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Rent in excess of variable costs is a net gain

scenic farmstead and pasture
COMMUNICATE: Communication among family members regarding the farm’s vision and goals will go a long way toward implementing a successful farm succession plan.
Agrivision: Talk to a tax professional before deciding to sell any assets.

Editor’s note: Eden dairy farmer and Agrivision panelist Doug Hodorff was involved in a car accident recently. While Hodorff is recovering from his injuries, Waldo dairy farmer Tom Kestell will be filling in for him.

Agrivision panel: Tom Kestell, Sheboygan County dairy farmer; Sam Miller, managing director, group head of agricultural banking, BMO Harris Bank; and Katie Wantoch,  Dunn County Extension agricultural agent specializing in economic development. 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 [email protected].

My husband and I are leasing our farm equipment, bins, dryer, buildings, etc., to a farmer, as we are in the process of retiring. To determine what we need to charge, we were using a guide from Iowa State Extension, “Computing a Grain Storage Rate.” The farmer prefers to pay only taxes, insurance and repairs, with no consideration for the yearly drop in value of the equipment. Meanwhile, our equipment is decreasing in value, and we are not being reimbursed for it. In your opinion, should we be reimbursed for the depreciation of our equipment? Also, are there any good guidelines we should follow for lease of tractors, combines, etc.? Should depreciation as well as repairs, insurance and taxes be included in the lease rate for these? We would appreciate any information you can provide and your opinion on this matter.

Kestell: I’ve been trying to lease land from my neighbor for the taxes. However, my neighbor feels he needs a reasonable return on the current value of the land. You also need a return on the current value of the equipment you are leasing out. You will also need to account for depreciation of these assets. These assets will depreciate whether you use them or they sit idle. However, they will depreciate much faster if they are used. Every time you turn a tire, dry a bushel of corn or turn an auger … the value of this equipment will go down. I would sell these assets to the party that is leasing them and recoup as much of your investment as possible before they have no residual value. 

Miller: You should be reimbursed for the value of your asset. Depreciation cost plus the other expenses you mentioned is a reasonable estimate for what the return on the asset should be. If you are not able to negotiate a lease that provides this reimbursement, you may consider selling either the facility itself or the bins and dryer to realize their value. As you mentioned, many state Extension services provide guidelines for leasing equipment and facilities or providing custom work. You may also want to visit with your tax professional about the tax implications if you sell the equipment, or to calculate a reasonable return on a lease. You mentioned you were in the process of retiring; this is another great reason to visit with your tax professional, should you sell any other land, equipment or inventory assets. Good luck with your negotiations.

Wantoch: The Iowa State Extension publication is a great tool to assist in figuring a rental rate for farm grain storage. I would also suggest you visit the website aglease101.org, developed by the North Central Regional Cooperative Extension Services. This website contains publications, forms, survey results and worksheets to assist you with rental of farmland, buildings and equipment. You might find the publication “Rental Agreements for Farm Buildings and Livestock Facilities” to be very useful when negotiating with your tenant.

Keep in mind that while you have assets that have outlasted your need for them, your tenant is looking to use resources and not make a large fixed investment. It sounds like the farmer is paying for the variable costs (insurance, repairs) related to use of the grain bin, but you are also looking to cover some of your ownership, or fixed, costs. You mentioned depreciation for equipment or facilities, which depends on the remaining useful life. Remember that you are estimating loss of value due to use, not depreciation for income tax purposes. You could calculate your total ownership costs (depreciation, insurance, etc.) and operating costs to provide a starting point for negotiating a rental rate. Remember, owner’s (fixed) costs occur whether the asset is rented or not, so any rental amount in excess of variable costs is a net gain. 

Coming home
My wife and I are in our late 40s. Our son graduated from college in May with a degree in dairy science. Originally he planned to work three years off the farm after graduation to get experience working for someone else and to save some money. So far, despite his best efforts, he has not been able to find a full-time job. He is living at home and working on our 225-cow dairy farm for wages. We farm and own 400 acres and owe $300,000 on our farm. I have an offer to work full time as a district sales manager for a seed company. I know it is not what our son or we planned, but would it make more sense for our son to replace me on the farm and for me to work off the farm? Should we let him work on the farm for wages for three years before we form an LLC, or should we form the LLC now and make him a partner? He has no money to bring to the table, but he also has no debt. What are your thoughts?

Kestell: Congrats to your son on his recent graduation. It is also great that he has no college debt to weigh him down. I’m quite surprised, however, that he could not secure a job on a dairy farm. I would approach the job market as an intern, not looking for top wages but for the ideal situation in which to develop his skills. This can act as his “grad school,” where a mentoring and successful dairy producer can give him real-life experiences on a farm other than your own. One year would be adequate time to broaden his horizons and finish his education.

I would wait a year or two before forming a limited liability company to see how well you work together. This will give you time to explore your various options and to build a solid foundation under your LLC and business relationship. I definitely would not take an off-farm job, but would work together to improve the profitability of your operation.

Miller: As farms transition, there is a difference between ownership and management. Your son needs experience, and your original plan was for him to work elsewhere before coming back to the farm. Your off-farm sales manager offer also provides an opportunity for your son to step into a management role at the farm to gain experience.

In my opinion, it would be best for him to work for wages to be certain it is something he does want to do for the long term. You could establish part of his compensation as “sweat equity” to be granted when you form the LLC, if he wants to become a partner in the business. If three years is your timetable, establish this value and timetable, and reassess things in a few years to determine you both want to continue the transition. This should provide motivation for your son — the ability to gain experience in managing and operating the dairy on a daily basis. Work with a qualified dairy business consultant, your local Extension ag agent or a farm technical college instructor to assist in putting together the plans, job descriptions and performance measurement standards in order to bring this plan to reality.  Good luck with the transition of the business and your potential new sales manager role.

Wantoch: While there may never be a “right” time to start work on farm succession planning, I would encourage you to work with a farm business consultant, technical college instructor or Extension agent to start looking at all of the options that you listed. Start by conducting an inventory of your dairy farm — people, wealth and management.

Multigenerational succession planning means that there are family members at different life stages who may have different goals, attitudes and needs. Wealth refers to an inventory of the farm’s assets and liabilities, as well as whether the farm has been profitable in recent years. Management is also critical in succession planning to ensure that the expertise and knowledge are passed between the generations. It sounds like you are eager to incorporate your son into your operation, but is your son as willing to take over the management role, or is someone else filling your shoes? If your son has limited experience managing employees, how will this be viewed by them? Communication among family members regarding the dairy farm’s vision and goals for current and future plans will go a long way toward implementing a successful farm succession plan.

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