Rev. Rul. 58-257

Advice has been requested with respect to the application of section 37 of the Internal Revenue Code of 1954 in the case of landowners who materially participate in the production or management of agricultural or horticultural crops on a crop-share basis, within the purview of that phrase for purposes of section 1402(a)(1) of the Self-Employment Contributions Act of 1954 (chapter 2, subtitle A, Internal Revenue Code of 1954).

Section 1402(a) of the Self-Employment Contributions Act, which defines the term `net earnings from self-employment,' specifically provides:

(1) there shall be excluded rentals from real estate and from personal property leased with the real estate (including such rentals paid in crop shares) together with the deductions attributable thereto, unless such rentals are received in the course of a trade or business as a real estate dealer; except that the preceding provisions of this paragraph shall not apply to any income derived by the owner or tenant of land if (A) such income is derived under an arrangement, between the owner or tenant and another individual, which provides that such other individual shall produce agricultural or horticultural commodities (including livestock, bees, poultry, and fur-bearing animals and wild life) on such land, and that there shall be material participation by the owner or tenant in the production or the management of the production of such agricultural or horticultural commodities, and (B) there is material participation by the owner or tenant with respect to any such agricultural or horticultural commodity.

Section 37 of the Code provides in part as follows:

(c) RETIREMENT INCOME.-For purposes of subsection (a), the term `retirement income' means-

(1) in the case of an individual who has attained the age of 65 before the close of the taxable year, income from-

(A) pension and annuities,

(B) interest,

(C) rents, and

(D) dividends, * * *.

The exclusion provided in section 1402(a)(1) of the Self-Employment Contributions Act relates to the exclusion of rentals from the term `net earnings from self-employment' and the exception thereto merely provides that income of the type described in the exception shall be included in the term `net earnings from self-employment' provided there is material participation by the landowner or by a tenant subleasing to another individual. Such exception does not result in the income's losing its identity as rentals paid in crop shares.

Accordingly, where there is a landlord and tenant relationship between a farm owner and a tenant and the landlord (or sublessor, if applicable) has materially participated in the production or management of agricultural or horticultural commodities, the income derived, or at least a part thereof, by the farm owner (or sublessor) will ordinarily constitute retirement income within the meaning of section 37 of the Code to any farm owner (or sublessor) who has attained the age of 65 if the income has been reduced to money or its equivalent.

Section 911 of the Code provides, in part, as follows:

* * * In the case of a taxpayer engaged in a trade or business in which both personal services and capital are material income-producing factors * * * a reasonable allowance as compensation for the personal services rendered by the taxpayer, not in excess of 30 percent of his share of the net profits of such trade or business shall be considered as earned income.

The 30-percent rule expressed in section 911 has no application to section 1402(a)(1) of the Self-Employment Contributions Act. However, the determination of earned income by the 30-percent rule in accordance with section 911(b) of the Code is applicable to section 37 of the Code. The only connection between section 37 of the Code and section 1402(a)(1) of the above Act is the designation of a certain type of income; namely, rents, including rents paid in crop shares, which are includible in the term `retirement income' where a landlord and tenant relationship exists and which are ordinarily excluded from the term `net earnings from self-employment' but for the exception provided in the amendment to section 1402(a)(1) of the above Act where there is material participation by the landowner or by a tenant subleasing to another individual.

Revenue Ruling 56-416, C.B. 1956-2, 14, and Revenue Ruling 56-417, C.B. 1956-2, 17, which relate to the question of personal services as an income producing factor in the case or ordinary rentals are euqally applicable where rents paid in crop shares under a rental arrangement are involved; that is, if there is such `material participation' by the landlord or by the sublessor which satisfies the 30-percent rule requirements of section 911(b) of the Code, then the gross rents must be reduced by a reasonable allowance as compensation for personal services, not to exceed 30 percent of the net rental income, for the purpose of coming within the meaning of retirement income under the provisions of section 37(c) of the Code.

Under the limitations provided under section 37(d)(2) of the Code, the earned income as determined under 30-percent rule, as provided by section 911(b) of the Code, must be taken into consideration in reducing the $1200 of retirement income, subject to the conditions relating to the age of the individual.

Accordingly, it is held that rental income which comes within the exception provided in section 1402(a)(1) of the Self-Employment Contributions Act, does not lose its identity as rental income for the purposes of section 37 of the Code. Where there is a landlord-tenant arrangement and the landlord materially participates in the production or management of agricultural and horticultural crops, the 30-percent rule contained in Code section 911(b), ordinarily applicable in such situations, should be considered in computing retirement income for purposes of section 37(c) of the Code.

Revenue Ruling 56-496, C.B. 1956-2, 17, and Revenue Ruling 56-357, C.B. 1956-2, 14, in equating rental income from crop shares with retirement income, gives no consideration to the application of the 30-percent rule in section 911(b) of the Code. To that extent, they are inconsistent with the foregoing and therefore modified accordingly.