Government Programs and Lease Arrangements

Scott Clawson

NE Area Ag Econ Specialist

EQUITABLE LEASE ARRANGEMENTS 2015

OVERVIEW

• Essential reason that there are government sponsored price programs is to mitigate risk

• Essential reason that conservation programs exist is to provide assistance or encouragement to improve stewardship of resources

EQUITABLE LEASE ARRANGEMENTS 2015

Crop Programs

EQUITABLE LEASE ARRANGEMENTS 2015

• ARC (revenue coverage) and PLC (price coverage)• Both require owner action for sign up / changes / lease needs to be provided

/ FSA POA

• If the lease is set up as a cash lease, no payment to the property owner• Why?

• Owner is not bearing risk, regardless of if the crop makes or fails, high yields or low yields

• Income is “guaranteed”

• What if you are in a crop share, 1/3 – 2/3? Partial payment can be had• Why?

• You have risk in the crop

• If the crop fails, you are out the inputs you provided, so there is risk

• What about crop insurance?

Livestock Programs

• LDP (Livestock Disaster Program)• Most recent occurrence was from drought (2011, 12, 13)

• Protected producers against loss of forage

• Who received funds?• If you were on a cash lease, the tenant (cattle owner) received funds

• Same story as before, who was at risk for financial loss?

• Still need written leases, will have to at lease sign an FSA provided form for tenant

EQUITABLE LEASE ARRANGEMENTS 2015

General Advice from FSA

• Landowners cant require a tenant to apply for insurance or conservation programs

• Many conservation programs are available to landowners

• If a conservation program is in place, KREP may fence off waterways and tenants have to keep cattle off

• If you are inheriting a property, implementation and procedures may vary base on your type of ownership (trust, LLC, etc.)

• Keep good legal description of properties

EQUITABLE LEASE ARRANGEMENTS 2015

Thank you!

EQUITABLE LEASE ARRANGEMENTS 2015

Tenant Screening

and Written

Agreements

Damona Doye

damona.doye@okstate.edu

Rainbolt Chair of Agricultural Finance

OSU Agricultural Economics Department

Preparing to lease land

Goal for the land?

Goal for the lease?

Non-negotiables?

Expectations with regards to operating

practices?

Qualifications and attributes that you want in

a tenant?

Minimum requirements for a tenant?

Tenant screening

Advertising: Include price and minimum

requirements to screen parties who do not

qualify

Newspapers, electronic lists

Local businesses

Other landowners or producers in the area

Tenant screening

Verify ID if you don’t

know the person

Ask for a farm resume

Look for legal issues:

http://www1.oidcr.com

Interview potential

candidates

Ask for references

Interviewing candidates

Background and involvement in farming

How the property fits with their operation

Production practices and environmental

philosophy

Equipment, special knowledge they bring

Risk management and marketing practices

Farm insurance coverage and agent

Length of lease desired

Plans for communication

With whom do you want to do

business? Do they meet requirements?

Are they dependable?

Are they financially stable?

How easy will it be to establish and maintain a

working relationship?

What are their people skills? Communication skills?

Will they be a good neighbor?

Where is their base of operations?

What kinds of questions did they ask?

Follow up with references

Did they pay on time?

Any unpaid rent?

Any legal or tax issues?

Trouble or damage?

How was communication?

Would you rent to this tenant again?

Consider paying for services such as a credit

check or background check.

You’ve found the right tenant....

Equitable agreements are negotiated

Both tenants and landlords should estimate

their contributions to production

Use of area standards or traditions may not

be in the best interest of either party

Worksheets and spreadsheets are available

to summarize contributions and analyze

alternatives

An equitable share lease should follow

five basic principles

1. Share cost of yield increasing inputs

2. Adjust or re-evaluate shares as technology changes

3. Divide total returns in same proportion as resources

contributed

4. Compensate tenant for unused long-term investments at

termination

5. Maintain good landlord/tenant communications

Effect of land quality and farm cost on

crop-share rental arrangements

Annual yield per acre

Annual operating cost per acre ($)Costs

Least productive land

Most productive land

2/3 tenant1/2 tenant

Determining an equitable cash

rentMarket approach

Landlord’s ownership costs plus return to

equity

Residual income method

www.agecon.okstate.edu/budgets

Put the agreement in writing!

