This Article is Provided Courtesy of Dan Childs – Senior Agricultural Economics Consultant – Noble Research Institute
Landowners who choose not to operate their land have several options when considering lease agreements. This article reviews the options from a landowner’s perspective.
Two factors usually determine which option a landowner will choose:
- How much the landowner wants to be involved in management.
- How much risk the landowner feels comfortable taking.
Typically, the greater the risk exposure, the greater the potential return. However, higher risk exposure can also result in a lower rent in some years. Over the long term, the net rent should be higher when taking greater risks compared to lower-risk alternatives though the landowner should expect fluctuations in annual rent. This may not be acceptable to some landowners, who desire a consistent revenue stream each year.
There are basically three types of options for cropland. Each has its advantages and disadvantages.
The custom farm option will generate the highest return over time but also exposes the landowner to the most risks.
The income and expenses would be reported on Schedule F with any profit being subject to both self-employment and income tax. It would also meet the requirements for material participation and allow the land to be available for special use valuation for estate tax purposes if that was a concern by the landowner.
A crop share option will generate the next highest return after a custom farm and expose the landowner to less risk.
If the landowner materially participates in this option (if they are involved in such things as deciding which crop to grow, what variety, how much fertilizer to apply and what pesticides to use), their share of revenue and expenses are reported on Schedule F with the profit subject to both income and self-employment tax. If the landowner does not materially participate, their share of revenue and expenses are reported on Form 4835 with the profit subject only to income tax.
The cash rent option is the lowest risk to the landowner and typically results in the lowest rent over time.
This option is the most popular for landowners who are risk averse and prefer consistent rents. The revenue is reported on Schedule E and is only subject to income tax. The landowner would not qualify as materially participating. There are other options for leasing crop land limited only by one’s imagination. Indexing rent to the price of the commodity is a common version of cash rent options.
FORAGE PRODUCTION LAND
Leasing out forage-producing land is a bit more complex because of the different uses and types of forage grown on the land. Only a select few of the more common options will be discussed.
When renting land for grazing cows and calves, the most common option is a cash rent by the acre.
Issues in the agreement would typically address such things as stocking rate, maintenance of fences and improvements, weed and brush management, lease terms, and the rate per acre.
Since the productivity of land varies across properties, a more equitable arrangement is to base the rent on a rate per animal unit of carrying capacity.
The rate per animal unit is determined by the value per hundredweight of a 500-pound steer calf as reported by the USDA Market News for the Oklahoma National Stockyards auction market the first week of August. The first week of August is used because that week typically represents near the average price for the year not the spring high or the fall low. The value per hundredweight becomes the annual rate per animal unit.
For example, if the Market News reported a 500-pound steer calf to be $200 per hundredweight ($2 per pound), the annual rent per animal unit would be $200. A lease could be designed such that $100 per animal unit is paid in January and the remaining portion is paid on Sept. 1, after the early August steer price is known. Care for the animals would be the responsibility of the cattle owner along with other responsibilities agreed to in the agreement.
Lease agreements for growing cattle commonly referred to as stockers are typically based on gain or rate per head per day. In some areas of the country, rates are based on a grazing season and often include care.
When the rate is based on gain, a rule of thumb is one-half of the value of gain. Value of gain is usually calculated by comparing the current price per head of the animal at the beginning of the graze period to the price per head of the heavier animal at the end of the graze period. The price of the heavier animal is determined by using the Chicago Mercantile Exchange feeder cattle futures price for the month closest to, but not before the end of, the graze period multiplied by the expected end weight of the animal.
For example, the current price of a 600-pound steer is $1,000 per head. Assume the end of the graze period is July, and the animal is expected to weigh 800 pounds. Based on the August feeder futures, the expected price is $145 per hundredweight or $1,160 per head. Divide the difference of $1,160 and $1,000 or $160 by the difference in weight of 200 (800 – 600) pounds for a value of gain of 80 cents. One-half of 80 cents is 40 cents, which is the rate a landowner would charge for stocker cattle grazed on a gain basis including care.
Other items to negotiate would be how beginning and ending weights are determined, who absorbs death loss, who pays for fly control, mineral and any supplemental protein.
When weighing cattle is a problem, a rate per head per day is common.
Rates per head per day will range from 1.5 to 2 times the gain rate per pound. If the gain rate would be 40 cents per pound, the daily rate would be 60 cents to 80 cents per head per day.
Any lease agreement should be written down, signed by both parties and dated. The most important reason for a written lease is to document what each party agreed to. Sometimes we forget what the agreement was. Written documentation will hopefully alleviate any misunderstandings. Even though there are reasonable and customary guidelines for many lease agreements, keep in mind that everything is negotiable.
Dan Childs is a senior agricultural consultant in the producer relations program, where he serves as an economist. His areas of interest include farm taxation and estate planning, financial budgeting, planning and analysis, and livestock marketing. Childs enjoys working with farm families and helping them achieve their goals. He joined the Noble Research Institute staff in 1978. To learn more about the Noble Research Institute, please visit: https://www.noble.org.