Does the cropland you rent need tiling, limestone, conservation structures or other long-term improvements? If you're thinking about making improvements at your own expense, the experts advise: Put it in writing.
“Memories fade. Paper doesn't,” says Donald Uchtmann, who specializes in agricultural law at the University of Illinois. Tenants need a written agreement that spells out how they will be reimbursed for improvements if they have to quit farming the land before the end of the asset's useful life.
Farm operators regularly ask him about making improvements to leased fields, Uchtmann says, “especially as land ownership becomes more distant.”
Nationwide, farmers leased 38% of total farmland in 2002, according to the most recent Census of Agriculture. And in some states, the percentage of leased cropland is much higher. Iowa farm operators, for example, rented 59% of the land they farmed in 2002, up from 43% in 1982, according to an Iowa State University report.
Although improvements such as drainage tile add value to the property, landowners may be unwilling or unable to incur the upfront costs.
“Most landlords are retired farmers,” says Doug Wulf, a farmer and drainage contractor from Morris, MN. Owners may not see the need to improve drainage, he says, or“they don't want to spend the money.”
In other cases, the landowner may not benefit much from improvements that the tenant wants. For instance, “landlords may want to pass along the cost of limestone” or other long-lasting fertilizers, Uchtmann says.
Grain bins are another common example. Tenants — especially the 7% of farm operators who own no land — “may be looking for another place to store grain, other than the local elevator,” Uchtmann says. “So they might find it advantageous to construct storage on a leased farm.”
Tenants may be willing to share the cost of improvements that have a long payback period, or even foot the entire bill, says Stephen Matthews, a farm law expert at the University of Missouri. But they fear losing their investment if the landowner sells the property or dies, or if they lose their lease for some other reason, he says.
The law can be harsh when it comes to compensation for permanent improvements, Uchtmann tells renters. “Absent some provisions in the lease or other binding agreement,” he says, “the farmland owner may have no obligation to compensate the tenant.”
Traditionally, most farmland leases have been verbal contracts. In many places they are still the rule, Uchtmann says. But even if you and your landlord have always gotten along perfectly well on trust and a handshake, “special agreements, such as an oral agreement that the tenant, upon leaving the property, is entitled to payment for permanent improvements,often are difficult to prove,” he says.
“Sticky issues” can arise when renters lack paper agreements, says Parman Green, a longtime Extension ag business management specialist at the University of Missouri. “Time passes and you forget what arrangements were made. Or the landlord dies and you don't have any evidence to show the heirs.”
Informal agreements between siblings, uncles and nephews or other family members can become really thorny, too. Green, who has a store of examples, says, “Such as when a child comes back to the farm and makes permanent improvements on land owned by the parents. Too frequently, these types of operational situations are entered into without adequate communication and formality.”
To protect your investment on rented land, these experts say you and the owner should agree in writing on:
The improvements to be made. Specify what each person will furnish and the value of the tenant's contribution.
The depreciation rate for the tenant's contribution, and the lease year when depreciation begins. The amortization rate that you and your landlord agree on can be different than the farm income tax depreciation schedules, which may allow assets to depreciate faster than their value decreases. Other methods, such as appraisal, may be specified to determine the asset's current value, Matthews says.
How any remaining value will be reimbursed if the tenant leaves the farm before his costs are fully recovered. Uchtmann points to the example of a farm where limestone needed to be applied. “The lease provisions allowed the tenant to be reimbursed for a portion of his expenditure if he wasn't on the farm for four years,” he says.
Put It In Writing
Sign and date your agreement. Because of the legal issues and sums of money that may be involved,it's wise to consult a lawyer, Uchtmann adds.
Green, like Uchtmann, considers tenant-paid improvements “the choice of last resort.” Still, Uchtmann says, if the only way to drain that wet spot in your leased field is to do it yourself, “be sure to have the agreements in place so you benefit fully from your investment.”
Who Pays What?
An agreement covering improvements made by renters at their own expense should provide fair compensation for the undepreciated value of improvements when the lease ends. The agreement should include:
- Landowner's consent for the improvement
- Description and location of the improvement, including whether it is removable or permanent
- When the improvement will be completed
- Percentage of materials, labor and machinery that will be contributed by the landlord and tenant
- Tenant's net cost
- Annual rate of depreciation (percent)
- Date depreciation begins
- Tenant and landowner signatures and dates signed
A good written agreement encourages cooperation between tenants and landlords, says ag law expert Stephen Matthews of the University of Missouri. It means that beneficial improvements can be made by “whoever wants to take the initiative, or has the cash flow or borrowing ability.”
Doug Wulf, a Morris, MN, farmer and drainage contractor, says tenants and landowners often ask him, what's a fair arrangement? “I tell them, whatever you can agree to is fair.”
Farmers and landowners may share the cost of drainage improvements, with one paying for labor and the other for materials, says Mitch Brethorst of Miles Tiling,a Brandon, MN, drainage company. “Or another option is for the tenant to apply the cost of tile toward the land rent. If they can get a five- to 10-year contract, it works well for both tenant and landowner.”
Wulf says the tenants he works with are typically willing to spend up to $200/acre on tiling. “It's becoming more and more common,” he says.
In his own farming operation, he paid for 100% of the tiling cost on the rented land. “We have a 15-year lease,” he says. “If we break the lease, we forfeit the cost of tiling. But if the landlord breaks the lease, the tiling cost is prorated over 15 years and the landowner would have to reimburse us.”
Installing irrigation on rented land is also becoming common, says Lowell Nelson, of Hancock, MN, a farmer and an attorney who often handles farm contracts. “From a tenant's point of view, if the land is good for irrigation, you can't really justify farming without it. The landowner may know that's the best use of the property, but may not have the money to put in a well,” he says.
However, “If the tenants know they're guaranteed to rent the land for a certain number of years, they'll consider making improvements,” says Nelson. In some circumstances, “the landowner might reduce the rent because of the value the tenant is adding to the land over time.”
There could also be tax advantages for tenants making long-lasting improvements, Nelson adds. Under federal law, farm operators may elect to write off qualified improvements in the current tax year, “while landowners would have to depreciate the improvement over a number of years.”
In 2007, Section 179 Expense Method Depreciation allows farmers to immediately expense up to $125,000 of qualified capital expenditures on their federal tax return, for purchases up to $500,000.