Encourages understanding by both parties

Serves as a reminder of terms agreed upon

Legal resource and guide for heirs

Consult with a lawyer

Free lease forms at www.aglease101.org Pasture

Crop Share

Fixed and Flex Cash Rental Arrangements

Machinery and Equipment

Farm Building or Livestock Facility

Beef Cow

Terms that should be specified in all

agreements Parties to lease and description Date

Names and addresses

Legal description

Signatures

General terms Time period of lease, including start/end dates

Rental amount or respective shares/contributions What will be provided by each party (machinery, equipment, labor, other

inputs) and who makes decisions

Payment arrangements (when, how, penalties, assurances)

Partnership intentions

Conditions under which property may be subleased

Willingness to sign security agreement

Ohio State Univ. Extension FR-0003-02, Farm Rental Agreement Checklist

Terms that should be specified in all

agreements Termination When and how lease may be terminated

Reimbursement provisions for improvements, crop in ground, etc.

Acts that constitute default

Tenant’s right if property is transferred or condemned during the lease period

Terms that should be specified in all

agreements Operation and maintenance Use of premises

Farming/ranching practices

How property will be maintained

Fences

Soil conservation

Noxious weeds

Whether tenant has the right to make improvements and be compensated

Whether the tenant has the right to utilize improvements made by the landlord or other assets on the land

Compliance with FSA, NRCS, other agency requirements

Other environmental clauses

Terms that should be specified in all

agreements Landlord rights and government payment Right to enter the property for a specific purpose

Right to a security interest in production or other provisions for ensuring payment

Retained rights

Statement of which party will participate in federal farm programs

Nature of landlord participation in management

Terms that should be specified in all

agreements Other Records to be kept

Damages

Mineral rights

Crop or forage insurance

Handling of extenuating circumstances

Arbitration

Pasture rental arrangements

Possible ways to delineate stocking rate

By the head

By animal units (both parties should agree on what an animal unit is)

By pounds

Important to agree on the number, size, type of animals and grazing period duration

Establishing land owner and livestock owner contributions

Cash, share of gain, price risk adjustment

18AgLease101.org

Leasing resources

www.aglease101.org, publications, forms, worksheets

www.aglease.info, OSU production and management info

www.agecon.okstate.edu/budgets

www.osufacts.okstate.edu CR-216, OK Pasture Rental Rates

CR=230, OK Cropland Rental Rates

AGEC-940 Tax Aspects of Leasing

AGEC-198, Negotiation Strategies

http://www.nass.usda.gov/Statistics_by_State/Oklahoma/Publications/County_Estimates/index.php

Cash rents

Other OSU resources

OSU Farm Management Facebook

https://www.facebook.com/OSUFarmManagement/

Oklahoma Women in Ag and Small Business

Facebook

https://www.facebook.com/OKWomenInAg

OSU Agricultural Economics Extension

https://www.agecon.okstate.edu/extension

What is fair? Not fair?

Fair does not equal legal.

Legal does not equal fair.

Everything is negotiable up front.

Legal is what you agreed to or if not

addressed, what the law substitutes.

Roger Sahs, Asst. Extension Specialist

OSU Agricultural Economics Department

Agricultural Land Rental Trends and Arrangements

USDA/NASS (http://quickstats.nass.usda.gov/)

0

5

10

15

20

25

30

35

0

200

400

600

800

1,000

1,200

1,400

1,600

1,8001970

197

3

197

6

197

9

198

2

198

5

198

8

199

1

199

4

199

7

2000

200

3

200

6

200

9

201

2

201

5

Ca

sh

Re

nt ($

/ac)

La

nd

Va

lue

($

/ac)

Oklahoma Non-Irrigated Cropland Cash Rents and Land Prices

Land Value Cash Rent

0

2

4

6

8

10

12

14

0

200

400

600

800

1,000

1,200

1,400

1,6001

97

0

197

3

197

6

197

9

198

2

198

5

1988

199

1

199

4

1997

200

0

200

3

2006

200

9

201

2

2015

Cash R

ent ($

/ac)

La

nd

Va

lue

($

/ac)

Year

Oklahoma Pasture Cash Rents and Land Prices

Land Value Cash Rent

USDA/NASS (http://quickstats.nass.usda.gov/)

2014 Non-Irrigated Cropland Average Cash Rent

8 to 1516 to 20

31 to 3526 to 30

36 plus

21 to 25

N/A

2014 Pasture Land Rental Rates

5 to 910 to 14

25 to 2920 to 24

30 plus

15 to 19

N/A

USDA/NASS (http://www.nass.usda.gov/Surveys/Guide_to_NASS_Surveys/Cash_Rents_by_County/

Cash and share lease agreements• What portion of the income do I receive?

