Farm Progress

Country Counsel: One benefit of a long-term lease is the tax treatment of the drainage tile.

Robert Moore, Co-owner

June 27, 2017

3 Min Read
IN WRITING: A long-term lease must be in writing and should be signed by both the tenant and landlord. As with all leases over three years, signatures must be notarized for the lease to be enforceable.filmfoto/iStock/Thinkstock

It is well established that subsurface drainage is a good investment for much of Ohio’s farmland. While drainage improvement is a good investment, it is also a large investment for the landowner. Tenants often find themselves in a situation where the land they are farming would benefit greatly from subsurface drainage. However, the landowner is reluctant to spend $800 per acre on drainage when they are only receiving $150 a year in rent. In this situation, consider a long-term lease as a solution.

The tenant and landlord can enter into a long-term lease to protect both parties. The tenant agrees to pay for the cost of installing the drainage tile. In exchange for this investment, the landlord agrees to lease the land for a long term, often 10 to 15 years. The longer term of the lease ensures that the tenant that will receive a return on his investment. The landlord benefits by having his land improved, making it more valuable.

When entering into a long-term lease, determining the lease rate is an issue. Fixing a rate through the entire term of the lease will likely lead to an unfair result. For example, Tenant and Landowner enter into a 10-year lease for $150 per acre for each year of the lease. Corn and soybeans go back up to $7 a bushel and $14 a bushel, respectively, in year five, and Landowner is receiving below market lease rate. Of course, crop prices could drop leading to Tenant paying more than market rate. The solution is to renegotiate the lease rate every two to three years. The tenant and landowner can discuss any adjustments needed to the rate to be fair to both. If they cannot agree on the lease rate, they consult with an independent, mutually agreeable third-party who decides the lease rate.

Protect against terminated lease
Another issue becomes a potential termination of the lease by the landlord. Tenant may be justifiably concerned that he will invest significant money into a landlord’s land only to have the landlord terminate the lease in the first few years of the lease. To prevent this from happening, or at least to compensate the tenant in such a situation, an early-termination provision should be added to the lease. This provision would require the landlord to pay the tenant the proportionate share of the cost back. For example, Tenant and Landlord enter into a 10-year lease and Tenant invests $800 per acre in drainage tile. Landlord terminates the lease in year five without cause. Landlord would be required to pay Tenant $400 per acre minus 50% (five of 10 years) of the initial cost. The cost of the drainage project should be well documented to avoid any misunderstandings in the event of a payback by Landlord.

Tax treatment
Another benefit of a long-term lease is the tax treatment of the drainage tile. A cash rent landowner must depreciate tile over 15 or 20 years. The tenant, as an active producer, can often expense the tile under Section 179.

A long-term lease must be in writing and should be signed by both the tenant and landlord. As with all long-term leases (over three years), signatures must be notarized for the lease to be enforceable. The lease, or a memorandum of lease, should also be recorded. Recording the lease ensures that the lease will remain in effect even if the landowner transfers the land to someone else.

Moore is an attorney with Wright and Moore Law Co. LPA. Email [email protected].

 

About the Author(s)

Subscribe to receive top agriculture news
Be informed daily with these free e-newsletters

You May Also Like