Retiring Farmers Often Choose a Rental Option

April 3, 2021 | Guido van der Hoeven

As farmers and ranchers approach retirement (however defined) generating an income stream to meet lifestyle needs comes into focus. An obvious resource is renting the land, either using a cash rent or crop-share model.  What about the machinery and equipment?  The farmer or rancher can decide to have an equipment sale which generates a lump-sum payment, less sales costs, but this will trigger IRC § 1245 recapture resulting in a sizable tax bill.  A second sales strategy is to sell the equipment in a piecemeal fashion over time to manage the tax bill resulting from IRC § 1245 recapture.

Alternatively, should the farmer or rancher desire to maintain ownership of the machinery and equipment, but still retire from farming, the machinery and equipment can be rented with the land as part of the rental agreement.  IRC § 1402(a)(1) states “… there shall be excluded rentals from real estate and from personal property leased with real estate (including such rentals paid in crop shares …”. Thus, if the rental agreement is for the farm or ranch land with the accompanying machinery line rented so that the tenant can operate and maintain the land, the rent received, less allowable expenses, is not subject to self-employment tax. Such arrangements are common between related parties, e.g., grandparents and grandchildren.  However, such a lease arrangement can be used between unrelated parties.

Example: Rental of Farmland and Equipment

Grandpa George retired at the age of 70 after operating a crop farm for 50 years.  He and his granddaughter, Beatrice, a recent graduate of State University, enter a rental agreement for Beatrice to lease his farmland and equipment line as a combined package. Beatrice will pay $75,000 cash rent, payable in two semi-annual payments on April 1 and November 1 each year. As part of the rental agreement, Beatrice is required to maintain and repair the equipment to a reasonable standard.

Grandpa George is responsible for paying property taxes on the farmland and equipment (if any) and for maintaining a general casualty and liability insurance policy on the property. Because Grandpa George took full advantage of bonus depreciation and IRC § 179 expensing over the past decade while farming, his adjusted cost basis is zero in the machinery. See Schedule E, Supplemental Income and Loss, illustrated below.

To clarify, Grandpa George, in the example above, is not a “real-estate professional.” Thus, Grandpa George escapes the self-employment tax because he is a passive landlord receiving rents. If Grandpa George exceeds a threshold based on filing status, his net rental income is subject to the Net Investment Income Tax (NIIT).

If Grandpa George, in the example above, rented his equipment line separately from the land, a personal property rental business would be created. Therefore, this rent income would be reported on IRS Schedule C, Profit or Loss from Business, and net profits would be subject to self-employment tax as a unique trade or business.