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© 2018 Land Grant University Tax Education Foundation, Inc. 287

AGRICULTURAL AND NATURAL RESOURCE

ISSUES

9

LEARNING OBJECTIVESAfter completing this session, participants will be able to do the following:

✔✔ Understand how new loss limitations apply to farm and nonfarm losses

✔✔ Depreciate farm vehicles and other assets

✔✔ Explain how the new like-kind exchange rules impact an equipment trade-in

✔✔ Apply the general rules that are applicable to making and revoking farm and ranch tax elections

✔✔ Discuss how the qualified business income deduction applies to farm rental income

✔✔ Calculate the qualified business income deduction for a patron of an agricultural or horticultural cooperative

INTRODUCTIONThis chapter discusses new loss limits that for tax years beginning after December 31, 2017, and before January 1, 2026, extend the excess loss lim-itation that previously applied only to farm losses (if the farmer was receiving applicable subsidies) to all noncorporate businesses, including farm-ers. It also explains the new rules that eliminate the 20-year limit on net operating loss carryovers, eliminate the carryback period for nonfarm losses (with a limited carryback still available for farm losses), and limit the amount of deduction in the carryover years to 80% of that year’s taxable income.

This chapter reviews new and existing rules for depreciation of farm assets, including a revised recovery period for farm equipment and machinery, mandatory use of ADS for certain tax-payers that elect out of the new interest expense limitation, depreciation of farm vehicles, how the

Issue 1: Farm Loss Deduction Limits . . . . 288Issue 2: Depreciation of Farm Assets . . . . 293Issue 3: Farm and Ranch Tax Elections . . 305Issue 4: Farm Lease Income and the

QBI Deduction . . . . . . . . . . . . . . . . . . . 316Issue 5: Section 199A and Agricultural

and Horticultural Cooperatives . . . . . 319

Land Grant University Tax Education Foundation

Land Grant University Tax Education Foundation

COPYRIGHT 8/27/2018 LGUTEF

288 ISSUE 1: FARM LOSS DEDUCTION LIMITS

An applicable subsidy is any direct or counter-cyclical payment made under Title I of the Food, Conservation, and Energy Act of 2008, or any payment in lieu of such payment. An applicable subsidy also includes any loan received from the Commodity Credit Corporation (CCC).

Calculating the Excess Farm LossAn excess farm loss is calculated as the excess of the aggregate deductions from all farming busi-nesses of the taxpayer over the sum of the aggre-gate income and gains attributable to farming businesses plus a threshold amount. The thresh-old amount is the greater of

1. $300,000 ($150,000 MFS), or2. the excess (if any) of the aggregate net farm

income for the 5 preceding tax years.

In determining the aggregate net farm income for the preceding 5 years, any deductions not allowed due to the application of the loss limits in that year are not considered until the year in which the deduction is allowed.

Example 9.1 Excess Farm Loss

Scott Macintosh, a single taxpayer, experienced a disastrous year due to a combination of bad weather and poor market conditions. Scott oper-ates his farm as a sole proprietorship. To pay his bills and wait to sell his crops at a higher market price, Scott obtained a CCC loan. In 2017, Scott had a $472,000 loss. Scott’s Schedule F (Form 1040), Profit or Loss From Farming, for the prior 5 years showed the amounts seen in Figure 9.1.

ISSUE 1: FARM LOSS DEDUCTION LIMITS Special rules and limits apply to farm losses and farm net operating losses.

Prior to 2018, special limits applied to taxpayers who received applicable subsidies from the fed-eral government. The Tax Cuts and Jobs Act of 2017 (TCJA), Pub. L. No. 115-97, imposes new limits on farm and other losses. The losses may also be limited by the at-risk rules and the passive activity loss rules. An allowed loss may result in a net operating loss (NOL). A farm NOL is subject to different rules than NOLs resulting from other sources.

Pre-2018 Farm Loss Limits on Taxpayers Receiving Government Payments

Prior to 2018, if a taxpayer received an applicable subsidy for the tax year, any excess farm loss for that year had to be carried over to the next tax year [I.R.C. § 461(j)]. This rule did not apply to C corporations.

Practitioner NoteCasualty Losses

Deductions for losses due to casualty, disease, or drought are not subject to this excess farm loss limitation and are not included in any of the loss limitation calculations.

elimination of like-kind exchange treatment for personal property affects basis and depreciation on farm equipment trade-ins, special rules for single purpose agricultural (livestock) or horticul-tural facilities, and a new rule for replanting of citrus plants after a casualty.

This chapter also explains the general rules for making and revoking farm and ranch tax elections, the specific elections to calculate self-employment

earnings using the farm-optional method, and the I.R.C. § 165(i) election to deduct a disaster loss for the tax year immediately preceding the tax year in which the disaster occurred.

Finally, this chapter discusses how the I.R.C. § 199A deduction applies to farm rental income, and how it applies to income of a specified agri-cultural or horticultural cooperative.


New Limitations on Excess Business Losses of Noncorporate Taxpayers 289

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FIGURE 9.1 Scott’s Schedule F (Form 1040) Net Farm Profit

Year Schedule F Net Profit

2012 $3,200

2013 $2,700

2014 $5,200

2015 $1,600

2016 $4,800

Scott’s aggregate net income for the pre-ceding 5 years was $17,500 (Figure 9.1). His threshold amount is $300,000 (the greater of the statutory amount or his 5-year aggregate income of $17,500). Scott’s Schedule F (Form 1040) loss was therefore limited to $300,000, and he carried over deductions of $172,000 ($472,000 actual loss – $300,000 threshold amount allowed) to his 2018 Schedule F (Form 1040).

Practitioner NoteFarming Business Defined

Farming business for this limitation is defined the same as it is for the uniform capitalization rules [I.R.C. § 263(a)]. However, if the taxpayer is engaged in farming, and also processes that com-modity, the processing activity is included in the calculation of excess farm loss. If the taxpayer is a member of a cooperative, the cooperative’s processing of that commodity is treated as the taxpayer’s farming business. Farm income also includes net gain or loss from the sale of farm business assets reported on Form 4797, Sales of Business Property, and crop share rents reported on Form 4835, Farm Rental Income and Expenses.

Partnerships and S CorporationsFor partnerships and S corporations (including LLCs taxed as a partnership or S corporation), the farm loss limit is applied at the individual owner level. Therefore, partners or shareholders must take into account their proportionate share of income, gain, loss, and deductions from the farming business. If the partnership or S corpora-tion receives an applicable subsidy, then the part-ners or shareholders may be subject to the excess farm loss limitation rules. Unless the partner

or shareholder is a C corporation, these flow-through farm business items are combined with those of the taxpayer to determine any excess farm loss.

Law ChangeNew Loss Limitations

The TCJA eliminates the section 461( j) farm loss limitation for tax years beginning after Decem-ber 31, 2017, and replaces it with a broader loss limitation that applies to all business losses, both farm and nonfarm.

New Limitations on Excess Business Losses of Noncorporate Taxpayers

For tax years beginning after December 31, 2017, and before January 1, 2026, the excess business loss of any noncorporate taxpayer is disallowed [I.R.C. § 461(l)]. Thus, the excess loss limitation that previously applied only to farm losses, and then only to those who were receiving applicable subsidies, now applies to all noncorporate busi-nesses, including farmers.

Practitioner NoteS Corporations

I.R.C. § 461(l)(4) contains rules for applying this loss limitation at the shareholder level for own-ers of an S corporation. Therefore, it appears that the corporate exclusion from this loss limitation applies only to C corporations.

Calculation of Excess Business LossThe definition of excess business loss is expanded to include the excess of the aggregate deductions from all trades or businesses of the taxpayer for the tax year over the sum of

■■ the taxpayer’s aggregate gross income and gain of all those trades and businesses for the tax year, plus

■■ $250,000 ($500,000 for MFJ).



Cross-ReferenceNOLs

The TCJA also modified the rules for NOLs by elim-inating any carryback period for nonfarm NOLs. Farmers can still carry back NOLs 2 years. NOLs can be carried forward indefinitely. However, NOL carryforwards are limited to the lesser of the carryover amount or 80% of taxable income. See the “New Legislation—Business” chapter in this book for a discussion of the changes to the NOL. The farm NOL rules are discussed later.

Partnerships and S CorporationsAs with the prior excess farm loss limitation, the excess business loss limitation for businesses operating as partnerships or S corporations (including LLCs taxed as a partnership or S cor-poration) is applied at the individual owner level. Therefore, the shareholders or partners must take into account their proportionate share of income, gain, loss, and deductions from the business activ-ity. These flow-through trade or business items are combined with those of the taxpayer to deter-mine any excess business loss (unless the taxpayer is a C corporation).

Example 9.4 Pass-Through Entity Loss Limits

David from Examples 9.2 and 9.3 also has an interest in the Saw-You-Coming LLC. His Sched-ule K-1 (Form 1065), Partner’s Share of Income, Deductions, Credits, etc., shows an allocation of $9,000 net income. David’s combined business income must include the allocation from the LLC. He now has a $261,000 loss ($248,000 + $22,000 − $9,000). His deduction is still limited to $250,000, the threshold for a single taxpayer. He carries over the $11,000 excess business loss ($261,000 − $250,000) as an NOL.

At-Risk and Passive Activity Loss Limitation Rules

The TCJA did not modify the at-risk and pas-sive activity loss (PAL) rules. Both rules must be applied to limit the amount of the taxpayer’s farm or business loss from each activity prior to

The $250,000 ($500,000) threshold amounts are indexed for inflation (rounded to the nearest $1,000) for tax years beginning after December 31, 2018.

Observation5-Year Lookback

The excess loss definition does not include a look-back to the net income of the previous 5 years as it did under the prior excess farm loss rules.

Example 9.2 Excess Business Loss

David Stump, a single taxpayer, operates a log-ging business, a sawmill, and a wholesale nurs-ery operation. Due to unusually high rainfall and resulting muddy conditions, all his businesses experienced losses. His 2018 Schedule C (Form 1040), Profit or Loss From Business (Sole Propri-etorship), losses totaled $248,000. His Schedule F (Form 1040) showed a $22,000 loss. David’s combined business loss was $270,000 ($248,000 + $22,000). His deduction is limited to $250,000, the threshold for a single taxpayer.

The disallowed excess business loss is treated as part of the taxpayer’s NOL. In contrast, the disallowed excess farm loss under prior law was treated as a farm deduction in the subsequent year, subject to the deduction limitations in that year.

Example 9.3 Excess Business Loss Carryover

David from Example 9.2 can carry over the $20,000 disallowed excess business loss ($270,000 total loss − $250,000 allowed loss) as an NOL.

Planning PointerSelf-Employment Tax

The treatment of an excess loss as part of the NOL rather than as carryover deductions will impact farm taxpayers who are subject to self-employ-ment (SE) tax. The carryover deduction on Sched-ule F (Form 1040) reduced SE income. An NOL deduction will not reduce SE tax.


Farm Net Operating Losses 291

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passive activity income from the flower shop). Under the PAL rules the $43,000 disallowed PAL ($87,000 + $44,000) is carried over until Sam recognizes passive activity income or dis-poses of his entire interest in the winery. With the limitation on the winery loss, his total business loss is $242,000 [($242,000) − $44,000 + 44,000]. This loss is below the $250,000 threshold amount and may be deducted in full against nonbusiness income.

Practitioner NoteNonbusiness Income

The limitation on the deduction of business losses imposed by I.R.C. § 461(l) applies only if the tax-payer has nonbusiness income that exceeds the threshold amount. In effect, this rule simply limits the amount of current-year nonbusiness income that can be offset by business losses to the thresh-old amount. As in the past, any allowed business losses that exceed nonbusiness income become part of the taxpayer’s NOL.

Farm Net Operating Losses

Prior to 2018, farm losses could be carried back 5 years. The taxpayer could elect to treat the farm loss as a nonfarm loss and therefore carry it back 2 years. Or, the taxpayer could elect to forgo the carryback period altogether. The carryforward period was 20 years. In each year, the NOL was deducted in full against taxable income.

For tax years beginning after December 31, 2017, the TCJA eliminated the 20-year limit on carryovers, eliminated the carryback period for nonfarm losses, and limited the amount of deduc-tion in the carryover years to 80% of that year’s taxable income.

There is a 2-year carryback period for farm-ing losses. The taxpayer may still elect to forgo the carryback. A farming loss is the lesser of

1. the amount that would be an NOL if only the income and deductions attributable to farm businesses are considered, or

2. the amount of the NOL for the year.

Farming business is defined in I.R.C. § 263A for the uniform capitalization rules.

determining if the taxpayer has any excess farm or business loss.

The at-risk rules limit losses to the amount that the taxpayer has directly invested in the activity but also include certain obligations (debts for which the taxpayer is personally liable). Most loans obtained from related parties do not create at-risk amounts. Losses from pass-through entities are limited to the taxpayer’s at-risk amount in that entity. Disallowed losses are carried over until the taxpayer has at-risk amounts in the activity.

