Our Blog

Read the Latest News

 

Its July, its hot, and the worry will soon set in on Harvest ‘17. Minus some late season applications, the die has been cast on the crop, and mother nature will be the deciding factor as the crop moves toward maturity. It is time to evaluate where the farm operation is, where it is going, and where it needs to steer clear of in the coming years.

Does your operation have a one year, three year, and five-year plan? Has it reviewed its relationships with its land owners recently?  When is the operation going to need more labor? Where will it get that labor, and how will it retain its help when competing with off-farm jobs? Does the estate plan match the business plan? What vendors can you rely upon to grow with you, and which ones are not up to the task? Have you outgrown relationships with vendors and end users of your product? Why do you buy and sell where you do? How could you make it more efficient? How will new federal or state legislation and programs impact your operation? What would a sustained 10% hit to the gross income do to your operation and how would it adjust. Same question at 20%.

These questions need to be asked frequently, and they need to be answered honestly after considering the environment you are operating in.

Consider a couple of the environmental factors farm operations are experiencing right now.

  1. This year has been particularly interesting for farm operators, as lenders are tightening their purse strings, margins seem to be shrinking, and the equity in the once red hot farm land market appears to be receding. Dairy operations are being asked to check with the buying creamery before expanding herds significantly.

  2. Banks are not keen on the slim cash flows. Operators are being asked to consider consolidation, releasing high rental rate ground, and stream lining their operations to be lean in the coming years. Those operators who bought shiny equipment in the last several years are starting to regret aggressive short term note payments and taking accelerated depreciation.

  3. The ever-aging population of farm land owners who are needing high rents to cash flower their health care needs. What does your land owner need from its tenant to meet its own obligations?

While farm operators are used to having to know everything from tire changing, yield monitor calibration, and agronomy, it is highly unlikely to have all the answers yourself. Those involved with professionals like tax preparers, lawyers, appraisers, marketing specialists, and bankers, to accurately assess the question and its costs, will be far better off.  

Consider this example of behaving like a professional. A large dairy operation installed a scale and told its suppliers point blank, “we will pay for what goes across the scale on the farm, scale in and scale out.” The operation thinks the scale paid for itself the first year.

Businesses that grow take risks, and balance it with the reward. The opportunities for those with the patience and planning will be many in the coming years. A solid cash base to work from will result in opportunities for capital and equipment purchases in the coming years with good value. Operators who can “do the math”, make cash flows that work, and treat farming operations as business operations, not emotional baggage, will be poised to capitalize and grow.

The world of ag law never stops. Here are some of the recent changes in the law that impact agriculture. Every once in a while, a quick tour is in order.

