review that with your tax advisor now. If you wait to after year-end, you may be too late.