Farmland investment is an excellent way of diversifying because of its solid long-term returns that don’t correlate with the stock market. Leasing farmland can provide a long-term investor with some short-term cash flow. With the profits from many crops on the rise in the last few years, farmland owners who choose to share the risks and rewards of farming through crop share leasing may see their profits grow, too.
Crop shares are more complicated than lump-sum payment cash rent leases. With a crop share lease, the tenant and owner split the costs and the profits of the crops. In this case, an investor’s return can be affected significantly by bad weather, poor farming conditions or a less than stellar tenant. Investors must maintain records of shared expenses and market their crops, which involves more time and effort than a cash rent lease.
However, there are a number of benefits to crop share lease agreements, most notably sharing both the risks and the rewards with the tenant. Experienced landowners may be able to share their wisdom with a tenant, which could result in the tenant making more financially rewarding decisions. Landowners who participate in the management may also be able to time buying inputs, such as fertilizer and seeds, and selling crops to manage for tax purposes, according to Colorado State University’s Cooperative Extension.
Crop share investors must be involved with cropping decisions and marketing A healthy crop of ripening apples ready for harvest|]In recent years, investors relying on crop share leases may have seen higher returns than those using cash rents.
“From the mid ’90s up through 2005, cash rental rates were providing higher returns to landowners than crop share leases without the risk,” Timothy Eggers, a field agriculture economist with Iowa State University, said in an e-mail interview. “With the higher prices in 2006 and 2007, crop share leases are providing a comparable return. The higher prices for the 2006 crop would’ve [resulted] in higher returns. Depending on the responsiveness of the cash rental rate change, the 2007 returns were likely higher as well.”
Nevertheless, crop share leases are still on the decline throughout the country.
“Share rents are decreasing because of their complexity,” Gary Schnitkey, farm management extension specialist at the University of Illinois, said in an e-mail interview. “Landlords have to be involved in the cropping decisions and pay for cropping expenses up front. They have to also market grain and be involved with the Farm Service Agency.”
Marketing crops and paying for inputs make crop share leases much less desirable for farmland owners, Eggers said. Additionally, crop share leases have additional complications that may present difficulties for out-of-area investors.
“Crop share agreements not only tend to be more complicated but also require another layer of trust between tenant and landlord,” Jim Stordahl, assistant extension professor at the University of Minnesota, said in an e-mail interview. “For example, since the crop is literally shared, the landlord needs to trust that the tenant did not ‘forget’ to deliver the last load during harvest. This may be even a greater concern with absentee landlords.”
The level of involvement required with a crop share lease may be a positive or a negative for an investor, depending on their characteristics and desires. Some investors may also consider a custom farming lease in which the tenant supplies all labor, equipment, planting, pest control, harvesting and storage of crops and the owner pays all other expenses. In these cases the tenant generally receives a fixed payment per acre or per operation performed from the owner.
“In a 50-50 crop share lease, the owner takes half the risk of price and yield variation, as well as the risk of rises in input prices such as fertilizer and seed,” Edwards said. “As a custom farming owner, he/she takes all of these risks.”
The level of involvement with a custom farming lease is higher than the level of involvement required for a crop share lease.
“Custom farming, or a share lease, requires more involvement in marketing than a cash lease, which may be rewarding to some owners or frustrating to others,” Edwards said.
Perhaps most importantly for investors considering a crop share lease, assisting in decision making on a farm may show “material participation” for government and financial management purposes, according to Colorado State University’s Cooperative Extension. It is much easier to prove material participation with a crop share lease than with a cash rent lease.
Lack of material participation reduces federal farm program subsidies A cotton bumper crop in 2007 brings big yields to landowners and tenants|]Material participation was originally placed in tax law to determine whether a farm owner was liable for self-employment taxes, according to Purdue University’s Extension. Landlords who make key decisions regarding the farm, such as which crops to plant or whether to use herbicide, must report income and expenses and pay self-employment taxes.
Material participation may limit Social Security payments, depending on the age of the landlord and other income. Lack of material participation may negatively affect federal farm program payments, which subsidize some of the expenses of farming. Owners hoping to receive federal farm program payments should speak to their local Farm Service Agency about how material participation affects their federal farm program payments.
Material participation is also a consideration for federal estate tax savings qualification, according to Purdue University’s Extension. Special use valuation allows a reduction of up to $750,000 in land value to be included in the estate of someone who has passed away. This valuation requires a 10-year period of material participation by the heirs, according to Purdue University and The Tax Adviser.
A landowner may maintain eligibility for that valuation with a cash rental to a family member, who may satisfy both a material participation requirement and an “at risk” requirement. To be at risk generally requires a crop share lease.
Crop share leases do not require material participation. An investor who chooses a crop share lease will have to determine whether they are a material participant, which has different implications for taxation. Investors may want to consult a tax attorney, their local Farm Service Agency or other professionals in the field regarding the tax implications of material participation.
If the farmland meets the qualifications for special use valuation, investors may want to consider whether the deduction makes participating in the farmland management—and dealing with any self-employment taxes that may come along with that decision—worthwhile.