  1. Des Moines Waterworks. They attempted to hold drainage districts responsible for nutrient run off fails.  The sue and settle method of the federal activist groups was not successfully parroted by the DSM Waterworks in their attempt to get additional parties to the table on nutrient run off management.
  2. Syngenta Litigation. The lawsuits have their first “bell weather trials” (aka test cases) working their way through the courts in Kansas and Minnesota. The results of these cases will determine if a global settlement is in the cards for the coming months. If you are a producer of corn in Iowa in the years in question, you are either represented individually by opting out of the class action, or you are represented by the class action lawyer, who essentially carries the case for all the nonspecifically represented corn producers.
  3. Pink Slime. The trial against ABC and its reporters for characterizing Beef Products, Inc.’s lean, finely textured beef as pink slime is underway. BPI says the report ruined its production, cut demand rapidly, and damaged the company to the tune of $1.9 billion (which could be tripled under South Dakota law where the suit is being heard).
  4. Industrial Hemp. Nevada (the state, not the town in Iowa with a different pronunciation of the same word) authorized growing industrial hemp for commercial purposes.
  5. Soda Tax. Seattle imposes a 1.75 cents per ounce tax on all non-diet sodas sold.
  6. Hazardous release exemption challenged.  Activist groups are challenging the EPA when it exempted farms from hazardous release reporting requirements. The district court found it didn’t have the authority to make the exemption. Producer groups were also suing the EPA, saying the exemption wasn’t broad enough and should cover concentrated animal feeding operations as well. Twenty-Eight Senators have asked the EPA to appeal the decision to the Supreme Court. The producers and the senators are worried that the reporting requirements (including low level ammonia and sulfur emissions that happen during livestock production) will expose farms to liability for not reporting correctly, and if they are reported correctly, the reporting system will be overwhelmed and create dangerous conditions. Further, farm groups fear the reporting requirements will subject them to attacks by extremist groups, because of the ease in which they can discover where feeding operations are located and managed via this reporting.
  7. Ag Supply Liens. Suppliers to ag feeding operations (like a feed mill) must file a new UCC filing statement with the Secretary of State every 31 days to maintain its ag supplier’s lien for feed sold within the last thirty days. Further, that lien is for the full amount of the feed supplied, and it attaches in full to the animals that consumed the feed. This is an important clarification that should help ensure distressed livestock farmers can still gain access to feed on credit, without the feed supplier sitting behind the operating credit lender in priority.
  8. Partition of real estate. Breaking up is hard to do, but splitting in kind falls from disfavor with the court. The Iowa Supreme Court ruled that when two parties own property, splitting up dollar bills is preferred to splitting up the farm.  The old “you pour, and I pick” method of splitting drinks won’t work either. This preference by the court means squabbling co-owners shouldn’t look to the court to split a farm, unless it is both fair and practicable. As no two pieces of dirt are ever the same, it creates a high bar. This is good news if you are an auctioneer or real estate agent, as court ordered sales appear to be favored going forward. Right after that ruling by the Supreme Court, the appeals court found that dividing in kind into identifiable tracts with no topographical differences would work, so all hope is not lost for those seeking to split the farm versus buying a co-owner out.
  9. Easements. Once a landowner is paid for the easement, the easement cannot be expanded without further compensation. The court indicates the key is to look at the use of the easement within the original idea of the grant of the easement. For example, allowing ingress/egress to a field doesn’t expand to parking on the access lane unless there is more to the story. If the use isn’t that clear, the court will look at the lay of the land, the actions in the first couple of years of the easement with an expansive view of allowing the easement holder the upper hand.
  10. Fences. Once again, good fences make good fences, and long standing fences make property lines; however, this is only true if coupled with conduct that shows ownership up to the fence. Fences not on the property line make fences the new boundary line after a period of years, but that installation of the fence needs to be coupled with mowing, grazing, or maintaining the area for your claim to stick. Also, fence agreements can be enforced, as one defendant found out when he entered into a fence agreement with his neighbor and then failed to follow its terms. The complaining neighbor picked up about $19,000 of damages and attorney’s fees because the agreement allowed for attorney’s fees to the prevailing party.
  11. Leases. After the court of appeals found one horse makes you a farmer for lease purposes, the Iowa Supreme Court gave further clear guidance. The new standard of whether a lease is a farm lease, for termination purposes, is the “primary purpose” test. The courts will now look at the actual use of the property to determine if it is a farm lease. So, the tenants out there with fainting goats, a herd of cats, and a broken-down nag will not get the September 1st protection that an actual farm tenant receives. In another matter, the court enforced the proration of unused lime as called for in the lease between the tenant and the farmer, which was a first legal test of that fairly standard provision.  The court also clarified that 99 year leases for primarily non-ag use would be acceptable under the Iowa Constitution.
  12. Nuisance.  A hog facility was found liable for interfering with a neighbor’s use and enjoyment of the property by not following generally acceptable management practices and was ordered to pay over $400,000 in damages.  The hog facility unsuccessfully complained the damages were too high, with the court finding that personal inconvenience, annoyance, discomfort and loss of full enjoyment of the property were caused by the odor from the hog facility. These damages may be limited in the future by the new law enacted in March that limits damages of this type.
  13. Insurance Contracts. I have often remarked that insurance companies do three things very well: deny claims, delay claims, and defend claims.  The insurance company has an army of attorneys who draft the terms of the insurance policy, and they are quick to defend the exact coverage.  A custom grower’s insurance policy was not responsible for the death of 837 hogs, because the contract only covered damage caused by the hogs, not damage TO the hogs.  Knowing the terms of your coverage can be the difference between a bump in the road and bankruptcy.

Within that, the constant is that taxes will change but will always be present.

The likelihood that major tax reform legislation will be introduced and passed in 2017 is high. Some believe that like-kind exchanges remain at a high risk for repeal. Many have used this process to delay capital gains tax by selling farm ground, and instead of taking a check, replacing it with additional farm ground in other areas. As equipment becomes bigger, the value of having adjoining parcels cannot be disputed.

In the local market, pressure in the mid 2000’s came from investors with proceeds from sales near large metropolitan areas. These investors were quick to bid up ground, as they were motivated to delay paying capital gains.  As the market tapered off slightly, the investors sold their holdings locally and moved towards Missouri and Kansas where ground was not booming at the same rate.

Land can account for up to 100% of farm operators “retirement”, and is on average, 30% of commercial investments. The statewide average value for an acre of farmland is about 17.5% lower than 2013 peak values, with declining values for the last three years (5.9% in 2016). Prices stay high when demand is high and supply is low. The desire to avoid capital gains tax has been shown to increase demand. The lion’s share of ground in Iowa is held by those who have a high probability of needing expensive nursing home care in the next 20 years. Like-kind exchanges could help keep the market up for land prices, even in the face of additional sales in the coming years.

The House Republican Blueprint for Tax Reform doesn’t address like-kind exchanges, which are disfavored by some. It proposes full expensing for all capital asset acquisitions, excluding the cost of the land. Right now, land improvements of certain types need to be added to the basis of the property, and not deducted as an expense or depreciated. Full depreciation of real property improvements may well face stiff resistance.

The Blueprint proposes a maximum tax rate of 16.5% for capital gains. President Trump has proposed a maximum rate of 20%.