After the at-risk rules are applied, the PAL rules then limit the amount of farm or business loss from rental activities (with some exceptions) and any business activity in which the taxpayer does not materially participate. The losses from the taxpayer’s passive activities are limited to the taxpayer’s passive activity income. Disallowed losses (segregated by the activity from which they arose) are carried over until the taxpayer has pas-sive activity income from any source, or com-pletely disposes of his or her entire interest in the activity.

Cross-ReferenceLoss Limitations

See the “Loss Limitations” chapter in the 2017 National Income Tax Workbook for further infor-mation on the at-risk rules and PAL limitations.

Example 9.5 PAL Limits and the Excess Business Loss Limits

In 2019, Sam Adams, a single taxpayer, has income and losses from the business activities shown in Figure 9.2.

FIGURE 9.2 Sam’s Business Income and Losses

Activity Income (Loss)

Farm operation (active) ($242,000)

Winery (passive) ( 87,000)

Flower shop (passive) 44,000

Total net loss ($285,000)

Although Sam has a $285,000 overall loss, he does not have an excess business loss. Sam must first apply the PAL limits. Sam’s deductible win-ery loss is limited to $44,000 (the amount of his



the $132,000 excess business loss as an NOL. Because the entire loss resulted from farming, Denise can carry the $132,000 loss back 2 years (unless she elects to forgo carryback) and then forward indefinitely until it is used. The amount of the NOL deducted in each carryover year is limited to 80% of her taxable income.

Because of the excess business loss limitation rule, Denise could use only $250,000 of her loss against current-year nonbusiness income. She must amend prior-year returns or wait for a future year to use the remaining $132,000 loss.

Practitioner NoteLoss Carryback

I.R.C. § 461(l) specifies that any excess business losses are treated as an NOL carryover to the fol-lowing tax year under I.R.C. § 172. I.R.C. § 172(b)(1)(B) says that any portion of an NOL that is a farming loss is carried back 2 years. The carryback is automatic. Thus, until the IRS issues further guidance, it is unclear if a farming excess business loss will be automatically carried back (absent an election to carry it forward), or must be carried forward.

Example 9.7 NOL Created Due to Less Nonbusiness Income

Assume Denise from Example 9.6 had no wage income. Her deductible farm loss would still be limited to $250,000. However, her taxable income and resulting NOL would be as shown in Figure 9.4. Denise’s NOL equals the full amount of her farm loss because none of it was used to offset taxable income in the current year.

Planning PointerDecision to Carry Back

Tax rates may be lower under current law. Farm-ing taxpayers should carry back NOLs if taxable income in the two prior years was subject to a higher tax rate.

Example 9.6 Excess Business Loss and Resulting NOL

In 2018, Denise Deciduous, a single taxpayer, experienced a $382,000 loss on her fruit farm. She is actively involved in the fruit farm operation. Denise is also a plastic surgeon, and she earned $420,000 in wages from a local medical group. She also earned $8,000 of interest and dividends. Even though she claims only the standard deduc-tion, she is expecting a refund of most of the tax withheld on her wages. However, her deductible loss will be limited to the $250,000 threshold amount. Denise’s $166,000 taxable income is cal-culated as shown in Figure 9.3.

FIGURE 9.3 Denise’s Taxable Income Calculation

Wages $420,000

Farm loss (limited to threshold amount)

(250,000)

Interest and dividend income 8,000

Standard deduction ( 12,000)

Taxable income $166,000

She has a $132,000 excess business loss ($382,000 – $250,000). Denise has no NOL for the year. However, I.R.C. § 461(l) categorizes

FIGURE 9.4 Denise’s Taxable Income and NOL

Farm loss (limited to threshold amount) ($250,000)

Interest and dividend income 8,000

Standard deduction (12,000)

Taxable income ($254,000)

Add back: nonbusiness deductions in excess of nonbusiness income ($12,000 − $8,000) 4,000

Subtract: excess business loss ($382,000 − $250,000) (132,000)

NOL ($382,000)


New Rules for Depreciation Methods 293

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Example 9.8 Farm Equipment Purchases

Jack Daniels purchased a new combine on Sep-tember 28, 2017. In May 2018, he purchased a new tractor and a used plow. In August 2018, Jack added a new fence line and in September he constructed a grain bin. These assets are assigned to the MACRS recovery classes shown in Figure 9.5.

FIGURE 9.5 MACRS Recovery Classes

New combine (2017) 7-year

New farm tractor (2018) 5-year

Used plow (2018) 7-year

Fence (2018)* 7-year

Grain bin (2018)* 7-year

*The fence and grain bin are in the 7-year MACRS recovery class regardless of whether they are new or used.

New Rules for Depreciation Methods

For assets used in agriculture that are placed in service after December 31, 1986, the maximum rate of depreciation was the 150% declining bal-ance (DB) method. Trees and vines bearing fruit or nuts (10-year MACRS property) were lim-ited to straight line (SL) depreciation. For assets placed in service after December 31, 2017, the TCJA increases the rate of depreciation to 200% DB for farm assets in the 3-, 5-, 7-, and 10-year MACRS recovery classes. Assets in the 15-year and 20-year MACRS recovery classes are still limited to a maximum 150% DB rate. Residential rental property and nonresidential real property continue to be limited to SL depreciation, even when held by a farmer.

ISSUE 2: DEPRECIATION OF FARM ASSETS Farm assets are subject to slightly different depreciation rules than nonfarm assets. The TCJA revised some of these differences and added other depreciation rules that will have a significant impact on the calculation of net farm income.

Several farm assets have recovery periods that differ from those of their nonfarm counterparts. In addition, the maximum recovery method for farm assets has been limited to 150% declining balance (DB). Producers subject to the uniform capitalization rules (I.R.C. § 263A) were given the ability to opt out of these rules—but the cost was the requirement that they depreciated their assets using the alternative depreciation system (ADS). Farmers also tend to trade in their equip-ment on a more regular basis than many nonfarm businesses and, due to acreage covered, use sev-eral vehicles that are categorized as lightweight or sport utility vehicles (SUVs).

Revised Recovery Period for Farm Equipment and Machinery

The Tax Cuts and Jobs Act of 2017 (TCJA), Pub. L. No. 115-97, provides that new farm equipment and machinery placed in service after December 31, 2017, are classified as 5-year MACRS prop-erty rather than their previous classification as 7-year MACRS property. These assets must be used in a farming business as defined by I.R.C. § 263A. Under this definition, equipment used in incidental processing activities is included, but equipment used in contract harvesting of a crop produced by another taxpayer is not. A taxpayer who simply buys and resells plants or animals grown or raised by another taxpayer is not in the business of farming.

Used equipment is still classified as 7-year MACRS property. The ADS life for all farm equipment and machinery, both new and used, is 10 years. Grain bins, cotton ginning assets, and fences are still 7-year MACRS property with a 10-year ADS life.


294 ISSUE 2: DEPRECIATION OF FARM ASSETS

The TCJA added another situation in which taxpayers must use ADS. The TCJA limits the deduction for net business interest expense to 30% of adjusted taxable income. Adjusted tax-able income for the business is determined with-out any deduction for interest, depreciation, the 20% I.R.C. § 199A deduction, or any NOL car-ryover. If the taxpayer elects out of the interest expense limitation, the taxpayer must use ADS to calculate depreciation on all assets having a MACRS recovery class of 10 years or more, including those assets that were placed in service in prior years.

The interest deduction limitation does not apply to a business with average gross receipts for the 3 prior years of $25,000,000 or less.

A specified agricultural or horticultural coop-erative can elect out of the interest expense limi-tation. The cooperative must be organized under subchapter T and be engaged in one of the fol-lowing activities:

1. The manufacturing, production, growth, or extraction in whole or significant part of any agricultural or horticultural product

2. The marketing of agricultural or horticultural products that its patrons have manufactured, produced, grown, or extracted

3. The provision of supplies, equipment, or ser-vices to farmers, or other cooperatives in the prior two categories

Planning PointerChange in Accounting Method

Taxpayers who must change their deprecia-tion method because of this interest deduction rule do not have to file Form 3115, Change in Accounting Method. The change is considered a rule change rather than a change in accounting method, even though it is the result of a taxpayer election.

Cross-ReferenceBusiness Interest Deduction Limitation

See the “New Legislation—Business” chapter in this book for a further explanation of the inter-est deduction limitation.

Example 9.9 Depreciation Methods

Jack Daniels, from Example 9.8, paid $430,000 for his new combine in 2017. He elects out of bonus depreciation and does not elect any sec-tion 179 expense deduction. The half-year con-vention applies. Jack depreciates the combine over a 7-year MACRS recovery class using the 150% DB method. His depreciation is $46,071 [($430,000 ÷ 7) × 0.5 × 150%].

If Jack waits until 2018 to purchase the new combine, his depreciation is $86,000 [($430,000 ÷ 5) × 0.5 × 200%], which is $39,929 ($86,000 − $46,071) more than if he had purchased the com-bine in 2017.

Planning PointerExcess Depreciation

This increase in the rate of depreciation for many farm assets, combined with the shorter MACRS recovery class for new farm equipment and machinery, may generate more depreciation than is needed by some taxpayers. The taxpayer can elect to use the SL method of depreciation and now may also elect to use the 150% method. Both elections are made on a class-by-class basis each year. To further reduce the amount of depreciation, the taxpayer may elect to use the alternative depreciation system (ADS), which cal-culates depreciation using the SL method and lengthens the recovery period.

Limits on Interest Expense Deduction and the Use of ADS

Prior to 2018, farmers, like other taxpayers, could elect to use the alternative depreciation system (ADS) to reduce their annual depreciation expense and extend the number of years over which that expense could be claimed. Also, farm-ers who were subject to the uniform capitalization rules (UNICAP) could elect out of UNICAP but were then required to use ADS to calculate depre-ciation on assets acquired after electing out.


Vehicle Depreciation Rules 295

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FIGURE 9.7 Vehicle Cost Recovery Periods

GDS ADS

Over-the-road tractor 3 4

Lightweight trucks 5 5

Heavy general-purpose trucks 5 6

Passenger vehicles 5 5

The definitions of these vehicles are impor-tant to determine the correct recovery class.

■■ An over-the-road tractor is a highway truck designed to tow a trailer or semitrailer and that does not carry cargo on the same chassis as the engine. (Note, however, that the trailer and trailer-mounted containers are 5-year MACRS property with a 6-year ADS life.)

■■ A lightweight truck is a truck with unloaded vehicle weight greater than 6,000 pounds but less than 13,000 pounds.

■■ A heavy general-purpose truck has an unloaded vehicle weight of 13,000 pounds or more.

■■ A passenger vehicle is any four-wheeled vehicle manufactured primarily for use on public streets, roads, and highways that has an unloaded gross vehicle weight (GVW) of 6,000 pounds or less. This definition includes automobiles, trucks, and vans.

Practitioner NoteSport Utility Vehicles

Sport utility vehicles (SUVs) are generally catego-rized as trucks under these definitions. But see the special limits on the section 179 deduction for SUVs discussed later.

Passenger Automobile RulesI.R.C. § 280F limits the amount of depreciation that can be claimed annually on any passenger vehicle. Ambulances, hearses, and vehicles used directly in the trade or business of transporting persons or property are excluded from this defini-tion regardless of vehicle weight.

The I.R.C. § 280F limit applies to the total depreciation calculated for the year, including any section 179 deduction or bonus depreciation. The first-year limit is greater for taxpayers claim-ing bonus depreciation. The TCJA established

Example 9.10 High-Debt Farm Operation

Dan Dairyman reports the amounts shown in Figure 9.6 on his 2018 tax return.

FIGURE 9.6 Dan’s 2018 Return Amounts

Gross farm receipts $ 32,000,000

Interest expense (5,000,000)

Depreciation on cattle and equipment

(4,000,000)

Depreciation on dairy facility (1,000,000)

Other farm expenses (20,000,000)

Net taxable farm income $ 2,000,000

Dan first determines his adjusted business income by adding back his deductions for interest and depreciation to his net taxable farm income. Dan’s adjusted business income is $12,000,000 ($2,000,000 + 5,000,000 + $4,000,000 + $1,000,000). His interest expense deduction is limited to $3,600,000 ($12,000,000 × 30%). The remaining $1,400,000 ($5,000,000 – $3,600,000) of interest expense is carried over to 2019, where it will again be subject to the 30% limitation.

Dan could elect out of the business interest limitation, but he would have to calculate depre-ciation on the dairy facility (10-year MACRS property) using the ADS life (15 years) instead of the GDS life (10 years). The depreciation deci-sion will defer expenses over the remaining life of any asset Dan has in a MACRS recovery class of 10 years or more. The interest deferral is only to next year. Dan’s depreciation deduction on this cattle and equipment is not affected by his deci-sion because its recovery period is less than 10 years.