• What portion of the costs do I contribute?

• What portion of the risk do I bear?

• What crop and land management practices will be followed?

• What will be the condition of the land and improvements at the end of the lease?

Cash lease agreements

• Tenant pays landlord a fixed amount per acre per year.

-$/acre or $/head for grass pasture

-$/hd/day or $/cwt./mo. for grazing wheat/crop residues

• May be single or multi-year.

• Can add flexible component.

Cash lease advantages

Landlord• More stable income

• Payment can be scheduled for any time of year

• Eliminates or greatly reduces cash expenditures

• Reduced management responsibility

• Shifts risk

• Fewer potential conflicts about sharing and marketing crops

Tenant• Total managerial freedom

• Fewer chances of conflict over decisions

• Receive all benefits of a “good year” and superior management

• Eliminates time and effort associated with dividing crops and input purchases as well as the related record keeping

Cash lease disadvantages

Landlord • Can become inequitable due to

changes in prices, costs and technology

• Fewer opportunities for income tax management

• Will not realize benefits of good price and/or yield years if the agreement is not flexible

• Greater chance of soil depletion or overstocking pasture

Tenant• Must shoulder all the price and

yield risk if the agreement lacks flexibility

• Large capital requirements for inputs

• May be required to pay part of the rent early in the year before the crop is planted

• Landowners may attribute above average yields to soil rather than management

Share lease agreements

• Landlord and tenant share proportionally in costs and risks of production, then share returns accordingly

• May be single or multi-year

• Typically 2/3 tenant crop share in OK

• $/lb. of gain on wheat pasture-production risk shared by pasture owner and cattle owner.

Share lease advantages

Landlord• Receives benefits of good price

and/or yield years

• Land and improvements are more likely to be maintained

Tenant• Less capital may be required

• Less experienced tenants can benefit from the landowner’s managerial input

• Share price and yield risk with landowner

Share lease disadvantages

Tenant• Need to discuss management

practices with landlord on a continuing basis

• Joint decisions result in more opportunities for conflicts

• Must share benefits of a “good year” and superior management

• Must maintain records of shared expenses and divide crops

Landlord• More variable income and

increased risk• Need to discuss management

practices with tenant on a continuing basis

• Increased capital requirements associated with share of cash expenses

• Must maintain records of shared expenses

• Increased responsibilities• More possibilities for conflicts

with tenant

Check out these websites:

aglease.info & aglease101.org

Income Tax Issues of Leasing

Tulsa – December 2015

What is Being Leased?

• Land

• Machinery and Equipment

• Livestock

• Combination of the Above

Tax Issues

• Income Tax treatment of lease payments

• Self-Employment Tax implications

• Net Investment Income Tax rules

Type of Lease

• Fixed Rent: Cash or Commodity

• Production-Based Rent: Commodity

• Landowner materially participates in the

rental arrangement

Material Participation

(meet 1 or more of the tests)

1. Perform any 3 of a, b, c, or d:

a. Pay at least half of direct production costs

b. Furnish at least half of the tools, equipment, and livestock

c. Advise or consult with tenant

d. Inspect production activities periodically

2. Make management decisions.

3. Work 100 hours or more over 5 weeks.

4. Take actions that show that material and significant involvement in production.

Methods to Avoid

Self-Employment Taxes

1. Do not “materially” participate in the

business

2. Lease only land

3. Lease both land and machinery

under one contract.

Net Investment Income Tax

• Active farmers are not subject to Net Inv.

Income Tax on

– Operating income

– Gain on sale of assets used in farming

• Net Inv. Income Tax is 3.8% of lesser of

– Net investment income

– Excess Modified Adjusted Gross Income

MAGI Thresholds for NIIT

Investment Income Is

Gross income from:

• Interest,

• Dividends,

• Net capital gains,

• Rental and royalty income,

• Nonqualified annuities, and

• passive activities for the taxpayer.

Investment Income Is Not

• Wages,

• operating income from a nonpassive business,

• income from the sale of business property,

• social security benefits,

• alimony,

• tax exempt interest,

• self-employment (SE) income, and

• distributions from retirement plans.

Why is this Important?

Without material participation in the lease:

• Lease payments are subject to NIIT

• Sale of land will be subject to NIIT

• Sale of other assets will be subject to NIIT