Tax Implications of a Farmland Lease

Updated June 1, 2022

Overview

The decision to lease farm ground comes

with many choices: cash rent, crop share, or

some combination thereof. Parties to a lease

must understand that each option has distinct

income tax implications. This fact sheet

provides a brief overview of several key tax

considerations associated with farmland

leases, as they apply to individual

landowners.

Cash Rent Lease

Under a cash rent lease, the farm tenant

generally pays a cash sum (usually on a per

acre basis) to the landlord for the privilege of

renting the farm ground. Rent received by a

landlord under a typical cash rent lease is

rental income, not subject to self-

employment tax.

This means also that the

income will not be credited as net earnings

from self-employment tax.

This means also

that the income will not be credited as net

earnings from self-employment tax.

This

means also that the income will not be

credited as net earnings from self-

employment for social security eligibility

purposes. Individual cash rent landlords

report their rental income on Schedule E, IRS

Form 1040.

Cash rent landlords are generally not

considered to be in the business of farming

for tax purposes. Consequently, they face

limitations with respect to expenses and

losses they can offset against their income.

Cash rent landlords, for example, do not

qualify for the following tax breaks:

• IRC § 179 Expense Deduction

• IRC § 175 Deduction for Soil and

Water Conservation Expenses

• IRC § 1301 Farm Income

Averaging

• IRC § 6654 Special Rule for

Estimated Tax Payments

This means, for example that cash rent

landlords cannot use Section 179 to

immediately expense the cost of field tile.

They are, however, allowed to depreciate the

cost of the tile over a 15-year period.

Likewise, cash rent landlords are not eligible

to presently deduct the cost of soil and water

conservation improvements, such as

terracing. They must instead capitalize those

expenses (add the cost of the improvement to

the basis of the land).

Cash rent landlords may generally deduct the

cost of ordinary and necessary expenses

relating to the production of the rental

income. These expenses might include taxes,

interest, repairs, insurance, management fees,

agents’ commissions, and depreciation.

Because rental income, however, is passive

income, cash rent landlords are subject to

special passive loss rules.

This also means

that cash rent income is net investment

income, subject to the 3.8% net investment

income tax for higher income earners.

Crop Share Lease

A crop share lease is generally an

arrangement under which the landlord agrees

to rent the farm ground to the tenant in

exchange for a share of the crop. The tax

treatment of income earned by a landlord

under a crop share lease is largely dependent

upon the landlord’s level of participation in

the farming activities governed by the lease.

If the landlord materially participates under

the lease, any income from the lease is

subject to self-employment tax.

The landlord

will report the income and expenses on

Schedule F, IRS Form 1040. If the landlord

does not materially participate, the income is

not subject to self-employment tax, and the

landlord will report the income and expenses

on IRS Form 4835. Any net income or loss

will be carried to Schedule E, IRS Form

1040.

A landlord materially participates in a lease if

(A) the landlord has an arrangement with the

tenant requiring the landlord to materially

participate in the production of the

management of the production of the

commodities AND (B) the landlord meets

one or more of the following four tests:

Test 1: The landlord does at least three of the

following

• Pays, using cash or credit, at least half

the direct costs of producing the crop.

• Furnishes at least half the tools and

equipment used in the production

activities.

• Advises or consults with the tenant.

• Inspects the production activities

periodically.

Test 2: Regularly and frequently makes, or

takes an important part in making,

management decisions substantially

contributing to or affecting the success of the

enterprise.

Test 3: Works 100 hours or more spread over

a period of 5 weeks or more in activities

connected with agricultural production.

Test 4: Does things that, considered in their

totality, show that the landlord is materially

and significantly involved in the production

of the farm commodities.

Unlike cash rent landlords, crop share

landlords, whether or not they materially

participate under the lease, may be eligible

for the following tax breaks:

• IRC § 179 Expense Deduction (watch

for noncorporate lessor rule)

• IRC § 175 Deduction for Soil and

Water Conservation Expenses

• IRC § 1301 Farm Income Averaging

• IRC § 6654 Special Rule for

Estimated Tax Payments

Non-materially participating crop share

landlords are generally subject to the passive

loss rules in the same manner as cash rent

landlords. Their income may also be subject

to the net investment income tax.

Section 199A Deduction

In 2018, the Tax Cuts & Jobs Act introduced

a 20 percent deduction for “qualified

business income” arising from a “qualified

trade or business.” Determining whether

rental income qualifies for the deduction

must be determined on a case-by-case basis,

depending upon the facts.

In general, IRS regulations state that a

landlord must meet two definitional

requirements for an activity to rise to the level

of a trade or business:

• Good faith intention to make a profit

• Considerable, regular, and

continuous activity

Relevant factors include, but are not limited

to, (i) the type of rented property (commercial

real property vs. residential property), (ii) the

number of properties rented, (iii) the owner’s

agent’s day-to-day involvement, (iv) the

types and significance of any ancillary

services provided under the lease, and (v) the

terms of the lease (net lease v. traditional,

short-term v. long-term).

In general, a cash rent lease under which the

landlord merely collects a check will not

qualify as a trade or business so as to qualify

the income for the deduction. Many crop

share leases, however, will. Landlords with

questions should consult with a tax

professional.

1 This fact sheet is for educational purposes only.

Landowners are encouraged to discuss specific

rental arrangements with a trusted tax advisor.

For more detailed information on this and other

topics, please visit www.calt.iastate.edu. The tax

implications of farm lease arrangements

involving business entities is beyond the scope of

this fact sheet, as is the impact of leasing

arrangements on valuation of property at death.

2 It is possible for a landlord and tenant to enter

into a cash lease under which the landlord is to

“materially participate.”

These types of leases are very rare, but would

require the landlord to pay self-employment tax

on the rental income. 3 Generally, passive losses

may be used to offset only passive income.

Passive losses, may, however, be applied against

ordinary income in an amount up to $25,000 if

the landlord “actively participated” in the rental

activity. This special allowance begins to phase

out when adjusted gross income is greater than

$100,000. It should also be noted that IRS

regulations recharacterize rental income from

land where less than 30 percent of the

unadjusted basis of the property is depreciable

as non-passive income. This means that passive

losses from other activities cannot be offset by

farm rental income. Any loss from the farm

rental activity, however, remains passive. Treas.

Reg. 1.469-2T(f)(3).

4 “Net earnings from self-employment” is

defined by Treas. Reg. § 1.1402(a)-1 as “gross

income derived by an individual from any trade

or business carried on by such individual, less the

deductions …attributable to such trade or

business.”