Vehicle Depreciation Rules

A variety of rules apply to the depreciation of farm vehicles. Figure 9.7 shows the general depreciation system (GDS) and the alternative depreciation system (ADS) recovery periods.



wait until after year 6 to recover any remain-ing basis [I.R.C. § 280F(a)(1)(B)]. In those future years, deductions are still limited to $5,760 annu-ally. This is because the basis in the property is reduced by the full amount of calculated depre-ciation, without considering the section 280F limits, and the depreciation that is disallowed in year 1 must be deferred until after the end of the vehicle’s recovery period.

Example 9.11 Passenger Automobile Depreciation Limits

In 2018, Honey Hamm purchased a new pickup truck that she uses 75% in her hog operation. The pickup cost $32,000 and has a GVW of less than 6,000 pounds. If Honey does not elect out of bonus depreciation, she can deduct $13,500 ($18,000 × 75%) of her $24,000 ($32,000 × 75%) business basis in 2018. She will deduct the remaining $10,500 ($24,000 − $13,500) begin-ning in 2024 (year 7). The depreciation deduc-tion in 2024 is limited to $5,760, and $4,740 will be deducted in 2025 (year 8).

Either a technical correction or an IRS safe harbor is expected to rectify this problem by allowing taxpayers to elect 50% bonus depre-ciation on vehicles subject to the section 280F limits. Honey in Example 9.11 could elect out of bonus depreciation for this pickup, but that elec-tion would apply to all property in the 5-year cost recovery class, which now includes farm tractors.

Practitioner NoteRev. Proc. 2011-26

In 2011 the bonus depreciation was 100%, and the IRS issued Rev. Proc. 2011-26, 2011-12 I.R.B. 560, which provided a safe harbor to mitigate this recovery delay to year 7. The unrecovered basis was calculated as if the taxpayer had used 50% bonus depreciation (instead of 100%) and the regular MACRS deduction on the balance (after applying the 50% bonus depreciation). If there was an unrecovered basis amount using this calculation, the taxpayer could continue to depreciate the automobile in years 2 through 6.

the following section 280F limits for vehicles acquired after September 27, 2017, and placed in service in 2018:

■■ Tax year 1: $10,000 ($18,000 if bonus depre-ciation is claimed)

■■ Tax year 2: $16,000■■ Tax year 3: $9,600■■ Tax years 4 and after: $5,760

These depreciation limits are based on 100% business use and must be prorated for business use that is less than 100%.

Practitioner NoteSubstantiation of Use

When vehicles are used for both personal and business purposes, the taxpayer can deduct only the expense attributable to the business use. This typically requires detailed recordkeeping. How-ever, farmers can claim 75% of the use of a car or light truck as business use without any alloca-tion records if the farmer used the vehicle dur-ing most of the normal business day directly in connection with the business of farming [Temp. Treas. Reg. § 1.274-6T(b)].

The increased first-year limit applies whether the taxpayer uses 100% bonus depreciation, or, for the first tax year ending after September 27, 2017, elects to use only 50% bonus depreciation. These limits are adjusted annually based on infla-tion. However, different inflation adjustment factors will be used for lightweight trucks and pas-senger automobiles, so it is likely that future caps will be different after 2018.

Practitioner NotePrior-Year Limits

For tax years prior to 2018, the annual limits for lightweight trucks and vans classified as passen-ger vehicles were different from those of auto-mobiles. The limits for years prior to 2018 are in the “Tax Rates and Useful Tables” chapter in this book.

As the law is currently written, taxpayers claiming 100% bonus depreciation may face an unintended consequence. After claiming an $18,000 deduction in year 1, they may have to


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ObservationPickup Trucks

A common configuration for one-half-ton pick-ups is the crew-cab with a short box. The short box for most manufacturers is less than 6 feet in length. Therefore, these pickups are considered SUVs.

The TCJA provides that the $25,000 section 179 limit will be adjusted for inflation in incre-ments of $100 for years after 2018.

Planning PointerSection 179 vs. Bonus Depreciation

The limit on the section 179 deduction may be irrelevant for many taxpayers because the TCJA allows taxpayers to claim 100% bonus deprecia-tion on both new and used vehicles. However, the bonus depreciation decision applies to all assets within any given recovery class placed in service that year by the taxpayer. The section 179 decision is made on an asset-by-asset basis rather than class by class. Tax planning with the differ-ences between these two cost recovery options is discussed later.

Cross-ReferenceAdditional Information

FS-2018-9 (April 2018) highlights some of the new rules and limitations for depreciation and expensing under the TCJA. See the “New Legisla-tion—Additional” chapter in this book for a dis-cussion of the proposed regulations that clarify the TCJA changes to bonus depreciation.

Practitioner NoteLeases

The IRS also provides lease inclusion tables that attempt to apply the section 280F limits to tax-payers who lease vehicles. These tables provide an amount to be included in the taxpayer’s income based on the value of the vehicle in the first calendar year that the vehicle is leased. The amount provided in the table is based on a full year of leasing and 100% business use, so the tax-payer may need to prorate these amounts.

Section 179 Limit on Certain Vehicles (including SUVs)The section 179 deduction is limited to $25,000 for vehicles that are primarily designed to carry passengers, are not subject to section 280F, and have a gross vehicle weight of 14,000 pounds or less, but more than 6,000 pounds. This limit applies to SUVs, but it excludes certain pickup trucks, cargo vans, and buses. Specifically, the limitation does not apply to the following:

■■ Vehicles designed to have a seating capacity of more than 9 persons behind the driver’s seat

■■ Vehicles equipped with a cargo area of at least 6 feet in interior length that is an open area or is designed for use as an open area but is enclosed by a cap and is not read-ily accessible directly from the passenger compartment

■■ Vehicles that have an integral enclosure, fully enclosing the driver compartment and load carrying device; do not have seating rearward of the driver’s seat; and have no body section protruding more than 30 inches ahead of the leading edge of the windshield



Under the TCJA, this trade-in is now a tax-able event and therefore must be reported as two separate transactions.

1. Amos reports the “sale” of his old tractor because a taxable exchange is reportable in the same way as a cash sale. The sale price is the amount received in the exchange. In this case, the sale price is the $112,000 trade-in value. Amos has a $50,738 ($112,000 − $61,262 adjusted basis) taxable gain. Amos reports this gain on Part III of Form 4797, Sales of Business Property, as shown in Fig-ure 9.8. Figure 9.8 shows the 2017 Form 4797, as the 2018 form was not available at the time of this publication.

2. Amos has a $397,000 basis in the 4-wheel-drive tractor, which is the full purchase price. He calculates depreciation or gain or loss on a future sale using this $397,000 basis.

Practitioner NoteAlternate Calculation

In the absence of IRS guidance, this example pre-sumes that the sale price of the 2-wheel-drive tractor is its trade-in value. The IRS could also issue guidance directing that under I.R.C. § 61, the sale price and cost basis include the cash paid. In this example, the sale price would be $397,000 ($112,000 + $285,000), and the cost basis would be $346,262 ($61,262 + $285,000). The calcula-tions would yield the same $50,738 ($397,000 − $346,262) gain.

No Like-Kind Exchange Treatment for Personal Property

The TCJA eliminated tax-free like-kind exchanges for personal property after 2017. I.R.C. § 1031 continues to allow tax-free exchanges of qualify-ing real property. Under prior law, a taxpayer could exchange like-kind equipment, and any realized gain would be recognized only to the extent that cash or unlike property was received in the transaction. Realized gain would be calcu-lated by subtracting the adjusted tax basis of the property given up (plus any exchange expenses) from the FMV of the property received.

The elimination of like-kind exchange treat-ment for personal property means that farmers who trade in a piece of equipment when acquir-ing replacement equipment will now have a reportable tax event. In most cases, this will result in a taxable gain and increased basis in the newly acquired asset. In some cases, the exchange could create a reportable loss.

Example 9.12 Farm Tractor Trade-In

In 2018, Amos Corngrower decides he needs a 4-wheel drive tractor. The tractor’s list price is $397,000. The dealer will take Amos’s 5-year-old, 2-wheel-drive tractor in trade and give Amos a $112,000 trade-in allowance, which reduces the cash price to $285,000 ($397,000 – $112,000). This 2-wheel drive tractor has a $61,262 ($250,000 original cost – $188,738 accumulated deprecia-tion) remaining adjusted tax basis.

Prior to the TCJA, this trade would have qualified as a section 1031 tax-free, like-kind exchange. Amos would not have any taxable or reportable gain. His basis in the new tractor would have been $346,262 ($285,000 cash paid + $61,262 adjusted basis in the old tractor).


No Like-Kind Exchange Treatment for Personal Property 299

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FIGURE 9.8 Form 4797, Reporting Taxable Exchange of Tractor



Single-Purpose Agricultural (Livestock) or Horticultural Facility

Single-purpose agricultural (livestock) or hor-ticultural facilities are in the 10-year MACRS recovery class (15-year life under the ADS). In contrast, general-purpose farm buildings are in the 20-year MACRS recovery class. Buildings used for residential rental purposes or nonfarm business purposes are 27.5-year and 39-year MACRS property, respectively, even if owned by a farmer and located on farm property.

Pursuant to I.R.C. § 168(i)(13), the structure must be a single-purpose livestock or horticul-tural structure (therefore, single-purpose equip-ment storage does not qualify). A single-purpose livestock structure must be specifically designed, constructed, and used for housing, raising, and feeding a particular type of livestock and their pro-duce, and for housing the equipment necessary for that housing, raising, and feeding. A single-purpose horticultural structure is a greenhouse specifically designed, constructed, and used for the commercial production of plants, or a struc-ture specifically designed, constructed, and used for the commercial production of mushrooms.

An enclosure or structure that provides work space is treated as a single purpose agricultural or horticultural structure only if such workspace is solely for

■■ the stocking, caring for, or collecting of live-stock or plants (as the case may be) or their produce;

■■ the maintenance of the enclosure or struc-ture; and

■■ the maintenance or replacement of the equipment or stock enclosed in the structure.

Planning PointerReduction in SE Tax

Taxpayers who are subject to self-employment (SE) tax may benefit from this law change. The taxable gain is reportable on Form 4797. Gen-erally, this gain will be ordinary gain due to the depreciation recapture rules of I.R.C. § 1245. Gains reported on Form 4797 are not subject to SE tax, but the increased depreciable basis will generate additional depreciation deductions which will reduce SE income. However, reduced SE income may impact retirement planning.

As shown in Example 9.12, the tax on equip-ment trades under the TCJA will be offset by deductions from the increased basis in the prop-erty received. The new rules simply introduce a timing consideration, which can generally be addressed by increasing depreciation deductions.

Example 9.13 Increasing Depreciation to Offset Trade-In Gain

Amos from Example 9.12 purchased only the tractor in 2018. He is under the I.R.C. § 179 investment limit of $2,500,000. He can elect a $50,738 expense deduction and eliminate the taxable gain from the trade-in.

Taxpayers may not always be able to imme-diately offset the gain recognized by taxable exchanges. For example, the taxpayer may already be using the maximum $1,000,000 sec-tion 179 deduction or may have exceeded the $2,500,000 investment limit on qualifying pur-chases. Sometimes a taxpayer may not want to use bonus depreciation because it applies to the entire recovery class basis. A decision to use bonus depreciation (now 100%) on the farm equipment class may create more than the opti-mal amount of depreciation expense. Finally, the taxpayer must consider state income taxes. Many states uncouple from bonus depreciation or limit the section 179 deduction. Some states (e.g., New York) provide an investment tax credit that applies to basis after reduction for any sec-tion 179 deduction.


Choosing Section 179 or Bonus Depreciation 301

9

Dan’s state allows the full amount of sec-tion 179 expense but is uncoupled from bonus depreciation. Dan wishes to maximize his deduc-tions for both federal and state purposes. There-fore, Dan will expense the maximum allowed under section 179. His total qualifying pur-chases are $2,800,000 ($2,000,000 + $200,000 + $400,000 + $200,000). Because this exceeds the $2,500,000 section 179 investment limit, Dan must reduce his allowable section 179 deduc-tion by $1 for every $1 over the investment limit, or $300,000 ($2,800,000 qualifying purchases − $2,500,000 investment limit). Dan can claim only $700,000 ($1,000,000 maximum deduction – $300,000 phaseout) of section 179 expense. He can deduct 100% of the $2,100,000 ($2,800,000 – $700,000) remaining basis as bonus deprecia-tion. Alternatively, Dan can elect out of bonus depreciation and use the remaining $2,100,000 for MACRS depreciation.

Practitioner NoteDepreciation Elections

The taxpayer must first subtract the section 179 expense election from the basis of the property, then subtract bonus depreciation. Any remain-ing basis is recovered using the MACRS depre-ciation factor for the property’s recovery class. The taxpayer must make an election to expense under section 179, but the bonus depreciation is automatic. If the taxpayer does not want to claim bonus depreciation, the taxpayer must elect out of bonus depreciation.

