We have been farming for 40 years. We are in our early 60s and in good health. We milk 60 cows and own 200 acres. For the past 20 years, we have rented 52 acres from a neighbor, paying $75 per acre. The corn ground averages between 140 and 160 bushels per acre. The owner offered to sell us the 52 acres for $150,000. We have the cash to buy it. We have no debt or payments to make. We plan to sell our cows in the next five years and then grow crops for a few years before we retire. Should we buy the 52 acres? Please advise.
Tom Kestell: Congratulations on your successful career so far. Forty years went by quickly, and I hope you enjoyed your journey. You are faced with a decision with no bad consequences, either way you decide. If you have the cash to buy the property, you will not have to worry about payments disrupting your cash flow. Purchasing this land at the asking price should allow you to make a profit farming it and at the same time capture the appreciation of the land value over the next 10 years.
If you decide not to disrupt your savings, you are in a good position to borrow the money at low interest rates at this time, resulting in a similar financial outcome. I feel that the opportunity to purchase this land at a reasonable cost per acre should be both profitable and have long-term financial benefits to you and your wife.
A second matter to consider: If you don’t buy it, will someone else buy it? You have spent 20 years managing this land. You know its productive capabilities, and I am sure you are aware of its shortcomings, too. List the pros and cons, and I think the answer will be quite clear to you.
Sam Miller: First, congratulations on your excellent financial position! Your question is not as simple as it might seem. This is a great time for you to be looking ahead toward transitioning your business and funding living expenses after selling the cows and eventually retiring. Meet with a financial planner to evaluate your various sources of income versus living costs, philanthropy and gifts to children or others. Going through this process will help you decide if you should keep the cash or invest it in an income-producing asset to eventually receive farm rent income.
As for the transaction itself, the purchase price is about $2,885 per acre, and rent is $75 per acre. If you subtract $5 per acre for real estate tax, your return would be $70 per $2,885, or 2.4%. Compare this return to what you could earn in alternative investments. Your actual return may be higher, as land tends to appreciate over time. Bottom line, work through the planning exercise to understand your mix of investments, expected revenue streams and demands on cash as you eventually retire. On the surface, this seems like a good investment; understanding it as a part of your overall financial picture will lead you to the appropriate decision.
Katie Wantoch: Most of the time, the purchase of farmland is the largest investment a farmer makes in their career. Spending time on the breakdown of this decision is critical to your long-term financial security. I am concerned about this purchase and your future retirement, so you should approach this by considering the economic and financial analysis of the land purchase.
The economic perspective ponders how much the land is worth based on its net income earning potential. Future income will likely come from producing cash crops, but may also include hunting rights, recreational use fees, etc. Net income to an owner and operator of the land is the sum of the expected gross income from all crops produced on it, less the variable costs to produce it, and costs that occur from owning the farmland.
If you decide to rent this farmland to another operator after you retire, will the return on this land and its appreciation be greater than other investments? Conversely, financial feasibility is generating sufficient cash flows (money) to meet the required cash outflows. While owning farmland can be a very profitable venture over the long-term, farmland will typically never cash-flow when purchased with substantial borrowed capital. It doesn’t sound like this is the case for you and your wife, but I would proceed with caution. A land purchase may be economically viable but not financially feasible.
Good problem to have
We got the second payment from the Coronavirus Food Assistance Program, and my son and I are at odds over what we should do with the $75,000. I want to buy a new pull-type chopper to replace our old wornout chopper. The new chopper will cost about $50,000 more than $75,000, but I think it will be well worth it. He wants to pay off the remaining $72,000 we owe on our freestall barn. He thinks it is better to be out of debt than to have a reliable chopper to put up our four cuttings of alfalfa haylage and corn silage for our 225 cows. What are your thoughts?
Tom Kestell: At first glance, this appears to be a good problem to have — what to do with $75,000? I think it is a good time to take a step back and talk with your son, and evaluate your operation and your financial priorities. This appears to be a role reversal on how to invest in the farm. Many times, younger partners are more inclined to invest in the future needs of the farm than the older generation. As I said earlier, I would step back a bit and discuss how spending this extra income would affect your farm over both the long term and short term.
If you are a profitable operation already, the CFAP payments could drastically affect your tax liability. Paying off old debt will not do much to alleviate tax liability. I would first look at current liabilities, such as open accounts, and opportunities for cash discounts on seed and fertilizer and other inputs. If these costs are covered, I would then look into future needs to see how this purchase of a new chopper will affect your taxes and tax savings. New equipment and new investments of this size can be written off against your tax liability all in the first year, if needed, or can be carried over into the future to mitigate taxes.
Another thought — with many large farms upgrading to self-propelled choppers, there will be late-model pull-type choppers available at greatly reduced prices from new. There is also an opportunity to purchase smaller self-propelled choppers that are in like-new condition for not much more than a pull-type one. I think this is the year to watch for surprise tax liabilities due to the CFAP payments. Both you and your son need to investigate the best use of this added income.
Sam Miller: This is a great dilemma to have — should I pay off debt or upgrade an asset? Fortunately, you did not need the funds to clean up payables or improve your working capital. Since the harvest season is done, it might make sense to pay off the debt and then start to accumulate cash to pay for the chopper, or at least make a healthy down payment. You may want to continue to “make” your loan payments by transferring them to a savings account that is used for capital replacement like the chopper. In addition, the depreciable life of the chopper is shorter than the freestall barn, so financing the chopper next year will allow you to build up some cash, plus you will be debt-free quicker than if you were still paying on the barn debt.
Complete a cash flow budget to determine what you can comfortably afford in debt service as a way to analyze how long it will take to pay off the chopper if you allocate the funds to the barn debt. A dairy business consultant, Extension agent or technical college instructor can assist with this analysis.
Katie Wantoch: Most of the time I would encourage you to pay off your debt and save up for the purchase of new equipment to avoid the additional loan fees and interest expense. However, 2020 is a year like no other! The coronavirus pandemic has directly impacted farmers and their operations. USDA Farm Service Agency and other government programs have provided direct relief for farmers who have faced market distributions (price loss) and associated costs because of COVID-19. This may create “income bunching” if you have received one or more of these program payments. The payments will be taxed as ordinary income, just like other crop or milk commodity sales, and may be subject to self-employment tax.
I would encourage you to contact your tax preparer or accountant for end-of-year tax planning. Your tax preparer may suggest tax methods to assist with this “income bunching,” such as prepay farm expenses or delay payment of farm expenses into the next calendar year, income averaging, retirement account funding, and varying depreciation schedules for used or new equipment purchases. Weigh all your options and advice that you receive from professionals before making a decision.
Agrivision panel: Tom Kestell, dairy farmer, Sheboygan County, Wis.; Sam Miller, managing director, group head of agricultural banking, BMO Harris Bank; and Katie Wantoch, Extension agriculture agent specializing in economic development, Dunn County, Wis. If you have questions you would like the panel to answer, send them to: Wisconsin Agriculturist, P.O. Box 236, Brandon, WI 53919; or email them to email@example.com.