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What to consider with sale-lease back

Corn field
TAX ISSUE: Capital gains is a concern for a sale-lease back. Select a farm with a high basis rather than a farm you’ve owned a long time.
Avoid potential problems if using transaction to gain operating capital.

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 at Iowa State University; Leslie Miller, Iowa State Savings Bank, Knoxville; and Rob Stout, Master Farmer, Washington, Iowa.

With low crop prices and sticky downward cash rents, I need to shore up my cash flow. I hear a lot of chatter about farmland sale-lease backs. As I understand it, I sell one of my farms. As part of the negotiation, the buyer agrees to lease it back to me for an extended period, possibly five years. How do you view this approach relative to me simply putting up more collateral to satisfy my current lender and his regulators? If I go the sale-lease back route, should I also attempt to get a buy-back provision for the end of the lease term in the sale-lease back contract?

Stout: If you have quite a lot of equity in this farm, it could free up significant capital, which could improve your cash flow situation. If you bought the property at a much lower price, it may trigger capital gains taxes, so you would want to check with your accountant first. A potential buyer will be looking for price appreciation, so it might be a little tricky getting them to add in a buy-back provision. A possibility would be for you to have right of first refusal on buying it at an appraised value in the future. Also, if there are depreciable assets on this farm, such as buildings or tile, there may be some legal ramifications that don’t allow depreciating the items again, so you should check that out beforehand. If you have more collateral that you can offer without jeopardizing your financial condition, that may be the best choice. However, I don’t see anything in the near future that indicates substantial profits are on the horizon, so I wouldn’t count on $5 corn or $15 soybeans to bail you out.

Zhang: Farmland sale-lease backs are getting popular now, which often involves you selling the land and then leasing it back, typically for first two or three years initially. Once you establish a good relationship with the buyer, often this could be extended. As you noted, commodity prices and farm income are still facing significant downward pressures, especially now given growing trade tensions and higher interest rates. While putting up more collateral uses your existing working capital, a farmland sell-lease back could potentially free some of your assets and enhance your cash flow. It is possible to include a buy-back provision, either in the form of the right of first refusal or specific terms for the buy-back, but you also need to bear in mind that the more restrictive these terms are, the lower sale prices you will get.

Miller: It’s not clear how selling the land and leasing it back can help your cash flow, unless you have too much debt on the land to begin with. Therefore, you must be careful not to pay too much rent just for the privilege of controlling that tract of land. If your cash rent is too high, that will do more harm than help. I would suggest working out a flexible lease with a low minimum that incorporates yields and prices into determining the final rent. This should make you and your banker more comfortable with a longer-term lease.

Most buyers do not want to be tied to a buy-back provision, unless they are working with a reduced purchase price. I think you are better off to maximize your sale price and not worry about the buy-back.

Farmers never truly retire

I’m 74 years old and farm 300 acres. I don’t have a mortgage, and don’t have any debt. I plant my own corn, but I hire a neighbor to plant my soybeans. The same neighbor combines my crops in the fall. That neighbor asked if I would consider renting my land to him. He would pay me $225 an acre. I made $67,000 on my crops in 2011 and 2012, but haven’t made that much money since then. I’m not sure if I’m ready to retire from farming. My neighbor said I could work for him as much as I want. Please advise.

Stout: None of us have made as much profit on corn and soybeans since 2012, so don’t feel alone. From a strictly financial standpoint, you would probably be ahead to rent out the farm at that price. Since you have no debt, you will be able to make a profit farming even with the low prices we have now, as long as you don’t count the cost of your land. The opportunity cost of your land is $67,500 since that is what you have been offered, and that might be hard to beat. Farm rent is not subject to Social Security tax like Schedule F income is, so that is an advantage to renting it out, too. It comes down to your desire to stay farming or retire. If you still love it, stresses and all, then know that it most likely will cost you money to continue farming. Your neighbor has made you a fair offer, and letting you continue to work for him might be the thing that allows you to keep doing the work you love, while adding the most to your bottom line.

Plastina: By renting the land to your neighbor, you would make $500 more than what you made in 2011 and 2012. However, it is important to consider the tax implications of renting out your acres. In particular, you will not be able to use Schedule F to file your taxes or claim any tax deduction from farming. On top of that, any additional income from any work you perform for your neighbor will count toward your taxable income, and you will need to pay extra machinery insurance fees to get coverage against liabilities that might arise when doing custom work for your neighbor. A final aspect to consider when evaluating this decision from an economic point of view is the likelihood of actually receiving the agreed payment in time. If after considering these basic aspects, renting your land to your neighbor seems to make sense, then it might be a good opportunity to test the waters of retirement from farming while keeping the door open to jump back at it if you do not enjoy the new situation.

Miller: If you don’t need the money, then I’m guessing that you enjoy the activity more than the money. If you are currently only planting corn and your neighbor does the rest, then it is possible you would get as much enjoyment out of helping the neighbor do everything. Instead of giving everything up at once, try leasing the cropland that will be in beans next year to see how that works. You can also try working with the neighbor part time. If everything goes well, then you can take the next step and lease all the ground. If not, you can simply claim that you miss it too much and take back any ground that you leased out.

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