Choosing Section 179 or Bonus Depreciation

The TCJA increased bonus depreciation to 100% and applies it to both new and used property. However, there are still some advantages of the section 179 expense deduction. Figure 9.9 com-pares the key elements of section 179 and bonus depreciation.

Example 9.14 Single-Purpose Livestock Structure

Dan Dairyman builds a new dairy facility for $2,000,000. The building houses an additional $200,000 of equipment for feeding the cattle and removing manure. Because the equipment is inci-dental to the care of the cattle, the building is still considered a single-purpose livestock structure and Dan can depreciate it over 10 years (or 15 years under ADS).

Example 9.15 Dual-Purpose Agricultural Structure

Dan from Example 9.14 has a cousin, Don. Don has been a crop farmer for the last 17 years, and he builds a barn identical to Dan’s new barn. He uses only 75% of the barn for dairy cattle and stores crop equipment in the other 25% of the building. Don’s building does not qualify as a single purpose livestock structure. The equip-ment within the building is not used directly in the care of the animals. Because it is a general-purpose farm building, Don must depreciate it over 20 years (or 25 years under ADS).

Single-purpose agricultural (livestock) or hor-ticultural facilities are included in the definition of I.R.C. § 1245 property. As section 1245 prop-erty these structures are included in the defini-tion of section 179 property. These structures are also eligible for bonus depreciation because the MACRS recovery class meets the requirement of 20 years or less.

Example 9.16 Section 179 and Bonus Depreciation

Dan Dairyman, from Example 9.14, built the $2,000,000 dairy facility, and he purchased $200,000 of dairy facility equipment, an addi-tional $400,000 of field equipment, and $200,000 of dairy cows for the milking herd. All assets were placed in service during 2018. All of the assets are included in the definition of section 1245 prop-erty so they are also qualifying property for an expense election under section 179. Because the recovery periods of all acquired assets is 20 years or less, they are subject to 100% bonus deprecia-tion unless Dan elects out. This election is on a recovery-class-by-recovery-class basis.



FIGURE 9.9 Comparison of Section 179 and Bonus Depreciation

Section 179 Bonus Depreciation

General limitations $1M, but reduced $1 for every $1 over the $2.5M investment limit

Unlimited

SUV limitations $25,000 maximum per SUV Unlimited

Business income limit Section 179 expense is limited to taxable business income of the year. Any excess is carried over to offset business income of future years

Unlimited—can be used to offset nonbusiness income or create an NOL

Election Election to expense any part of any qualifying asset

Automatically applies unless taxpayer elects out on a class-by-class basis

Qualifying property Any tangible property or computer software qualifying as section 1245 property, and, at the election of the taxpayer, qualified real property

Depreciable property having a useful life of 20 years or less, water utility property (unless rate-regulated), computer software available to the general public, qualified improvement property

Interaction with TCJA 30% interest deduction limitation

None Property that has had floor plan financing indebtedness does not qualify for bonus depreciation if the interest was taken into account in determining the 30% interest deduction limit

Basis Does not include any basis determined by the basis of other property of the taxpayer at the time of acquisition

Same rules as section 179 for used property, but do not apply to new property

Business use Property must be used more than 50% in a trade or business. Recapture occurs if business use subsequently drops to 50% or less

Bonus depreciation applies to any business portion

Related party rules Section 179 expense is disallowed on related party purchases. Related party is defined under I.R.C. §§ 267 and 707(b) but with limiting the definition of family of an individual to spouse, ancestors, and lineal descendants

Same rules as section 179 for used property, but do not apply to new property

Property leased to others Noncorporate lessor rules may prevent use of section 179

Allowed

Estates and trusts Not available Allowed

I.R.C. § 38 credits No credits allowed for any basis expensed under section 179

Bonus depreciation does not reduce basis for credits

Land improvements— parking lots, fences

Not qualified property Bonus depreciation allowed if recovery period is 20 years or less

Impact of electing out of farm UNICAP

No impact Taxpayer may not use bonus depreciation and must use ADS. The exception is that taxpayers may elect bonus depreciation at the time of planting qualifying vines, fruit, and nut trees under I.R.C. § 168(k)(5) regardless of their decision to apply UNICAP or elect out and use ADS


Election to Expense Costs to Replace Citrus Plants Due to Casualty 303

9

Cross-ReferenceQualified Improvement Property

Qualified improvement property is any improve-ment to an interior portion of a building that is nonresidential real property if the improvement is placed in service after the date the building was first placed in service. Qualified improvement property does not include improvements due to the enlargement of a building, any elevator or escalator, or the internal structural framework of the building. According to the TCJA Confer-ence Committee Report, qualified improvement property was intended to be 15-year property.Proposed regulations specify that qualified improvement property is eligible for bonus depreciation. See the “New Legislation—Busi-ness” chapter in this book for a further discus-sion of the new rules for qualified improvement property.

Example 9.17 Specific Dollar Amount of Depreciation Needed

Herb Aceous has $300,000 net cash income before depreciation. His goal is to have enough depreciation to create a net Schedule F (Form 1040), Profit or Loss From Farming, income of about $10,000. Herb’s depreciation on assets acquired before 2018 is $120,000. His equip-ment purchases for 2018 are $220,000. If Herb does not elect out of bonus depreciation, he will have to expense 100% of the 2018 equipment purchases. This would give him $340,000 total depreciation ($120,000 + $220,000) and create a $40,000 ($300,000 − $340,000) Schedule F (Form 1040) loss. Herb cannot claim bonus depreciation on only some of the equipment. The equipment is all in the 5-year MACRS recovery class (but would be 7-year if it was used equipment), and the election must be made for the entire class.

However, Herb can elect out of bonus depreciation and elect to expense $157,500 under section 179. Herb’s remaining basis in the new equipment will be $62,500 ($220,000 − $157,500). As 5-year property, regular MACRS depreciation will be $12,500 [($62,500 ÷ 5) × 0.5 × 200%]. Herb will therefore reach his Sched-ule F (Form 1040) net income goal of $10,000 ($300,000 − $120,000 depreciation prior year assets − $157,500 section 179 − $12,500 MACRS on new equipment).

Example 9.18 Fruit Grower Subject to UNICAP

Mac Intosh is an apple grower from Michigan. Mac elected out of UNICAP for 2018 so that he could deduct preproductive expenses of his orchard as incurred. Apple production and prices were good this year and Mac’s Schedule F (Form 1040) profit is $200,000 before depreciation on current-year equipment purchases. His current-year equipment purchases were $150,000. How-ever, because Mac elected out of UNICAP, he must use ADS (15-year, SL) to calculate his depreciation and cannot use bonus depreciation. Therefore, his MACRS depreciation is $5,000 [($150,000 ÷ 15) × 0.5)]. Alternatively, Mac can use section 179 to deduct his total basis in this year’s equipment purchases and reduce his net Schedule F (Form 1040) income to $50,000 ($200,000 − $150,000).

Cross-ReferenceUNICAP Rules

See the “Business Issues” chapter in this book for a discussion of the new rules that exempt a tax-payer from using UNICAP if the taxpayer’s aver-age gross receipts are $25,000,000 or less.

Election to Expense Costs to Replace Citrus Plants Due to Casualty

The TCJA modifies I.R.C. § 263A(d)(2)(C) to expand an exception to the requirement that pre-productive expenses of replanting be capitalized.

Generally, the I.R.C. § 263A UNICAP rules require taxpayers to capitalize the preproductive expenses for any nut or fruit producing tree, vine, or plant having a preproductive period greater than 2 years. The taxpayer recovers the capi-talized costs with depreciation deductions that begin when the plant becomes productive in mar-ketable quantities (i.e., sale proceeds sufficient to cover harvesting costs). The taxpayer may elect out of UNICAP but then must use ADS to calcu-late depreciation for all property used predomi-nantly in any farming business of the taxpayer or



1. The taxpayer has an equity interest of at least 50% in the replanted citrus plants at all times during the tax year in which the replanting costs were paid or incurred and such other person holds any part of the remaining equity interest.

2. Such other person acquires all of the taxpay-er’s equity interest in the land on which the lost or damaged citrus plants were located at the time of the loss or damage, and the replanting is on that land.

This provision is effective for amounts paid or incurred after December 22, 2017, and on or before December 22, 2027.

Practitioner NoteCitrus or Almond Grove

The election out of UNICAP does not apply to the preproductive costs of establishing a citrus or almond grove incurred prior to the close of the fourth tax year beginning with the tax year in which the trees were planted in the permanent grove. The exception to the UNICAP rules for replanting after loss or damage applies to only those cost incurred after the first 4 years follow-ing replanting.

ObservationMaterial Participation

The new replanting exception does not require the material participation by the minority equity or new owner. However, this owner must replant on the same land on which the grove was grow-ing prior to the casualty. If the replanting is done by the taxpayer who originally owned the grove, the general exception rules apply, and the replanting may occur on any land in the United States.

Example 9.19 Taxpayer Replants

In 2018, a hurricane destroyed Sonny Kist’s entire grapefruit grove. He spent $225,000 to replant the grove and another $20,000 to main-tain the grove after it was planted. However, Sonny decided that the previous location was too prone to hurricanes, so he moved his operation to a neighboring state. His new grove has the same

related person during a year in which the election is in effect. Even if the taxpayer elects out of UNI-CAP, the cost of acquiring the tree, vine, or plant must be capitalized (but the taxpayers can elect bonus depreciation on these acquisition costs at the time of planting).

I.R.C. § 263A does not apply to costs that are attributable to the replanting, cultivating, main-taining, and developing of any plants bearing an edible crop for human consumption (includ-ing plants that constitute a grove, orchard, or vineyard) if these plants were lost or damaged while owned by the taxpayer and the damage was caused by freezing temperatures, disease, drought, pests, or other casualty. The taxpayer may incur the replanting costs on land other than the land on which the damage or loss occurred, to the extent that the acreage of the land on which the replanting costs are incurred does not exceed the acreage of the land on which the damage or loss occurred. The taxpayer must plant the same type of crop as the lost or damaged crop. The land on which the replanting occurs must be in the United States. Planting density may be differ-ent than the original planting.

The replanting costs may be incurred by a taxpayer other than the one who owned the land at the time the plants were lost or damaged if two conditions are met:

1. The taxpayer that owned the plants at the time the damage or loss occurred owns an equity interest of more than 50% in such plants at all times during the tax year in which the replanting costs are paid or incurred.

2. The minority equity owner who claims the deduction materially participates in the replanting, cultivating, maintaining, or devel-oping of such plants during the tax year in which the replanting costs are paid or incurred. A person will be treated as mate-rially participating by meeting the mate-rial participation requirements under I.R.C. § 2032A(e)(6).

The TCJA adds modified language to the replanting exception requirements for citrus groves. I.R.C. § 263A(d)(2)(C) now allows the replanting of citrus plants by a person other than the person who owned the plants at the time of the casualty if either of the following two condi-tions are met:


General Rules 305

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Example 9.20 Another Taxpayer Replants

Assume that Sonny from Example 9.19 incurred the same expenses. However, he agreed to crop share with Ruby. Ruby paid $110,000 of the replanting. Sonny therefore still has at least 50% [($225,000 – $110,000) ÷ $225,000 = 51%] of the equity in the replants. Under the general rule, Ruby must materially participate to avoid capi-talizing the replanting costs. The new replant-ing exception does not apply because it requires that the replant occur on the same land as the destroyed grove, even if another taxpayer now owns that land.

number of acres as the grove destroyed by the hurricane. Under the general exception to the UNICAP rules, Sonny may deduct the $225,000 replanting costs. He has replanted the same crop, on no greater acres, and within the United States. However, Sonny must capitalize his $20,000 pre-productive expenses because they are incurred within the first 4 years of planting.

ISSUE 3: FARM AND RANCH TAX ELECTIONS This issue explains how and when to make farm and ranch tax elections.

This issue reviews the general rules that are appli-cable to making and revoking elections. Figure 9.10 (later in this issue) shows specific farm and ranch tax elections. For each, it lists the author-ity for the election, how to make the election, the period for which the election is valid, certain criteria for the election, and whether the elec-tion can be revoked. This issue also discusses the farm optional method to calculate self-employ-ment earnings, and the I.R.C. § 165(i) election to deduct a disaster loss for the tax year immedi-ately preceding the tax year in which the disaster occurred.

