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IRS SCRUTINIZES FARM RENTAL INCOME

Theresa M. Wade

The Internal Revenue Service (IRS) is planning to make important changes in regards to the manner in which the IRS treats income derived from rental agreements between farming entities renting land from individuals owning an interest in such farming entity.  Specifically, the IRS plans to inspect and audit farmer tax returns for evidence of these types of arrangements, and assess self-employment tax on related net rental earnings for the current tax year.

Rental income is typically considered “passive income” and exempt from self-employment tax, however, if an individual land owner “materially participates” in the farming operations, either through crop share arrangements, or actual production of the commodities or the management of production, that material participation could trigger self-employment tax.

This circumstance often arises when a farmer who owns real estate leases it to an entity through which the farmer performs farming activities on the leased property.  Many farmers using such a lease arrangement for their real estate elect to report the net rental income as a passive activity under the general real estate rental rule and do not pay self-employment tax on their net rental income.

Under the new IRS position, the lessor will no longer have the option as to whether to report the rental income derived from the lease as self-employment income.  If the farmer-lessor materially participates as an owner in the business entity farming the property, earnings under the lease arrangement will be subject to self-employment tax.  It does not matter the type of business entity farming the property, whether partnership, LLC or corporation.

If the situation described above applies to you, please contact Theresa M. Wade at twade@ghrlawyers.com or at 503-581-1501 to discuss proper application of the material participation regulations and whether another solution may be pursued to accomplish your business and tax objectives.