Improving Your Farm Lease Contract
A guide to understanding the business of farmland leases
Importance of Leasing
More than half of Iowa’s farmland is rented to tenant operators.
The trend over the past several decades has been for more of Iowa’s farmland to be leased rather than operated by its owners. In many cases, retired farmers or their heirs wish to continue to own farms, but do not want to operate them.
Leasing farmland involves a business agreement between the owner and the operator.
Reasons for Farm Leases
Land is an expensive resource. A large capital investment is required to purchase enough land to provide the farm family an opportunity to earn a satisfactory living.
Many individuals or institutions that own land are looking for someone to farm it to provide a return on their investment as well as maintain its productivity.
Common Types of Leases
The four most common types of leases used in Iowa are the fixed cash lease, the flexible cash lease, the crop share lease, and the custom farming contract. The common terms of these leases are described below.
Fixed Cash Lease
Under a fixed cash lease the tenant pays a given amount of cash rent per acre per year for the use of the farm resources. The tenant has a free rein in planning the crop and livestock production program on the farm unit, and receives all the crop and any associated USDA commodity program payments.
Flexible Cash Lease
A variation of the fixed cash lease is a flexible lease, in which the actual rent to be paid depends on the actual yields attained and/or the selling prices available during the lease period. This ensures that the rent paid is in line with the profitability of the crops grown that year..
Crop Share Lease
The distinguishing characteristic of a crop share lease is that the owner receives a share of the crop and USDA payments as a return for the land resources used.
The owner normally furnishes land and buildings and pays half of the costs of inputs such as fertilizer, seed, and pesticides when the crop is divided 50-50. Owners are usually responsible for drying, storing, and marketing their share of the crop, as well. The tenant usually furnishes all the labor, fuel, equipment, and the other half of the shared expenses.
Custom Farming Contract
Under a custom farming contract the operator supplies all the labor and equipment needed to perform tillage, planting, pest control, harvesting and moving of crops to storage. The landowner pays all other expenses, and receives all the crop and any USDA payments. The custom operator receives a fixed payment per acre from the owner, or a fixed payment for each operation performed.
Advantages and Disadvantages of Different Types of Leases
All types of leases have advantages and disadvantages to each party. The tenant and owner should consider this before choosing the type of lease and the terms that should be incorporated in it.
Fixed Cash Lease
Advantages of a fixed cash lease:
- The lease is simple with relatively few chances for misunderstanding.
- The owner is relieved of making day-to-day operating decisions.
- The owner has very little financial risk.
- The tenant has maximum freedom in planning and developing the cropping and livestock programs.
- The tenant has fewer records to keep when multiple landlords are involved.
Disadvantages and potential problems of the fixed cash lease:
- A fair cash rental rate may have to be renegotiated each year.
- Cash rents are likely to be too low in times of rising prices and increasing yields, and too high in times of low prices or low yields.
- Selling prices and production costs may be higher or lower than anticipated when the rental rate is set.
- Tenants are required to supply more operating capital.
- Tenants bear all the risk of production shortfalls.
Flexible Cash Lease
Advantages of a flexible cash lease:
- The amount of rent to pay increases or decreases automatically from year-to-year as prices and yields change.
- The need for the owner and tenant to renegotiate the rental rate each year is significantly reduced.
Disadvantages and potential problems of the flexible cash lease:
- Both parties must agree on a formula for setting the cash rent each year or every few years.
- Both parties must agree on how to determine the prices and yields to include in the formula.
- There is uncertainty about how much the tenant will pay and the owner will receive each year.
Crop Share Lease
Advantages of a crop share lease:
- Risks associated with price and yield variations are shared.
- The owner is more involved in making decisions and marketing the grain during the year.
- Both parties share the benefits from adoption of yield-increasing technology, or unexpected high yields or prices.
- The owner receives more information about yields and inputs used each year.
- A second USDA payment limit is created.
Disadvantages or potential problem areas of a crop share lease:
- The landlord and tenant must agree on how production expenses will be shared.
- Adjustments for sharing costs for storage and drying facilities, herbicides that reduce field work, or fertilizer and pesticide application may have to be made.
- The cropping plan to be followed and whether or not the farm participates in government programs must be agreed on.
- Added cash rent for the use of buildings and storage facilities may have to be negotiated.
- If the owner’s and tenant’s grain is stored in the same bin, marketing decisions have to be made jointly.
- The landowner may be considered a material participant, and farm income may be subject to self-employment taxation.
Custom Farming Contract
Advantages of a custom farming contract:
- There is very little financial risk for the operator.
- The owner benefits from any unexpected high prices, yields or government program payments.
- Only one party is responsible for marketing grain and making production decisions.
- Agreements are usually fairly simple to negotiate.
Disadvantages and potential problems of custom farming contracts:
- The owner bears all the risk of low yields or prices, or high input costs.
- The number and timing of field operations to be done each year may have to be modified, depending on weather conditions.
- The operator has to set priorities among the custom farmed land and other rented or owned land.
- The owner must communicate to the custom operator the cropping system, fertility program, and type of pest control to be used.
- Crop inputs such as seed, fertilizer and pesticides must be purchased and delivered in a timely manner.
- The landowner may be considered a material participant, and farm income could be subject to self-employment taxation.
Financing Improvements
There are three ways to handle the costs of making permanent improvements to a farm property such as buildings, storage structures, conservation structures, fences, waterways, and drainage tile.
- The landlord provides the improvement as part of the rental agreement with an understanding that the rental rate will be increased as a result.
- The cost of the improvements is shared by the landlord and tenant in some form. If the improvement is constructed on the farm, the tenant may furnish labor and machinery for the job, and the owner may pay for materials. It is useful to negotiate a provision in the lease for the tenant to be reimbursed by the landlord for the undepreciated value of the improvements if the lease period ends before the useful life of the improvement is over.
- The entire cost of the improvements is paid by the tenant. As in Option 2, a provision for reimbursing the tenant for the undepreciated value of the investment is important.
Setting the Length of Lease
Many farm leases are in effect for only one year at a time. In fact, in Iowa oral leases cannot be valid for more than one year. However, an Iowa State University survey showed that 41% of cash rent leases and 68% of crop share agreements had been in effect between the same parties for more than 10 years. The maximum fixed term for a lease contract in Iowa is 20 years, but leases can be routinely renewed if both parties agree.
Multi-year leases provide owners and operators with an incentive to invest in long-term improvements to the land and maintain soil fertility and conservation structures. They also avoid the uncertainty of building new relationships frequently.
Termination of a Farm Lease
A farm lease automatically continues from year to year unless either party gives a written notice of termination separate from the lease. In Iowa, a lease termination notice must be properly served in writing by September 1, prior to the end of the lease year. This applies to both cash and crop share leases, but not to custom farming agreements.
Summary
A good lease is the first step toward a satisfactory operating relationship between a landlord and a tenant. Although it is difficult to develop a lease that will provide for all possible situations, the parties should try to anticipate areas where problems could arise and include provisions in the lease to handle them. Only the parties involved can determine what is fair to each and what the final agreement should be. Many factors influence a leasing agreement, and each contract should be modified to fit the individual situation.
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