General Rules

The Internal Revenue Code and federal tax regulations offer alternative tax treatment for hundreds of items of income, deductions, and other tax attributes, including accounting peri-ods and methods. Generally, the taxpayer must choose the tax treatment by making an election, but the procedure to make elections varies sub-stantially. An election may be made affirma-tively on the taxpayer’s income tax return, by default on the taxpayer’s return, or separately from the return. The time for making an elec-tion and the length of the extension (if any) also varies. Elections also have different scope. Some are effective for only a single tax year or a single

item, while others are effective for all future tax years or all similar items. Finally, there are dif-ferent procedures to revoke an election. Some elections are revocable by statute without IRS consent, some only with IRS permission, and some are not revocable at all.

Making ElectionsSome elections happen automatically by statute, and the taxpayer must affirmatively elect out if he or she does not want the election to apply. For example, the installment sale method applies to any sale of property where the taxpayer receives at least one payment after the tax year of the sale. If a sale qualifies as an installment sale, the gain must be reported under the installment method unless the taxpayer elects out of using the install-ment method. To make this election, the tax-payer does not report the sale on Form 6252, Installment Sale Income; instead, the taxpayer reports it on Schedule F (Form 1040), Schedule D (Form 1040), and/or Form 4797, Sales of Busi-ness Property.

Other elections must be affirmatively made. For example, the taxpayer makes the section 179 expense deduction for eligible property by com-pleting Part I of Form 4562, Depreciation and Amortization.

Figure 9.10 shows how to make certain tax elections for farming and ranching taxpayers.


306 ISSUE 3: FARM AND RANCH TAX ELECTIONS

Extensions to Make ElectionsThe following three regulations provide guid-ance for obtaining extensions of time to make or revoke many types of statutory or regulatory elections:

1. Treas. Reg. § 301.9100-1 includes definitions and general standards.

2. Treas. Reg. § 301.9100-2 provides automatic extensions of time to make specified elec-tions. Automatic extensions do not require letter rulings, so user fees do not apply.

3. Treas. Reg. § 301.9100-3 covers extensions that require specific approval from the IRS (letter ruling requests).

Automatic ExtensionsThe length of an automatic extension partially depends on whether the election is regulatory or statutory. A statutory election is one for which the due date is set by statute, and a regulatory election is an election whose due date is prescribed in a Treasury regulation or in a revenue ruling, rev-enue procedure, notice, or announcement pub-lished in the Internal Revenue Bulletin.

An automatic 6-month extension from the original due date of the return is available for many statutory and regulatory elections whose due dates are the due date of the return, including extensions. This gives a taxpayer who filed by the original due date without an extension the same opportunity to make an election that is available to a taxpayer who received the 6-month auto-matic extension of time to file the return.

The criteria for an automatic 6-month exten-sion are as follows:

1. The due date of the election is the due date of the return including extensions.

2. The return is timely filed for the year in which the election should have been made.

3. Corrective action is taken within the 6-month extension period. Under Treas. Reg. § 301.9100-2(c), corrective action means com-plying with the requirements for filing the election that are set forth in the published guidance for that election. If an election must be filed on a tax return, the taxpayer must file an original or amended return and attach the appropriate form or statement for making the election.

4. The election is not one that must be made by the due date of the return excluding extensions.

Any filing used to make the late election (a return, a statement of election, or another form) must include at the top of the document “FILED PURSUANT TO § 301.9100-2.” The election is sent to the same address to which it would have been sent if it had been timely made. This exten-sion is automatic, and there is no need to establish reasonable cause for a failure to timely make the election.

Example 9.21 Automatic 6-Month Extension

Ted E. Bayer, a sole proprietor, filed his 2017 individual income tax return by April 15, 2018. He incurred a $20,000 net operating loss (NOL) in 2017 but did not make the election to forgo the NOL carryback. In September 2018 Ted’s new accountant reviewed his 2017 return and prior-year returns while calculating Ted’s third-quarter-2018 estimated income tax payment. The accountant expects Ted’s 2018 income to be substantially higher than his 2015 and 2016 income, and his AGI will make him subject to the net investment income tax on his interest and dividend income.

Ted may amend his 2017 return by October 15, 2018, to elect to forgo the 2-year carryback period. This will allow Ted to carry the 2017 NOL forward to reduce his 2018 taxable income.

The election is made on a Form 1040X, Amended U.S. Individual Income Tax Return. “FILED PURSUANT TO § 301.9100-2” must be written at the top of Form 1040X. No dollar amounts are needed on the Form 1040X, but Ted must complete the taxpayer identification sec-tion and the explanation of change (the election). Form 1040X and the election statement are sent to the IRS center specified in the Form 1040X instructions for Ted’s state of residence.

An automatic 12-month extension from the otherwise applicable due date is available for regulatory elections specified in Treas. Reg. § 301.9100-2(a)(2). The taxpayer must take cor-rective action within the extension period, which is 12 months from the due date for the election. If the taxpayer obtained an extension of time to file the original return, the 12-month period begins


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on the extended due date of the return. The auto-matic 12-month extension of time to make the election is available even if the taxpayer failed to timely file the related return.

Example 9.22 Automatic 12-Month Extension

Green Tree Pastures Homeowners’ Association maintains its books on a calendar-year basis. In December 2017 its officers changed. Its 2017 Form 1120-H, U.S. Income Tax Return for Homeowners Associations, was not filed by the March 16, 2018, due date, and the association did not request an extension of time to file. The failure to file a return was discovered in October 2018. Green Tree Pastures can make a late I.R.C. § 528 election to be taxed as a homeowners’ asso-ciation by filing Form 1120-H for 2017 no later than March 16, 2019. “FILED PURSUANT TO § 301.9100-2” must be written at the top of Form 1120-H.

Practitioner NoteReturn Filing Due Date Not Affected

The extension of time to file the election is not an extension of time to file the return. In Example 9.22, if Green Tree Pastures’ Form 1120-H shows a tax liability, the IRS will assess penalties and inter-est based on the amount of unpaid tax due. The penalties may be abated if Green Tree Pastures shows reasonable cause for the late filing.

Extensions Requiring ConsentTreas. Reg. § 301.9100-3 provides the IRS with discretion to grant extensions for regulatory elec-tions that do not qualify for automatic exten-sions. The IRS may grant these extensions if the taxpayer has acted reasonably and in good faith and if the interests of the government are not prejudiced.

A request for nonautomatic IRS approval of an extension of time to make an election is a request for a letter ruling from the IRS National Office. Guidance for obtaining a private letter ruling on an income tax matter is updated annu-ally in the first revenue procedure of the year. The current version is Rev. Proc. 2018-1, 2018-1 I.R.B. 1.

Treas. Reg. § 301.9100-3(b)(1) provides that a taxpayer is deemed to have acted reasonably and in good faith if the taxpayer

1. requests the relief before the IRS discovers that the election was not made;

2. failed to make the election because of events beyond his or her control;

3. despite due diligence, was unaware of the need to make the election;

4. reasonably relied upon the written advice of the IRS; or

5. reasonably relied upon a qualified tax profes-sional who failed to make, or advise the tax-payer to make, the election. (If the taxpayer knew or should have known that the tax pro-fessional was not qualified to render advice about the election or was not aware of the relevant facts, then the taxpayer’s reliance on the tax professional is not reasonable.)

Treas. Reg. § 301.9100-3(b)(3) provides that a taxpayer is deemed to have not acted reason-ably and in good faith if the taxpayer

■■ uses hindsight in requesting relief,

■■ knew of the election and its consequences and chose not to file it timely, or

■■ seeks to alter a return position for which an accuracy-related penalty has been or could be imposed at the time the taxpayer requests relief (considering any qualified amended return) and the new return position requires or permits the election for which relief is requested.

The interests of the government are preju-diced if the taxpayer’s tax liability, with the relief, is lower for all tax years affected by the elec-tion than it would have been if the election had been timely made (considering the time value of money) [Treas. Reg. § 301.9100-3(c)(1)]. If the request affects a tax year that is closed for assess-ment, the interests of the government are also deemed to be prejudiced.

Treas. Reg. § 301.9100-3(e) imposes several procedural requirements for extensions to make elections. The taxpayer must prove that he or she acted reasonably and in good faith and that the interests of the government will not be prejudiced by granting the extension. In addition, the tax-payer must comply with the following:



1. The taxpayer must follow all procedures applicable to requesting a letter ruling, and the request must be accompanied by the applicable user fee.

2. A detailed affidavit must set forth the reasons and circumstances for the failure to make the regulatory election. The affidavit must be based on the personal knowledge of the tax-payer and signed under penalties of perjury.

3. Crucial facts within the personal knowledge of other individuals must also be supported by affidavits from those individuals.

4. The taxpayer must state whether the return for which the election should have been made is under examination by the IRS or under consideration by an appeals office or a federal court.

5. The request must state when the return or other document claiming the election was required to be filed and when it was actually filed.

6. The taxpayer must include copies of all docu-ments that refer to the election.

The IRS may require a copy of the taxpayer’s return for the tax year for which the extension is requested and copies of returns for all other years affected by the election. If the election will affect other taxpayers, the taxpayer may also be required to provide copies of the related returns.

Revocation of ElectionsWhen elections affect not only the tax year in which the election is made but also all future tax years, the statute or the applicable regulations generally provide a procedure to revoke the elec-tion. Some elections, however, are irrevocable. For elections that are revocable, some may be revoked without IRS consent and others require consent. If IRS consent is required to revoke an election, an automatic consent is sometimes avail-able. Rev. Proc. 2018-31, 2018-22 I.R.B. 634, lists accounting changes for which IRS consent is automatic. Figure 9.10 shows which farm and ranch elections are revocable without consent, and which require IRS consent.

Cross-ReferenceElections Affecting Only One Tax Year

For elections that affect only one tax year, revoca-tion may be more difficult to determine because the question often has not been addressed by the Internal Revenue Code, Treasury, or the IRS. Elec-tions generally must be made by the due date of the return, and most election deadlines include any filing extension. Seemingly, a revocation must be made by the same deadline. See page 196 of the 2014 National Income Tax Workbook for a discussion of revocation of elections that affect only one tax year.

Table of Elections for Farming and Ranching Taxpayers

Figure 9.10 summarizes several elections for farm and ranch businesses. For each, it lists the authority for the election, how to make the elec-tion, the period for which the election is valid, certain criteria for the election, and whether the election can be revoked.


Table of Elections for Farming and Ranching Taxpayers 309

9

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, p. 3

21

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■■ A statement that the taxpayer is making an I.R.C. § 165(i) election

■■ The name or a description of the disaster and date or dates of the disaster that gave rise to the loss

■■ The address (including the city, town, county, parish, state, and zip code) where the damaged or destroyed property was located at the time of the disaster

For an election made on an original federal tax return, a taxpayer provides this information on Form 4684, Casualties and Thefts. A taxpayer filing an original federal tax return electronically may attach a statement as a PDF document if there is insufficient space on Form 4684 to pro-vide the information.

For an election made on an amended federal tax return, a taxpayer may provide the required information by any reasonable means. The tax-payer should write “Section 165(i) Election” on the top of Form 4684 and provide the rest of the information required in either the Explanation of Changes in Form 1040X, Amended U.S. Individ-ual Income Tax Return; Form 1120X, Amended U.S. Corporation Income Tax Return; or another appropriate form; or directly on the Form 4684, attaching a statement if there is insufficient room on the form.

A taxpayer may not make a section 165(i) election for a disaster loss if the loss is claimed as a deduction for the disaster year. If a taxpayer has claimed a deduction for a disaster loss in the disaster year and the taxpayer wishes to make a section 165(i) election for the loss, the taxpayer must file an amended return to remove the previ-ously deducted loss. The amended return must be filed by the date that the taxpayer files the return or amended return for the preceding year that includes the section 165(i) election.

Similarly, a taxpayer may not revoke a pre-viously made section 165(i) election and deduct the loss in the disaster year unless the taxpayer files an amended return to remove the loss for the preceding year. The amended return remov-ing the section 165(i) election must be filed on or before the date that the taxpayer files the return or amended return for the disaster year that includes the loss. A taxpayer that is required to file an amended return under this section must pay or make arrangements to pay any additional tax and

Cross-ReferenceAccounting Methods

The Tax Cuts and Jobs Act of 2017 (TCJA), Pub. L. No. 115-97, allows small business taxpayers to use the cash method of accounting, expands the types of farming C corporations (and farming partnerships with a C corporation partner) that may use the cash method, exempts certain tax-payers from the requirement to keep inventories, expands the exception for small taxpayers from the uniform capitalization rules, and expands the exception for small construction contracts from the requirement to use the percentage-of-com-pletion method. See the “Business Issues” chap-ter in this book for additional information. See also the “New Legislation—Additional” chapter in this book for a discussion of Rev. Proc. 2018-40, I.R.B. 2018-34, which provides procedures for a small business taxpayer to obtain automatic con-sent to change its method of accounting to a new method established under the TCJA.

Election to Deduct Disaster Losses

Rev. Proc. 2016-53, 2016-44 I.R.B. 530, contains rules and procedures regarding requirements for making and revoking the election under I.R.C. § 165(i) to deduct a disaster loss for the tax year immediately preceding the tax year in which the disaster occurred. This revenue procedure applies to any I.R.C. § 165(i) elections, revoca-tions, and other related actions that can be made or taken on or after October 13, 2016.