LEASING

Leases are old news in the U.S. farm community; we have been doing them for a long time. However, how we lease is changing.  Landowners are recognizing the value of the data generated by the farm operator in order to make better decisions about what the land value might truly be. Tenants are using the data to determine which farms are truly profitable, and which ones are lemons to be shed or demanded lower rent for.

You can choose from several types of lease arrangements. They all come down to three basic types:

Crop share   production, government payments, and crop insurance are shared between the landowner, and the operator who provides the labor. These arrangements also involve sharing crop expenses.  The problem is the landowner is still worrying about the weather and the markets. It is a great fit for the first couple of years after a land owner has had to quit farming themselves. It is almost like a half-way house for farm land owners moving to cash rent arrangements.

Cash rent really needs little explanation. The key is setting the price and the timing of when the payments are due.

Flexible lease arrangements provide a base cash rent, plus a bonus, which represents a share of gross revenue in excess of a base value. This allows the landowner to have a set price, but still capture some of the good year’s prices. It also ensures that in bad years, tenants aren’t paying for a tuxedo when all they needed was flip flops and a bathing suit.

If you have ever bought a pie, you know buying the whole pie is the only way to decide if it makes it Thanksgiving dinner or if you eat it alone in the dark. Consider this, you buy a pie for $10.00. Then If someone gave you 1/4th of a second, exactly the same pie but told you that the pie can’t be eaten until the other owner says so and they get to store the pie, that second pie’s ¼ interest should be worth less than the $2.50 that simple math would suggest. Not if you work for the government.

The IRS released proposed regulations in August that would enhance code sections regarding valuation of privately-held, minority interests that are controlled by the same family. This means LLCs, corporations and partnerships that many farm and small business operators use. It wasn’t out of the blue that the IRS decided to adjust the code, they lost in court and see a potential loss in revenue, so they are changing the rules.

This will impact  intra-family interest transfers like when an elder generation gifts a portion of the farm via LLC membership interest to the next generation. The prevailing theory is giving Junior 1/8 of the farm isn’t really worth 1/8 of the total value of the operation because Junior probably still takes orders from Ma and Pa and can’t control the company in any meaningful way and the company is not something that Junior could turn around and sell for 1/8th of the total value to a disinterested party. Think about that pie again.

Valuation principles have long been established showing that Junior interests in privately-held businesses like that are worth less than controlling (Ma and Pa) interests or similar interests in publicly-held companies like Target, IBM and the like . It makes sense that certain adjustments are made when valuing Junior interests in family contexts.

The two most common adjustments are discount for lack of control and the discount for lack of marketability. A discount for lack of control discounts the value of a business interest because Junior does not have the ability to manage the operations of the business and also does not have the ability to control the business. The discount for lack of marketability discounts value of a business interest because the interest cannot be sold and converted to cash as quickly as a publicly traded stock. Many take a 10-20% discount for these impairments.

The IRS has had some leeway in calling out sham discounts however, the latest set of amendments look pretty grim.

They include special valuation rules for such as:

Disregarding Restrictions – No discount for a buy sell restriction on who you can sell your interest to.

Elimination of Assignee Interest – No discount for the situations where the stock doesn’t have full rights, like when a spouse ends up with the family stock but doesn’t get voting rights.

Three Year Lookback – Makes transfers made within three years of death not eligible for a discount.

Assumed Put Option –Assumes that the junior holder in a family-owned business can sell back at full price within six months. Family owned business do not grant put provisions as they cause liquidity problems which would cripple the operations of the company, when owners can withdraw and demand cash at any time.

Family-owned businesses will lose lose an estate planning tool for families that a valid business purpose for junior interest, like running a farm and separating off farm heirs from on farm decisions.

This is a big change from the ways accepted by the IRS and tax court in years past. It invites a court challenge, which could create uncertainty for an extended period of time.

The regulations are subject to a 90-day public comment through November 2, 2016. Those interested in posting public comments should look at  at: https://www.federalregister.gov/articles/2016/08/04/2016-18370/estate-gift-and-generation-skipping-transfer-taxes-restrictions-on-liquidation-of-an-interest

If placed into effect gifts made before the actual implementation will not be subject to the new restrictions (unles the IRS forgets about the Consitutional provision on ex post facto laws). If entities are formed now but gifted after the change  they will be subject to the new view. The new rules could be in effect before the end of the year, as early as  Dec 2016.

 

Thursday, July 27, 2017
  • Patrick B. Dillon
  • Jill Dillon
image
Patrick B. Dillon enjoys finding solutions to legal issues and catching problems for clients. Pat practices in the Sumner office regularly represents clients in district, associate district and magistrate courts for agricultural, real estate, criminal and collection issues. He drafts wills and trusts, creates estate plans and helps clients through the probate process.
image
Jill Dillon focuses on family law, estate planning and IRS matters. Jill is a University of Northern Iowa undergraduate (Political Science Cum Laude) and a Drake University Law School graduate. Jill spent extensive time advocating for low income tax payers in front of the IRS and the State of Iowa Department of Revenue while at Drake.

Share Some Ideas

Do You Have a Tip or an Idea for a Story? Tell Us About It.
Contact Us!