The IRS recently issued new proposed regulations under Section 199A to clarify gray areas and change an unintended tax advantage for farmers who sell to cooperatives, created as part of the Tax Cuts and Jobs Act of 2017.
The new guidance on aggregation is one of the best items to come out of the proposed 199A regulations. In most cases, the IRS will not consider rental activities as qualified business income (QBI). However, the aggregation rules allow you to combine your land or real estate rental activity with other commonly owned entities. Aggregation also allows you to share wage and qualified property factors across entities, which could help maximize your 20% deduction.
But what exactly is “common ownership”? It is defined as one person or a group of people that own 50% or more of each entity through family attribution. Under common ownership, a related owner is deemed to own a fellow owner’s stock if they have a grandparent, parent, child or grandchild relationship. It’s important to note that siblings don’t qualify for the provision. Here are three examples to help illustrate this in action:
- Fred and Mark equally own a farm partnership that rents land they own personally. In this particular situation, Fred and Mark will get the 20% deduction on the land rent income and the income reported by the partnership.
- Now, let’s assume that the farm partnership has a third owner: Jeff. Fred, Mark and Jeff are brothers who own equal interest in the partnership that rents land from each of them, which they also own personally. Since Fred, Mark and Jeff are brothers, the two activities don’t qualify for aggregation, resulting in a potentially lower tax deduction.
- The situation becomes even more complex when you throw in another layer of generational ownership, along with a sibling who is not active in the family’s farming operations. Fred and Mark equally own the farming operations partnership that rents its farm land from another partnership, which is equally owned by Fred, Mark, their sister, Mary, and their father, Don. In this case, Fred and Mark will be able to aggregate their farming operations with their rental partnership, since they are each deemed to own 50% of both entities. Mary will not be able to take the 20% deduction on her share of the land rental income. Don’s eligibility for the 20% deduction is unknown — currently, the regulations are vague, and the IRS will need to further clarify whether an owner in his position must own part of the farming operations to qualify for the deduction.
These examples prove that while some structures are easy to understand within the context of the new regulations, others are more complex or need further clarification from the IRS. We hope the final regulations will open up the family attribution rules to siblings, since they are often part of the common ownership structure in many family farm and ranch operations. If the IRS does not adjust the regulations to include sibling relationships, challenges may arise for some owners moving forward.
This year, more than ever before, it’s important for you to contact your Wipfli relationship executive to gain a better understanding of what you should do to take advantage of the 199A deduction. For more information on the proposed regulations, read this recent article.