A taxpayer makes a section 165(i) election by deducting the disaster loss on either an original federal tax return or an amended federal tax return for the preceding year. The original or amended return must be filed no later than 6 months after the original due date for the taxpayer’s federal tax return for the disaster year (determined without regard to any extension of time to file) [Treas. Reg. § 1.165-11T(f)]. The taxpayer does not have to request an extension of time to file the federal tax return for the disaster year to use the due date identified in the temporary regulations.

A taxpayer must include with the return an election statement containing the following:


Farm Optional Method 315

9

A taxpayer farmer may use the farm optional method to calculate net earnings from farm self-employment if the gross farm income is $7,920 (for 2018) or less or the net farm profits are less than $5,717 (for 2018). These amounts are indexed for inflation each year.

Gross farm income is the total of the amounts from Schedule F (Form 1040), line 9, (gross income); and Schedule K-1 (Form 1065), box 14 [self-employment earnings (loss)], code B (gross farming or fishing income). Net farm profits are the total of the amounts from 2017 Schedule F (Form 1040), line 34 [net farm profit or (loss)]; and 2017 Schedule K-1 (Form 1065), box 14, code A [net earnings (loss) from self-employment].

To calculate net earnings using the regu-lar method, a farmer multiplies SE earnings by 92.35%. To calculate net earnings from self-employment under the farm optional method, the taxpayer calculates the following:

1. If gross farm income is $7,920 (for 2018) or less, net earnings equal two-thirds of gross farm income.

2. If gross farm income is more than $7,920 (for 2018), then net earnings are $5,280 (for 2018).

The net earnings are reported on Schedule SE (Form 1040), Part II, line 15.

The election to use the farm optional method is made each year by completing line 4b, Part I, Form 1040, Schedule SE. Taxpayers can make or revoke the election by filing an amended return.

Example 9.23 Farm Optional Method

Barry Cash is engaged in the business of farm-ing and computes income under the accrual method. Barry’s income tax returns are filed on the calendar year basis. For the year 2018, Bar-ry’s gross income from the operation of his farm is $6,000. His actual net earnings from the farm were $3,000. Barry can report the $3,000 actual net earnings, or, using the optional method, Barry may report $4,000 ($6,000 × 2/3) net earnings.

interest due as a result of removing the duplicative disaster loss deduction on the amended return.

A taxpayer may revoke a previously made section 165(i) election by filing an amended return for the preceding year that contains a revocation statement including the following information:

■■ A statement clearly showing that the election is being revoked

■■ The name or a description of the disaster and date or dates of the disaster for which the election was originally claimed

■■ The address (including the city, town, county, parish, state, and zip code) where the damaged or destroyed property was located at the time of the disaster and for which the taxpayer originally claimed the election

A taxpayer may revoke the election on or before the date that is 90 days after the due date for making the election. A taxpayer may provide the information required in either the Explana-tion of Changes in Form 1040X, Form 1120X, or another appropriate form or on a statement attached to the amended return.

Farm Optional Method

Self-employed taxpayers in the business of farm-ing may be able to calculate net earnings from self-employment using the farm optional method. The farm optional method may increase self-employment (SE) tax, which enables farmers with low income in a tax year to qualify for higher social security benefits. It may also increase earned income to make the taxpayer eligible for child, dependent care, and/or earned income credits. Farmers may elect the farm optional method even if they have a net loss from farming.

Practitioner NoteQuarters of Coverage

To qualify for Social Security retirement bene-fits, a worker born in 1929 or later must have 40 credits. This equals 10 years of work. The amount of earnings required for one quarter of credit in 2018 is $1,320, and the taxpayer can receive a maximum of 4 credits per year regardless of whether the employee/owner worked in all four quarters.


316 ISSUE 4: FARM LEASE INCOME AND THE QBI DEDUCTION

that commonly for legal or other nontax reasons taxpayers may segregate rental property from operating businesses. Solely for purposes of sec-tion 199A, the rental or licensing of tangible or intangible property to a related trade or busi-ness is treated as a trade or business if the rental or licensing and the other trade or business are commonly controlled under Prop. Treas. Reg. § 1.199A-4(b)(1)(i). This rule allows taxpayers to aggregate their trades or businesses with the asso-ciated rental or intangible property regardless of whether the rental activity and the trade or busi-ness are otherwise eligible to be aggregated under Prop. Treas. Reg. § 1.199A-4(b)(1).

The Internal Revenue Code and the regu-lations do not provide one general definition of trade or business. The determination of whether a trade or business exists is a facts and circum-stances test, but generally, the taxpayer must have a profit motive and some regular and con-tinued involvement in the activity. To be a trade or business for purposes of section 162, the tax-payer must be involved in the activity with con-tinuity and regularity and the taxpayer’s primary purpose for engaging in the activity must be for income or profit [Commissioner v. Groetzinger, 480 U.S. 23 (1987)].

Cross-ReferenceTrade or Business

See the “Trade or Business” chapter of the 2015 National Income Tax Workbook for a full discus-sion of the meaning of the term trade or business as it is used in several provisions in the Internal Revenue Code. See also the “Business Issues” chapter in this book for a discussion of how the QBI deduction applies to nonfarm rental income.

Income from Rental of Farm Property

A farm rental activity is a trade or business that qualifies for the QBI deduction if it is conducted regularly and with a profit motive, regardless of

ISSUE 4: FARM LEASE INCOME AND THE QBI DEDUCTION Farm lease income may be eligible for the QBI deduction.

Farm lease income from a trade or business is eligible for the I.R.C. § 199A qualified business income (QBI) deduction.

General Rules for QBI

For tax years after December 31, 2017, a taxpayer other than a corporation can deduct up to 20% of QBI from a partnership, S corporation, or sole proprietorship. Qualified business income (QBI) is the net amount of qualified items of income, gain, deduction, and loss with respect to any qualified trade or business of the taxpayer.

Cross-ReferenceI.R.C. § 199A

See the “New Legislation—Business” and the “Business Issues” chapters in this book for a com-prehensive discussion of the QBI deduction under section 199A, the limits on that deduction, and how the QBI deduction applies to nonfarm rental income. See also the “New Legislation—Addi-tional” chapter in this book for a discussion of the proposed regulations under section 199A.

Qualified items of income, gain, deduction, and loss means items of income, gain, deduction, and loss to the extent such items are effectively con-nected with the conduct of a trade or business in the United States and are included or allowed in determining taxable income for the tax year. A taxpayer in the trade or business of farm leasing may be eligible for the QBI deduction as a quali-fied trade or business, subject to other limitations governing the QBI deduction.

Trade or Business

Prop. Treas. Reg. § 1.199A-1(b) defines a trade or business with reference to I.R.C. § 162. Thus, a trade or business means a section 162 trade or business other than the trade or business of per-forming services as an employee. However, the preface to the proposed regulations acknowledges


Income from Rental of Farm Property 317

9

If the landlord periodically advises or consults with the tenant and periodically inspects the pro-duction activities on the land, the landlord may be able to show material participation. Material participation may also be shown if the landlord

■■ furnishes a large portion of the machinery, tools, and livestock used in the production of the commodities, or

■■ furnishes or advances money, or assumes financial responsibility, for a substantial part of the expense involved in the production of the commodities.[Treas. Reg. § 1.1402(a)-4]

The following four tests are used to deter-mine whether a landlord materially participates in either production or management of produc-tion on leased land:

1. A landlord is considered to materially par-ticipate by doing any three of the following:a. Pay, using cash or credit, at least half

the direct costs of producing the crop or livestock.

b. Furnish at least half the tools, equipment, and livestock used in the production activities.

c. Advise or consult with the tenant.d. Inspect production activities periodically.

2. The landlord regularly and frequently makes, or takes an important part in making, man-agement decisions substantially contributing to or affecting the success of the enterprise.

3. The landlord works 100 hours or more spread over a period of 5 weeks or more in activities connected with agricultural production.

4. The landlord does things that, considered in their totality, show material and significant involvement in the production of the farm commodities.[IRS Publication 225, Farmer’s Tax Guide]

A landowner who completely turns over management of the land to an agent, such as a professional farm management company, and does not otherwise materially participate in the farming operation, does not have SE income from renting land for agricultural use [Treas. Reg. § 1.1402(a)-4(b)(5)] but can still claim the QBI deduction if the purpose of the rental is income

the type of the lease and the type of services that the landlord provides. Special rules apply to self-rentals. Although farm rental income may be eli-gible for the QBI deduction, it may not be subject to self-employment (SE) tax, and it may be a pas-sive activity.

Cash LeaseUnder a cash rent lease, the farm tenant gener-ally pays a cash sum (usually on a per-acre basis) to the landlord in exchange for renting the farm ground. Because there typically is no material participation, rent received by a landlord under a cash rent lease is rental income, not subject to SE tax [I.R.C. § 1402(a)(1)]. However, even if the landlord does not materially participate, and the income is not subject to SE tax, a farm rental activity that is conducted regularly and for profit is typically a trade or business and is eligible for the QBI deduction.

If farm rental activity is a trade or business, farm rental income is reported on Schedule F (Form 1040) and Schedule SE (Form 1040), and any QBI deduction will offset the income tax on the rental income (but not the SE tax). Farm lease rents are included in SE income if

1. the income is derived under an arrangement between the lessor and tenant that provides that the tenant will produce agricultural or horticultural commodities on the land, and the lessor will materially participate in the production, or management of the produc-tion; and

2. the lessor materially participates with respect to the commodity.

Production refers to the physical work per-formed, and the expenses incurred in produc-ing a commodity. It includes activities such as the actual work of planting, cultivating, and har-vesting crops, and the furnishing of machinery, implements, seed, and livestock. Management of the production refers to services performed in making managerial decisions about the produc-tion of the crop (such as when to plant, cultivate, dust, spray, or harvest) and includes advising and consulting, making inspections, and making deci-sions on matters, such as rotation of crops, the type of crops to be grown, the type of livestock to be raised, and the type of machinery and imple-ments to be furnished.


318 ISSUE 4: FARM LEASE INCOME AND THE QBI DEDUCTION

The Tax Court, reversing its holding in previ-ous similar cases, held that the IRS failed to show a sufficient nexus between the rental income and the taxpayers’ obligations to participate in the production or management of the production of agricultural commodities. Therefore, the rent the taxpayers received pursuant to the lease was not includable in their net SE income.

Conservation Reserve Program Payments The United States Department of Agriculture (USDA) Conservation Reserve Program (CRP) is a voluntary conservation program administered by the Farm Service Agency (FSA) for land that has been used for farming or ranching. Taxpayers who are owners and operators of environmentally sensitive land enter into a 10- to 15-year contract under which they agree to implement a conser-vation plan. Typically, taxpayers agree to refrain from using the land for farming and ranching, to plant and maintain species to improve environ-mental quality, and to perform certain services to control weeds and pests. In exchange, taxpayers receive an annual rental payment for each year of the contract and cost-sharing payments for cer-tain costs of carrying out the conservation plan. These CRP “rental” payments are eligible for the QBI deduction if the rental is conducted regu-larly and for profit, regardless of whether they are subject to SE tax.

In Notice 2006-108, 2006-51 I.R.B. 1118, the IRS concluded that CRP payments are subject to SE tax. Since then, the 2008 Farm Bill, the Tax Court, and the US Court of Appeals for the Eighth Circuit have addressed SE tax on CRP payments.

Notice 2006-108 includes a proposed rev-enue ruling that holds that CRP rental payments (including incentive payments) are included in net earnings from self-employment if they are paid to either of the following recipients:

1. A farmer actively engaged in the trade or business of farming who enrolls land in the CRP and fulfills the CRP contractual obliga-tions personally

2. An individual not otherwise actively engaged in the trade or business of farming who enrolls land in the CRP and fulfills his or her CRP contractual obligations by arranging for a third party to perform the required activities

or profit. A triple net lease arrangement, where the tenant pays the taxes, insurance, and mainte-nance, may not give rise to material participation, and it may not qualify for the QBI deduction.

Self-RentalThe section 199A proposed regulations follow the definition of trade or business used for sec-tion 162 purposes, but specifically allow for self-rentals. Thus, for purposes of the QBI deduction, the rental of farm land to a related trade or busi-ness is treated as a trade or business if the rental and the other trade or business are commonly controlled.

Under the passive loss rules, income earned from a rental activity is (with some exceptions) generally passive income, regardless of whether the taxpayer is actively involved in the rental activity [I.R.C. § 469(c)(2)]. This rule prevents taxpayers from offsetting active income with pas-sive rental income losses. If the property is rented for use in a trade or business activity in which the taxpayer materially participates, the self-rental rule recharacterizes net rental income as non-passive. To qualify under the self-rental rule, the taxpayer must receive rental income for property that is rented for use in a trade or business activity in which the taxpayer materially participates, and not incidental to a development activity.

