Each month in Wallaces Farmer magazine, the Timely Tips panel answers questions sent by readers. Members of the Timely Tips panel are Alejandro Plastina and Wendong Zhang, Extension economists, Iowa State University; Leslie Miller, Iowa State Savings Bank, Knoxville; and Rob Stout, Master Farmer, Washington, Iowa.
A nearby landowner is upset because his current tenant was a month late paying the rent this spring. The landlord is already offering the farm to me for 2019. The rent price is reasonable, but I’m not sure it’s worth creating ill will in the neighborhood. Plus, I’m not sure I want to commit to 400 more acres until I decide if it’s feasible to trade for a bigger combine for 2019. He wants an answer. What do you suggest?
Stout: The landowner has most likely already decided he is going to rent the farm to someone other than the current tenant, so if there is any ill will it is going to happen anyway. Hopefully, none will be directed to you. As far as deciding on a larger combine, it appears you are going to have to make the decision to rent or not before you would be trading combines.
If you can cash flow renting the additional acres and the only extra equipment you would need is a larger combine, then it should work out. Machinery cost per acre should be lower with the additional acres,unless you spend a whole lot more than you need in upgrading your combine. You can always shop around now for a larger combine just to give you an idea of what your approximate trade-in cost would be, even if you’re not going to make the trade for a year.
Miller: Is that really the reason the landlord wants to change tenants, or is he looking for more money? If that is the case, he will be looking for more money next year, and this could be a one-year deal. And don’t overpay rent based on the empty promise of “you’ll have first rights on it next year.” Oftentimes, that means you get first rights in a bidding war.
The skeptic in me wonders why the old tenant was late with his payment. Is it possible that the land was losing money at the price he paid, and he had to juggle finances to get the money he needed? In our area, the land that is turning over is usually the least productive. It might be prudent to get historical yield information (and current fertility levels) before you jump.
If you have to upgrade equipment to add this piece, you should sign a multiyear lease. Otherwise, you could be stuck with a high-priced combine and not enough acres to carry the load. A lease that spans multiple years should, ideally, be some kind of flex lease, since none of us know what prices are going to do. If they go up dramatically, that would be fairer to the landlord. If they go lower, it keeps you from going out of business.
Zhang: Based on your description, it seems that the neighborhood should be well aware of the late-tenant situation, so I would not be too worried about the possible ill will just based on that. I would focus more on how adding 400 more acres would likely impact your profitability and perhaps more importantly your cash flow given the continuing low commodity prices.
The new tax law provided additional depreciation incentives for machinery purchases, so the bigger combine next year could be a good idea. But again, with the current low-to-negative margin for crop production, careful analysis on any decision affecting your cash flow and whole-farm profitability is needed before you rush into any financial commitment.
If you do decide to buy a larger combine, beware of possible capital gains taxes down the road, because with the new federal tax law, a 1031 exchange does not include machinery.
My wife and I have a partner on our dairy farm (400 cows and 1,500 acres). He owns 10% of the herd. He bought some of the shares, and we’ve gifted him the rest over the past six years. He worked for us for a couple of years before he became a partner six years ago. Now he wants to cash out his money and end the partnership. The problem is he wants to get paid book value for his share. We don’t mind buying out his share, but our issue is that he is expecting us to pay more than we think his share is worth. How do you suggest we resolve this matter?
Stout: Since this is a closely held operation, then you are not under any obligation to pay him book value for his shares at his request. With the current financial shape of the dairy industry, I would think the actual value would be somewhat less than book value. If he owns 10%, then he would also be liable for an equal portion of any debt, assuming the operation has some debt. How did you come up with the value for the shares you sold him in the past? You could use that same method to determine value for the shares at any point in time.
Miller: Were there any buyout provisions in the original agreement you signed to allow the purchase? If so, those are the rules to follow. If not, then you could sit down and complete a financial statement with your lender to get a value.
For the value to be fair, it is important to include deferred tax liabilities, as they can have a big impact on the real value of appreciated farmland and machinery. Once the current net worth has been determined, it might be fair to suggest the partner accept 10% of that value. However, before you sign any papers, check with your lender to make sure the partner’s exit will not harm the borrowing ability of the farming operation.