Terry E. Poole Principal Agent Emeritus University of Maryland Extension
What is a lease? Simply put, it s a contract by which one party (the landowner/landlord) gives another party (the tenant) the use and possession of some property for a period of time with certain payments. It is recommended that leases are done in writing, but some still just use a hand shake.
Why would a landowner lease their farmland? The landowner may own the land as an investment property, a heritage, or just for its esthetics. The primary reason for leasing land is for the added income, or return on investment. Other reasons for leasing include having a caretaker to protect the property, or maintain or add improvements to the property. Note: It does not take long for once clean, cultivated fields to return to a wild condition.
Cash or Share Lease Cash leases are more common than share leases. Leases where payments are made in the form of prearranged cash rents are cash leases. Rents for share leases are made in the form of a share of the income or profits or commodity produced.
Cash Lease With a cash lease, the landlord can plan on a relatively stable income. Neither bad weather, poor management, or down market prices will affect this income. In a cash lease, nearly all of the risks fall on the tenant. With a cash lease, the landlord can receive regular, periodic payments.
Cash Lease Tax Implications Rent income is not earned income; wages, salaries, tips, long-term disability, etc. are earned income. Rent is not considered when calculating earned income tax credit on the Earned Income Credit Worksheet. Rental income is recorded on Schedule 1040 Line 17. It will be a component of total income (line 22) and adjusted income (line 37). Cash rent is considered passive income.
Share Cropping Share cropping is not something that is commonly done around here. One form of this, that is often done, involves hay cropping. In the situation where a landowner has land in hay, that is mature, and has no hay equipment, it is common the have someone with equipment to make the hay in exchange for one-half of the crop.
Another Cash Rental Option Some landowners do not like dealing with tenants. Some tenants can be difficult to deal with and some can be slow pays (not on-time with payments). Another option to renting land to a local farmer would be to rent the land to the state or federal government. There are government soil and water conservation programs where the landowner receives a cost-share payment to plant specific perennial crops or trees, the land is then set-aside in return for receiving an annual cash payment.
Setting Rental Rates This is one of the most common questions Extension receives. There is a reported county average of cash rents received, but the actual amount received by landlords is varies based on several factors. Some of these factors are farm location (distance from home for tenant), condition and fertility of the soil, presence of perennial noxious weeds, land topography, restrictions on farming practices, varies etc. Can machinery access and operate in the fields.
Setting Rental Rates Land with well drained fertile soils, on gentle slopes, with little to no noxious weeds will command the highest cash rents. These lands require the fewest management inputs allowing the tenant to pay a higher rent with the expectation of a high crop yield. Poorly drained and lower fertility soils require more management and will produce lower crop yields.
Setting Rental Rates In situations where the farmland needs improvement from years of neglect, or is infested with noxious weeds, such as johnsongrass and canada thistle, some landlords have opted to give free or reduced rent to the tenant so that the land can be cleaned up. Another option on this situation has the landlord paying part of the expense of the herbicide treatments and limestone application in the case of fertility. Some landlords have allowed their land to be farmed free just to keep it from going wild.
Setting Rental Rates The rental rate should at least cover the interest, taxes, and insurance costs on the farmland. If buildings are involved, the minimum rate should cover any depreciation, repairs, interest, taxes, and insurance. These are fixed costs that the landowner has whether or not the land or buildings are being used.
Renting Pasture Land There are two general approaches that are most often used when arriving at a cost for renting pasture land. The first is a per acre cost; meaning that a price would be set for each acre of pasture being used by the tenant. The second is a per head per month cost. This means that the pasture cost would be based on the number of animals in the pasture. The animal unit is usually based on a mature animal with younger animals counting less.
Per Acre Pasture Rental The per acre approach is the simplest and gives the landowner fixed income for the year or season. The per acre approach also gives the tenant flexibility to apply fertilizer and manage stocking rates to their advantage. The per acre approach also allows the tenant to harvest any excess forage produced.
Per Acre Pasture Rental One problem with flat-rate renting is that the landowner and tenant may have conflicting goals. The tenant will probably want to have a high stocking rate, while the landowner will want to limit the number of animals to reduce damage to the pasture. Who pays for fertilizer and limestone is another problem, especially with year-to-year leases.
Per Head Pasture Rental Pasture rental, based on a cash per head per month, gives more weight to pasture quality and forage production. This method provides greater incentive for the landowner to improve the carrying capacity of the pasture by using good pasture forage species and good fertilization.