The IRS has ruled, and the Tax Court has held that, where a landowner rents farmland to a partnership owned by the landowner and family members and the landowner participates in the partnership’s farming activities under the partner-ship agreement, the landowner’s rental income is subject to SE tax as a trade or business. A similar outcome resulted from leasing farm land to a cor-poration where the landowner was an employee and shareholder of the corporation.

In Martin v. Commissioner, 149 T.C. No. 12 (2017), the taxpayers owned a farm, and rented a portion of the land to a wholly owned S cor-poration. The S corporation contracted with an unrelated entity to raise chickens according to the entity’s exacting specifications. The taxpayers followed the entity’s specific instructions to build structures designed only to raise the entity’s chick-ens. The S corporation paid the taxpayers wages for their labor and rent for the use of the farm and structures. The IRS asserted that the rent was subject to SE tax pursuant to I.R.C. § 1402(a)(1).


Taxation of Cooperatives and Their Patrons 319

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For taxpayers in the Eighth Circuit, the More-house case is the current law, and CRP payments for the nonfarmer should not be subject to SE tax. Outside the Eighth Circuit, CRP payments are subject to SE tax unless the payments are made to a taxpayer collecting social security benefits.

Crop ShareA crop share lease is generally an arrangement under which the landlord agrees to rent farm-land to the tenant in exchange for a share of the crop. The SE tax treatment of income earned by a landlord under a crop share lease depends on the landlord’s level of participation in the farming activities governed by the lease. If the landlord materially participates under the lease, the lease income is subject to SE tax [I.R.C. § 1402(a)(1)]. If the landlord does not materially participate, the income is not subject to SE tax. (See the earlier discussion of the tests for material participation.) If the crop share lease is a bona fide lease entered into regularly and for income or profit, it will be eligible for the QBI deduction.

The Food, Conservation, and Energy Act of 2008 (the 2008 Farm Bill), Pub. L. No. 110-234, § 15301, amended I.R.C. § 1402(a)(1) to exclude CRP payments from the definition of net earn-ings from self-employment if the CRP payments are made to individuals receiving benefits under section 202 (old-age and survivors) or section 223 (disability) of the Social Security Act. Thus, indi-viduals receiving the specified social security payments do not include CRP payments in net earnings from self-employment, and the taxpay-er’s participation in the required CRP activities or in the farming operation does not make the CRP payment subject to SE tax.

The Eighth Circuit has held that CRP pay-ments to nonfarmers are rental income, not SE income [Morehouse v. Commissioner, 769 F.3d 616 (8th Cir. 2014)]. In its Action on Decision 2015-02, the IRS states that it does not acquiesce with the court’s holding in Morehouse [A.O.D. 2015-02, 2015-41 I.R.B. 493 (October 13, 2015)].

ISSUE 5: SECTION 199A AND AGRICULTURAL AND HORTICULTURAL COOPERATIVES This section discusses the QBI deduction for sales through cooperatives.

The Tax Cuts and Jobs Act of 2017 (TCJA), Pub. L. No. 115-97, repealed the I.R.C. § 199 domes-tic production activities deduction (DPAD) for tax years after December 31, 2017. Instead, the TCJA gives cooperative patrons a deduction equal to 20% of the gross income of a specified agricultural or horticultural cooperative less qualified cooperative dividends paid during the tax year. By granting a deduction based on gross income, Congress unintentionally provided a potentially higher deduction for a farmer who sells to a cooperative.

For tax years after December 31, 2017, the Consolidated Appropriations Act (CAA), 2018, Pub. L. No. 115-141, modifies the deduction for qualified business income of a specified agricul-tural or horticultural cooperative under I.R.C. § 199A(g) to instead provide a deduction for qual-ified production activities income (QPAI) of a specified agricultural or horticultural cooperative

that is like the deduction for QPAI under former section 199.

This section reviews the taxation of coopera-tives and their patrons and explains the new sec-tion 199A deduction for cooperatives. It discusses calculation of the deduction at the cooperative level, allocation to patrons of the cooperative, and changes to the rules for how patrons calculate the deduction at the individual level. It provides comprehensive examples showing the calculation of a cooperative patron’s section 199A deduction.

Taxation of Cooperatives and Their Patrons

Certain corporations are eligible to be treated as cooperatives and taxed under the special rules of subchapter T (Cooperatives and Their Patrons) of the Internal Revenue Code [I.R.C.


320 ISSUE 5: SECTION 199A AND COOPERATIVES

of earnings from business done with or for other patrons to whom no amounts are paid, or to whom smaller amounts are paid for substantially identical transactions. A patronage dividend may include the following:

■■ Money■■ The stated dollar value of qualified written notices of allocation (defined later)

■■ The fair market value (FMV) of other property

Written Notice of AllocationA written notice of allocation means any capital stock, revolving fund certificate, retain certificate, certificate of indebtedness, letter of advice, or other written notice, that discloses to the recipient the stated dollar amount allocated to him or her by the cooperative and the portion of the alloca-tion, if any, that is a patronage dividend. A notice of allocation can be qualified or nonqualified.

Qualified Written Notice of AllocationA qualified written notice of allocation means a writ-ten notice of allocation that can be redeemed in cash at its stated dollar amount for a period that is not less than 90 days from the date the alloca-tion is paid. The distributee must receive written notice of the right of redemption at the time he or she receives the written notice of allocation.

A qualified written notice of allocation is also a written notice of allocation that the distributee has consented to take into account at its stated dollar amount. It does not include a written notice of allocation that is paid as part of a patron-age dividend or as part of a payment described in section 1382(c)(2)(A) (certain payments made on a patronage basis), unless 20% percent or more of the amount of the patronage dividend or the payment is paid in money or by qualified check.

Nonqualified Written Notice of AllocationA nonqualified written notice of allocation means a written notice of allocation that is not a qualified written notice of allocation and is not a qualified check that is not cashed on or before the ninetieth day after the end of the payment period for the tax year for which the distribution is paid [I.R.C. § 1388(d)].

§§ 1381–1388]. In general, the subchapter T rules apply to any corporation operating on a coopera-tive basis (except mutual savings banks, insur-ance companies, most tax-exempt organizations, and certain utilities).

For federal income tax purposes, a coopera-tive subject to the cooperative tax rules of sub-chapter T generally calculates its income as if it was a taxable corporation, except that, in deter-mining its taxable income, the cooperative does not include certain amounts paid for the tax year, such as

1. patronage dividends, to the extent paid in money, qualified written notices of alloca-tion, or other property (except nonqualified written notices of allocation) with respect to patronage occurring during the tax year; and

2. per-unit retain allocations, to the extent paid in money, qualified per-unit retain certifi-cates, or other property (except nonqualified per unit retain certificates) with respect to marketing occurring during the tax year.[I.R.C. § 1382(b)]

Because a patron of a cooperative who receives patronage dividends or per-unit retain allocations generally must include such amounts in gross income, excluding patronage dividends and per-unit retain allocations paid by the coop-erative from the cooperative’s taxable income in effect allows the cooperative to be a conduit for profits derived from transactions with its patrons.

Patronage Dividend I.R.C. § 1388(a) defines a patronage dividend as an amount a cooperative pays to its patron

1. based on quantity or value of business done with or for such patron;

2. under an obligation of the cooperative to pay this amount, and the obligation existed before the cooperative received the amount paid; and

3. that is determined by reference to the cooper-ative’s net earnings from business done with or for its patrons.

A patronage dividend does not include an amount paid to a patron to the extent that the amount is out of earnings of business that is not done with or for patrons, or the amount is out


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Former Section 199A

Former section 199A gave an advantage to doing business with a cooperative instead of a nonco-operative entity. Cooperative patrons could take a 20% qualified business income (QBI) deduc-tion from the gross cooperative dividends. Con-versely, sales to a noncooperative entity are eligible for a QBI deduction based on the tax-payer’s net income (gross sales minus expenses).

New Section 199A Deduction

Effective for tax years after December 31, 2017, the CAA § 101 modifies the QBI deduction of a specified agricultural or horticultural coopera-tive under I.R.C. § 199A(g) to instead provide a deduction for QPAI income of a specified agri-cultural horticultural cooperative that is similar to the deduction for QPAI income under former section 199.

The CAA provides a deduction from tax-able income that is equal to 9% of the lesser of the cooperative’s QPAI or taxable income [deter-mined without regard to the cooperative’s section 199A(g) deduction and any deduction allowed under I.R.C. §§ 1382(b) and (c) relating to patron-age dividends, per-unit retains allocations, and nonpatronage distributions)]. The amount of the deduction is limited to 50% of the W-2 wages paid by the cooperative. For this purpose, W-2 wages are determined in the same manner as under the other provisions of section 199A, except that wages do not include any amount that is not properly allocable to domestic production gross receipts. W-2 wages do not include any remuner-ation paid for services in Puerto Rico.

For oil-related QPAI, the section 199A(g) deduction is reduced by 3% of the least of the cooperative’s oil-related QPAI, QPAI, or tax-able income [determined without regard to the cooperative’s section 199A(g) deduction and any deduction allowed under sections 1382(b) and (c) relating to patronage dividends, per-unit retain allocations, and nonpatronage distributions]. For this purpose, oil-related QPAI for any tax year is the portion of QPAI attributable to the produc-tion, refining, processing, transportation, or distri-bution of oil, gas, or any primary product thereof.

Per-Unit Retain AllocationA per-unit retain allocation is any allocation by a cooperative to a patron for products sold by the cooperative for the patron. The amount of the allocation must be fixed without reference to the net earnings of the cooperative, and pursuant to an agreement between the cooperative and the patron.

Per-Unit Retain CertificateA per-unit retain certificate is any written notice that discloses to the recipient the stated dollar amount of a per-unit retain allocated to him or her by the cooperative. A qualified per-unit retain certifi-cate means any per-unit retain certificate that the distributee has agreed to take into account at its stated dollar amount pursuant to I.R.C. § 1388(h). A nonqualified per-unit retain certificate is a per-unit retain certificate that is not a qualified per-unit retain certificate.

Former Section 199

Former section 199 provided a deduction from taxable income (or, for an individual, adjusted gross income) that was equal to 9% of the lesser of the taxpayer’s qualified production activities income (QPAI) or taxable income (determined without regard to the section 199 deduction) for the tax year. The deduction was limited to 50% of the W-2 wages paid by the taxpayer and properly allocable to domestic production gross receipts.

W-2 wages were the total wages subject to wage withholding, elective deferrals, and deferred compensation paid by the taxpayer with respect to employment of its employees. W-2 wages did not include any amount that was not properly allocable to domestic production gross receipts. In addition, W-2 wages did not include any amount that was not properly included on a return filed with the Social Security Administra-tion on or before the sixtieth day after the due date (including extensions) for such return [I.R.C. § 199(b)(2)(C)].



2. Other expenses, losses, or deductions that are properly allocable to such receipts

Cross-ReferenceFormer Section 199

While the TCJA repeals the domestic produc-tion activities deduction (DPAD), the new section 199A deduction for cooperatives is similar to the DPAD. In addition, the IRS has been directed to provide regulations that address the proper allo-cation of items of income, deduction, expense, and loss for purposes of determining QPAI, and the regulations will be based on the regulations applicable to cooperatives and their patrons under former section 199 (as in effect before its repeal). See the “Domestic Production Activities Deduction” chapter in the 2016 National Income Tax Workbook for a discussion of former section 199.

Special RulesAll members of an expanded affiliated group are treated as a single corporation and the deduction is allocated among the members of the expanded affiliated group in proportion to each member’s respective amount, if any, of QPAI. An expanded affiliated group generally follows the definition in I.R.C. § 1504(a), except that the owners must pos-sess more than 50% of the voting power and stock value (not 80%).

In addition, for purposes of determining DPGR, if all the interest in the capital and profits of a partnership are owned by members of a sin-gle expanded affiliated group at all times during the partnership’s tax year, the partnership and all members of the group are treated as a single tax-payer. For a specified agricultural or horticultural cooperative that is a partner in a partnership, rules like the rules applicable to a partner in a partnership under section 199A(f)(1) apply.

Cross-ReferenceQBI Deduction for Partners and

ShareholdersSee the “Business Issues” chapter in this book for a discussion of a how a partnership and an S cor-poration allocate QBI items to their owners, and how the partners and shareholders calculate QBI at the individual level.

Specified Agricultural or Horticultural CooperativeThe CAA limits the definition of specified agricul-tural or horticultural cooperative to organizations to which part I of subchapter T applies. The organi-zation must be engaged in either of the following:

1. The manufacture, production, growth, or extraction, in whole or significant part, of any agricultural or horticultural product

2. The marketing of agricultural or horticultural products that its patrons have manufactured, produced, grown, or extracted

The definition no longer includes a coop-erative that is engaged solely in the provision of supplies, equipment, or services to farmers or other specified agricultural or horticultural cooperatives.

