Remember it is Qualified “Business” Income
We continue to get several comments and questions along the following lines:
“Since my income is under the threshold amount, then all of my cash rental income must qualify for the Section 199A 20% deduction?”
The answer in one word is “No”. Section 199A was placed into the code to provide a deduction to lower tax rates to be more comparable to the C corporation tax rate of 21%. C corporations typically are comprised of business income. In some cases, there is real estate in a C corporation but primarily it is business income. Also, the deduction was put into place to provide an incentive to create jobs (whether that works or not is a separate issue).
Many commentators assumed that since Real Estate Investment Trust dividend income would qualify for the deduction, then all rental income would qualify. However, a REIT is more like a business than pure rental income. Most REITS have several employees that provide services for the rental income, thus the income qualifying for the deduction.
Farm cash rental income will not qualify for the deduction unless you meet any of the following requirements:
- You provide enough services to make the rental income “material”. In this case, you likely will be required to pay self-employment tax on the income. If you are already over the wage base from salaries from a job, the extra tax deduction will be greater than the extra self-employment tax. As example, assume you are in the 24% tax bracket and have $100,000 of cash rental income. The Section 199A deduction will be about $20,000 (could be reduced fro the 1/2 SE tax deduction) which will save you $4,800 of income tax. The extra SE tax will be $2,900. In this case, you save net income and SE tax of $1,900. Now this is for $100,000 of cash rent income. If it is only $20-50,000, is it worth the hassle of meeting the “material” participation hassle. If your income is even higher, there is likely no benefit since at this point you have to have wages or qualifying property and cash rental property typically has neither.
- Your cash rental must be part of a common group. A common group is where the “same” owners own 50% or more of the “common” entities. For example, three brothers owning 100% of an S corporation and an LLC is a common group since they own 100% of each entity even though no one brother owns 50%.
Remember, the threshold only applies to two limits:
- Whether your deduction will be limited by a combination of wages and/or qualified property, and
- Whether your Specified Service Trade or Business income will be allowed as Qualified Business Income.
You still must have “business” income to get any deduction.
Paul Neiffer is a certified public accountant and business advisor specializing in income taxation, accounting services, and succession planning for farmers and agribusiness processors. Paul is a principal with CliftonLarsonAllen in Walla Walla, Washington, as well as a regular speaker at national conferences and contributor at agweb.com. Raised on a farm in central Washington, he has been immersed in the ag industry his entire life, including the last 30 years professionally. Paul and his wife purchase an 180 acre ranch in 2016 and enjoy keeping it full of animals.
Thanks for all the great work you do.
Can the services of a manager be counted when determining whether a rental activity rises to the level of a business, thus qualifying for the QBI deduction?