Rental Rate Cost Recovery Just as the fixed costs for the Ag land sets a minimum rental rate floor for the landlord, the potential profit margin for the tenant would set a maximum ceiling for the rental rate. The tenant should do a budget to determine what the upper limits would be for a rental rate in order to achieve profitability.
Constructing the lease In many farmland leases, the parties keep it simple by including only the names and addresses of those involved, property involved, length of the lease, and the rental rate. This may not be sufficient in every case, especially if improvements to the land are needed. These improvements could be fencing, or other capital improvements, liming, seeding, and any restrictions.
Constructing the lease Introduction: This section would contain the names and addresses of the landlord and tenant, starting and ending dates of the lease, whether or not the lease is renewable, and the property involved. Some landowners will lease their farmland based on the calendar year. Most landowners will lease their farmland like the federal fiscal year, from October 1 to September 30. *This has nothing to do with the feds, but is structured around the planting of small grains, such as wheat.
Constructing the lease Contributions: This section lists any contributions to the lease coming from the landlord in terms of expenses, reimbursements, condition of the property, and materials provided. The tenant may be expected to contribute rental payments, labor or machines to perform certain jobs, and compliance to certain restrictions.
Constructing the lease Payments of rent: This section would include the total amount of cash rent, if time payments are to be made, and penalties if payments are not made. With a share lease, this section would include the landlord s share of expenses, share of income or commodity, and how reconciliation would be made to determine shares.
Constructing the lease Termination: Reasons for termination of the lease could be listed in other sections; such reasons can be listed as: at the end of the lease period, or if the tenant fails to pay rent as stipulated, or if one of the parties should die. If a landlord decided to terminate or not renew a lease, it is recommended that a certified letter be sent to the tenant well in advance of the end of the current lease. This provides documentation that the tenant was notified of the lease termination.
Constructing the lease Here are some other clauses or sections that may be added to the lease. Will the tenant be permitted to build or remodel capital property that is, or becomes part of the landowner s property? If, so will the tenant be reimbursed or compensated for any portion of the cost or value of property if the lease is terminated? As an example, with fencing, the landowner supplies the materials and the tenant supplies the labor. Both will benefit from the fencing when completed.
Constructing the lease What happens if the tenant applies limestone, fertilizer, or seeds a hay crop? If the lease is terminated, some suggest a reimbursement that is factored to a timeline of 75% of costs before the 2 nd season, 50% after the 2 nd season, and 25% after the 3 rd season. This gives the tenant some assurance that there would be some compensation, if improvements are made to the pasture.
Constructing the lease The primary reason for Ag leases to run from October 1 to September 30 is to avoid the issue of small grains, which are planted in early fall and harvested into mid summer. But sometimes this cannot be avoided, so what can a landlord do when a lease is terminated after a tenant has planted a small grain crop? The landlord can reimburse the tenant for the entire cost of planting, or after harvest give the tenant the grain and keep the straw as compensation for the land use.
Constructing the lease What happens if a tenant participates in a conservation cost-share program on the rental property and the lease is terminated before the end of the program? The recommendation here is that the tenant would be compensated for any portion of the program value that would be left. The Soil Conservation District requires that both the landowner and tenant are involved with and understand their responsibilities when cost-share programs are implemented on a property.
Constructing the lease Both the landlord and tenant should check out their insurance coverage. The landlord s insurance may not cover the tenant s property even if it is attached to the landlord s property. The same goes for the landowner s property attached to the tenant s property.
Constructing the lease What happens if the landowner s property rights are jeopardized due to some action taken or not taken by the tenant? For example, the tenant s cows escape through the fence and cause damages. A clause should be added that makes the tenant responsible for all costs arising out of a lawsuit. The landlord should definitely have liability insurance.
Length of Lease Most Ag land leases are year to year (1 year). This gives the landlord flexibility over the tenant and the future of the property. Year to year leases will limit what a tenant elects to do with a property. The tenant will most often put only the minimum amount of plant nutrients, and plant only annual crops. This is hard on the soil. Longer leases will allow for better crop rotation and soil fertility.
Sample Lease Agreements Some good examples of farm leases can be found at this website: http://sustainablefarmlease.org/2010/06/form-leases/
Good luck with your Ag land leases