Domestic Production Gross ReceiptsDomestic production gross receipts (DPGR) gen-erally are a cooperative’s gross receipts from a lease, rental, license, sale, exchange, or other dis-position of any agricultural or horticultural prod-uct that was manufactured, produced, grown, or extracted by the cooperative in whole or in sig-nificant part in the United States. The coopera-tive is treated as having manufactured, produced, grown, or extracted in whole or significant part any agricultural or horticultural products mar-keted by the cooperative if such items were manufactured, produced, grown, or extracted in whole or significant part by its patrons.

DPGR do not include any gross receipts of the cooperative from property leased, licensed, or rented for use by any related person. In addi-tion, DPGR do not include gross receipts from the lease, rental, license, sale, exchange, or other disposition of land.

Qualified Production Activities IncomeIn general, qualified production activities income (QPAI) is DPGR reduced by the sum of the following:

1. The cost of goods sold that are allocable to such receipts


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Treatment of Cooperative Patrons

The CAA repeals the former section 199A deduc-tion for qualified cooperative dividends. In addi-tion, it repeals the rule that excludes qualified cooperative dividends from qualified business income of a qualified trade or business. It clari-fies that items of income excluded from qualified items of income, and thus excluded from quali-fied business income, do not include any amount described in section 1385(a)(1) (i.e., patron-age dividends). Accordingly, qualified business income of the qualified trade or business includes any patronage dividend, per-unit retain alloca-tion, qualified written notice of allocation, or any other similar amount received from a coopera-tive, if the amount is otherwise a qualified item of income, gain deduction, or loss.

The new section 199A deduction for the qualified trade or business of a patron of a speci-fied agricultural or horticultural cooperative is reduced by the lesser of

1. 9% of the amount of qualified business income from the trade or business that is allocable to qualified payments from the specified agricul-tural or horticultural cooperative, or

2. 50% of the amount of W-2 wages from the qualified trade or business that are properly allocable to such amount.

Transition Rule

The CAA clarifies that the repeal of section 199 for tax years beginning after December 31, 2017, does not apply to a qualified payment received by a patron from a specified agricultural or horti-cultural cooperative in a tax year beginning after December 31, 2017, to the extent that the pay-ment is attributable to deductible QPAI before January 1, 2018. The qualified payment is subject to former section 199, and patrons can deduct any deduction allocated by the cooperative to its patrons under former section 199. No deduction is allowed under section 199A for such qualified payments.

Allocating the Cooperative’s Deduction to Patrons

The CAA provides that an eligible patron who receives a qualified payment from a specified agricultural or horticultural cooperative can deduct the portion of the cooperative’s deduction for QPAI that is

1. allowed with respect to the portion of the QPAI to which such payment is attributable, and

2. identified by the cooperative in a writ-ten notice mailed to the patron during the period beginning with the first day of the tax year and ending with the fifteenth day of the ninth month following the end of the tax year.

Thus, the deduction is allocated among the patrons based on the quantity or value of business done with or for such patron by the cooperative.

The patron’s deduction cannot exceed the patron’s taxable income for the tax year, which is determined without regard to the deduction but after including the patron’s other deductions under I.R.C. § 199A(a). A qualified payment is

1. a patronage dividend or per-unit retain allocation,

2. received by an eligible patron from a speci-fied agricultural or horticultural cooperative, and

3. attributable to QPAI for which the coopera-tive claims a deduction.

An eligible patron is a taxpayer other than a corporation or another specified agricultural or horticultural cooperative. For this purpose, a cor-poration does not include an S corporation.

Finally, the cooperative cannot reduce its income under section 1382 for any deduction allocated to its patrons under this rule [i.e., the cooperative must reduce its deductions in an amount equal to the section 199A(g) deduction allocated to its patrons].



Example 9.26 QBI Deduction for Co-op Patron’s Sales—With Wages

The facts are the same as in Example 9.24, except that $25,000 of Pat’s $200,000 in expenses were W-2 wages that he paid to an employee. Pat’s tentative QBI deduction is still $10,000 (20% × $50,000). However, he must reduce his QBI deduction by the lesser of the following:

1. $4,500 (9% × $50,000) or2. $12,500 (50% × $25,000)

Pat has a $5,500 QBI deduction ($10,000 − $4,500).

Example 9.27 Calculation of Section 199A Deduction for a Cooperative and Its Patron

Green Pasture Cooperative (GPC) is a grain mar-keting cooperative. In 2018, GPC has $21,000,000 gross receipts from the sale of grain grown by its patrons. GPC pays $16,000,000 in per-unit retain allocation to its patrons at the time the grain was delivered and pays another $4,000,000 in patron-age dividends after the end of the 2018 tax year. GPC has $1,000,000 other expenses in 2018, including $400,000 of W-2 wages.

GPC has $21,000,000 DPGR gross receipts and $20,000,000 ($21,000,000 gross receipts − $1,000,000 other expenses) QPAI in 2018. GPC’s section 199A(g) deduction is $200,000, which is the least of

■■ $1,800,000 (9% × $20,000,000 QPAI), ■■ $1,800,000 (9% × $20,000,000 taxable income), or

■■ $200,000 (50% × $400,000 W-2 wages).

GPC passes through the entire section 199A(g) deduction to its patrons. Accordingly, GPC reduces its $20,000,000 deduction ($16,000,000 per-unit retain allocations + $4,000,000 patron-age dividend) by $200,000.

Tara Dactyl is a grain farmer in southwestern Minnesota. She grows corn and soybeans. Tara’s grain delivered to GPC during 2018 was 3.6% of all grain marketed through GPC. In 2019, Tara receives $144,000 (3.6% × $4,000,000) in patron-age dividends and $7,200 (3.6% × $200,000) of allocated section 199A(g) deduction from GPC for grain delivered to the cooperative in 2018.

Examples

Examples 9.24, 9.25, and 9.26 illustrate how patrons calculate the QBI deduction at the indi-vidual level. Examples 9.27 and 9.28 show how the deduction is calculated at the cooperative level and passed through to the patrons.

Example 9.24 QBI Deduction for Co-op Patron’s Sales—No Wages

Pat Patron, a single taxpayer, is a member patron of Big Co-op. In 2018, he sold all his grain through Big Co-op. Big Co-op paid Pat a $230,000 per-unit retain paid in money (PURPIM) and a $20,000 end-of-year patronage dividend. Thus, in 2018, Pat received $250,000 ($230,000 + $20,000) from Big Co-op for his grain sales. Pat also had $200,000 in expenses, which did not include any W-2 wages. Pat had no capital gain income in 2018, but he received wages from an outside job. His taxable income was $75,000.

Pat’s 2018 QBI is $50,000 ($250,000 − $200,000). Pat calculates a $10,000 (20% × $50,000) tentative QBI deduction. Pat’s taxable income is below the $157,500 threshold for single taxpayers, so his QBI deduction is not limited by the W-2 wages limitation. Because all of Pat’s ten-tative QBI deduction is attributable to qualified payments he received from Big Co-op, Pat must reduce his QBI deduction by the lesser of

1. $4,500 (9% × $50,000), or2. $0 (50% of $0 W-2 wages attributable to Pat’s

co-op payments)

Because Pat paid no wages for his grain busi-ness, he does not have to reduce his QBI deduc-tion. Pat claims the $10,000 QBI deduction.

Example 9.25 Pass-Through Deduction

The facts are the same as in Example 9.24, except that in 2018, Big Co-op also allocated a $2,500 deduction to Pat for his share of the co-op’s QPAI. The deduction does not exceed Pat’s tax-able income after subtracting his QBI deduction ($75,000 − $10,000 = $65,000). Pat’s QBI deduc-tion is $12,500 ($10,000 + $2,500).


Examples 325

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■■ $1,800 (9% × $20,000 qualified business income related to qualified payments received from GPC), or

■■ $30,000 (50% × $60,000 W-2 wages related to qualified payments received from GPC).

Therefore, Tara’s deduction for the grain trade or business is $8,200 ($10,000 − $1,800). Tara does not have any other qualified trades or businesses, so her combined qualified business income is $8,200.

Tara’s 2019 deduction under section 199A is $15,400 ($8,200 combined qualified business income + $7,200 deduction passed through from GPC). Figure 9.12 shows the line-by-line calcu-lations of Tara’s deduction.

Tara’s taxable income is $75,000 in 2019 (determined without regard to section 199A), and her filing status is married filing jointly. Tara’s qualified business income related to her grain trade or business for 2019 is $50,000, as shown in Figure 9.11.

The portion of the qualified business income from Tara’s grain trade or business related to qualified payments received from GPC in 2019 is $720,000 ($576,000 per-unit retain allocations + $144,000 patronage dividends). The portion of her $800,000 expenses that are allocable to the GPC income is $700,000, and the portion of her $75,000 W-2 wages that are allocable to the GPC income is $60,000. Thus, Tara’s net income allo-cable to the GPC income is $20,000 ($720,000 − $700,000). Note that the percentage of expenses that are allocable depends on all the facts and circumstances, and as with Tara, the fraction of expenses allocable to W-2 wages can differ from the fraction of other properly allocable expenses.

Tara’s initial deduction for her grain trade or business is $10,000 (20% × $50,000). The deduc-tion is reduced by the lesser of

FIGURE 9.11 Tara’s Grain Trade or Business Qualified Business Income

Gross receipts from sales to an independent grain elevator $130,000

Per-unit retain allocations received from GPC in 2019 576,000

Patronage dividends received from GPC in 2019 for 2018 144,000

Farm expenses, including $75,000 of W-2 wages (800,000)

Total qualified business income $ 50,000



FIGURE 9.12 Calculation of Tara’s Section 199A Deduction

1 Gross GPC sales $21,000,000

2 Paid to GPC patrons (per-unit retains) $16,000,000

3 Patronage dividends $4,000,000

4 Other expenses $1,000,000

5 Wages included on line 4 $400,000

6 DPGR $21,000,000

7 QPAI (line 7a – line 7b) $20,000,000

7a Gross sales $21,000,000

7b Other expenses $1,000,000

8 GPC’s section 199A(g) deduction (lesser of lines 8a, 8b, and 8c) $200,000

8a 9% of QPAI (line 7 × 0.09) $1,800,000

8b 9% of taxable income (line 7 × 0.09) $1,800,000

8c 50% of W-2 wages (line 5 × 0.5) $200,000

9 Adjusted deduction (line 9a – 9b) $19,800,000

9a GPC’s deduction $20,000,000

9b Section 199A(g) deduction $200,000

10 Tara’s % of total grain marketed through GPC 3.6%

11 Tara’s patronage dividends (line 3 × line 10) $144,000

12 Tara’s share of GPC’s section 199A(g) deduction (line 8 × line 10) $7,200

13 Tara’s 2019 taxable income (without regard to section 199A) $75,000

14 Tara’s QBI related to grain trade or business [(lines 11 +14a + 14b) – (lines 14c + 14d)] $50,000

14a Other gross receipts $130,000

14b Per-unit retains $576,000

14c Expenses not including W-2 wages $725,000

14d W-2 wages $75,000

15 QBI allocable to GPC [(lines 11 + 14b) – (lines 15a + 15b)] $20,000

15a Expenses allocable to GPC (not including wages) $640,000

15b Wages allocable to GPC $60,000

16 Tara’s deduction for the grain trade or business (line 16a – the lesser of line 16b or 16c) $8,200

16a 0.20 × line 14 $10,000

16b 0.9 × line 15 $1,800

16c 0.5 × line 15b $30,000

17 Tara’s deduction passed through from GPC (line 12) $7,200

18 Tara’s section 199A deduction (lines 16 + 17) $15,400


Examples 327

9

1. $1,800 (line 16b in Example 9.27), or 2. $0 (50% × $0 W-2 wages related to qualified

payments received from GPC).

Tara’s section 199A deduction is $17,200 ($10,000 + $7,200 passed through from GPC). Figure 9.13 shows lines 16–18 of Tara’s calculations.

Example 9.28 Section 199A Deduction with Zero Patron Wages

The facts are the same as in Example 9.27 except that in 2019 Tara has $800,000 expenses and pays no W-2 wages. Tara’s deductible amount for the grain trade or business is $10,000 (line 16a in Example 9.27). Her deduction is reduced by $0, which is the lesser of

FIGURE 9.13 Tara’s Calculations with Zero Wages

16 Tara’s deduction for the grain trade or business (line 16a – the lesser of line 16b or 16c) $10,000

16a 0.20 × line 14 $10,000

16b 0.9 × line 15 $18,000

16c 0.5 × line 15b $0

17 Tara’s deduction passed through from GPC (line 12) $7,200

18 Tara’s section 199A deduction (lines 16 + 17) $17,200


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