Before getting to today’s post, I wanted to correct a mistake I made in yesterday’s post. The seminar/webinar in Fergus Falls, Minnesota is on Wednesday September 19, not September 20 as I indicated in the post.
The Section 199A 20% deduction applies to trade or business income. The IRS does not consider most real estate rentals as trades or businesses. However, the proposed regulations provide safe harbor treatment for certain commonly owned activities.
The Section 199A proposed regulations now require common ownership in order to:
- Allow farm cash rental income to qualify for the deduction, or
- Allow aggregation of entities to fully deduct Section 199A when farmers are over the threshold.
If a farmer has two entities in which one entity is the farm operation and the other entity is cash renting the ground to the farm entity, common ownership allows the cash rental income to qualify as a trade or business, which allows the deduction. This is true even if the farmer is under the threshold. If cash rental income does not qualify as a trade or business, there is no Section 199A deduction on this income no matter the income level, in the IRS’ view.
If the farmer is over the threshold, then they need to be able to aggregate the two operations together to create enough wage or property investment to allow for a full Section 199A deduction. The cash rental income is usually larger than the farm income. Since there are no wages paid in this entity and usually little or no qualified (depreciable) property, then without common ownership, the farmer will not get a Section 199A deduction on the cash rents.
We still are not sure on crop share farm rentals. This may qualify as a trade or business, however, you will likely want to aggregate if over the threshold.
Common ownership requires each entity to have at least 50% common ownership. You are able to count certain related parties as "one" owner. Brother and sisters are not related parties for purposes of common ownership, according to the proposed regulations. Only lineal ancestors and decedents qualify as related parties. We may need some additional clarity from the IRS on the 50% or more provision. The actual wording of the regulation states 50% or more, however, all of the examples refer to more than 50%. We are assuming the wording of the regulation is correct.
Here are some examples to help you determine whether you have common ownership:
John, Jim and Jordan farm together as a partnership. Each of them own farm land that is rented to the partnership. They are all brothers. This is not common ownership. None of the brothers own at least 50% of the partnership, therefore, none of the cash rent income will qualify for the Section 199A deduction based on the regulations.
One option to fix this is for the brothers to separately farm their ground and simply contract with the partnership for equipment, etc. If they are under the threshold, they will not care about wages or qualified property. If over the threshold, each farm should separately pay wages since partnership wages will not be available for the cash rented ground's income. This may not work well in states that require sales tax on farm equipment rentals (such as Washington State).
Now, let's assume that John is the father of Jim and Jordan. In this case, there is common ownership. John is deemed to own 100% of the partnership as the father of Jim and Jordan. Jim and Jordan are deemed to each own 66.67% of the partnership (their share plus their dad's). In this case, all of the cash rent income qualifies for the Section 199A deduction.
Fred owns an S corporation and cash rents ground from a family limited partnership (FLP). The FLP is owned 60% by his parents, 20% by him and 20% by his sister who lives in Chicago. Fred is deemed to own 80% of the FLP (his 20% plus his parent's 60%). Therefore, his share of the cash rent ground will qualify for the Section 199A deduction. His sister's share will not qualify. She is deemed to also own 80% of the FLP, however, she does not own (actually or constructively) any of the S corporation, therefore, her cash rent will not qualify. We are not yet sure whether Fred’s dad will qualify or not. There may be requirement that he has some actual ownership in Fred’s S corporation to qualify. The regulations are not very clear on this.
As you can see, having common ownership can be very complicated. We are hoping that the final regulations will provide more clarity on this and perhaps allow brothers and sisters to be treated as related parties since many farm operations are structured this way. We will keep you posted.