Gladstone Land Corporation (LAND) just recently raised $50 million in their IPO at a $15.50 price to invest solely in farmland.  To date, they have purchased acreage in California and Florida (primarily berry related) and just closed on a blueberry farm in Michigan.  Since its IPO, the price has increased almost 10% to close at $16.80 on May 20, 2013.

The company intends to elect Real Estate Investment Trust (REIT) status which allows the company to pay no income taxes assuming at least 90% of its taxable income is distributed as dividends each year.  In reviewing their balance sheet, it does appear their farmland purchases to date are fairly leveraged.  As of March 31, 2013, they have incurred total purchases of about $40 million with almost $30 million of long-term debt.  Their current long-term debt bears interest at 3.5%, but is scheduled to reset in another year or so.

Their margin is in good shape now, however, if rates rise a couple of points, it may be difficult for them to maintain their expected dividend payout.

I have seen many private farmland investment funds get capitalized over the last few years, but this is the first publicly traded farmland REIT in the US that I am aware of.  There are many similar companies in Europe and Asia.  Normally, if we see a flood of these type investments on the public market, a top in the market may not be far off.  We shall see.

Paul Neiffer, CPA

The Kansas City Federal Reserve 4th quarter survey of Ag conditions spotlighted an ever upward trend in farm land prices.  On a year-over-year basis, irrigiated farmland in Kansas, Nebraska and the Mountain states all saw increases over 30% and non-irrigated land increased by more than 20% in all states.

For the last two plus years, land prices on a year-over-year basis in most corn belt states have increased 15% or more.  We are starting to see the Federal Reserve discuss how to reduce and then eliminate the fiscal stimulas (QE 1, 2, 3 …..).  Once this stimulas is removed, interest rates should start to revert to their norm.  The question is what the norm will be.  If we end up like Japan, we may still have very low interest rates.  If we end up like previous recoveries from recessions, long-term interest rates should range around 3% plus inflation.  Currently, this would suggest rates in the 5-6% range.  How would this effect farm land prices.

If cash rents are at $350 per acre and land is trading for $15,000, then the cash return is about 2.3%.  In today’s very low interest rate environment, this may be acceptable.  But if rates rise to 5% and a farm investor wants a cash rate of return of 4% on their land, this suggests a value of $8,750 per acre.  Also, there are certain expectations built into land right now (the price is going up, I need to grab that quarter section before the neighbor does) that “gooses” land values.

What happens when these “gooses” fly away.  Does the mentality revert back to the 1980s or will we see something in between. 

We shall see.

Paul Neiffer, CPA

Many farmers have seen substantial appreciation in their farmland values over the last decade.  Many of these farmers are approaching retirement age and would like to “cash” in on these values and diversify their holdings.  They do not have any children to take over the farm and are worried that values in their immediate area may see a substantial drop over the next few years or would like to geographically diversify their holdings.

One option to consider is to use a Section 1031 exchange on their farmland into an UPREIT.  There are several UPREITS that are investing in farmland over a broad geographical area and others that are invested strictly in commercial properties.  The possible appeal to a farmer selling their land is the deferral of their income tax and more broadly diversifying their risk.  The UPREIT essentially trades units for the farmers land.  In return, any income from the UPREIT is allocated to the farmer based on their ownership %.

In order to take advantage of these vehicles, you must find the appropriate UPREIT to approach to see if they are interested in purchasing your farmland.  If so, then the transaction can be structured in a tax-efficient manner.  Most UPREITS allow the farmer to cash in their shares at a later point in time.  One drawback to these vehicles is that the farmer is no longer in control.

If this might appeal to you, you need to discuss this with your tax advisor.  These are not common as a regular 1031 exchange, but are very much a viable option.

Paul Neiffer, CPA

With farmland prices at or near an all-time high, many farmers are considering selling their farmland and rolling over the gain into other real estate on a tax-deferred basis using a Section 1031 tax-deferred exchange.  Under these rules, the farmer has 45 days from the date of closing (not when you sign the offer) to identify the real estate they wish to buy (usually up to three can be identified without any issue) and then another 135 days or 180 days total to finally close on this replacement property.

The farmer must reinvest the net selling price of the property sold in the purchase of the new property.  For example, if land is sold for $1.5 million with $100,000 of selling costs and $400,000 of debt paid off, the farmer must reinvest $1.4 million and at least $1 million of cash.  They can pay more than that in cash, but the minimum is the $1 million.

If the farmer meets these rules, they automatically assume there will be no tax due, however, certain things can spring a nasty surprise at tax time.

First, the sale of farmland may also involve the sale of personal property such as wells, fences, grain bins, etc. that are subject to Section 1245 recapture.  Farm land can normally be reinvested into any other real estate, however, personal property has greater restrictions on what qualifies.  If the farmer sold their $1.5 of farmland, but $300,000 of this was personal property that was not acquired for the same kind, then the farmer will have $300,000 of ordinary income that could easily cost $100,000 without having any cash to pay for it.

Second, if the owner of the property lives in a state separate from their land holdings, the whole gain may be subject to state income taxes.  Many states require any replacement property to be reinvested in the state of sale.  If not, the state will assess tax when the reinvestment property occurs out of state.  For example, assume a Missouri resident owns the $1.5 million farm in Oregon and rolls over the farm land into an apartment building in Missouri.  Assuming a $1 million gain, this whole amount will be subject to Oregon tax of about $100,000, again with no cash to pay for it.

Third, many taxpayers assume that these day requirements automatically roll over to the next business day which is not correct for Section 1031 purposes.  You must count the actual days and if the 45 day or 180 day date falls on a Saturday, Sunday or Holiday, you must make sure to perform the required task BEFORE that date.

This can be a very complicated transaction and it is very important to review this with a tax advisor that understands these rules.

Paul Neiffer, CPA

A common question that arises in our meetings with clients is about making sure that the farm remains in the family for multiple generations.  One option for accomplishing this is the use of a Dynasty Trust.  Many states such as South Dakota, Delaware and Alaska allow for trusts that are either perpetual or last for 100′s of years.  This allows the farm family to place land into the trust and make sure that the farmland will remain in the family for multiple generations.  However, there are several questions that you must answer before doing this:

• Is this what all of the family wants to happen?  Has this been discussed with all of the next generation?  Even though the assets may be placed into a trust, if communication has not occurred, “fights” about this may occur.
• Is the property large enough to support the dynasty trust structure?  The passing of 500 acres to the next generation in a dynasty trust may make sense, however, once it passes onto the next generation or the one after that and there are suddenly 45 beneficiaries of the trust; the use of a trust may not make sense from an administration standpoint.  The fees to properly allocate income and prepare the tax return may exceed the income generated by the trust.
• How much control from the “grave” are you trying to achieve.  My friend told me the only way to take his fortune to the grave with him was to write a check that could not be cashed.  Is your desire to control this from the grave or do what is best for the next generation(s).  Sometimes this is the same answer, but many times it is not.
• Is it better to transfer assets now than to wait for the estate?  In many cases, a transfer during life make more sense than waiting for a step-up in basis.  If the land will remain in the family for multiple generations, there will be no sale anyway.  By gifting now, you may be able to escape estate taxes later.  The dynasty trust can be used during your lifetime.

These are some of the important questions that must be answered.  There are most likely many others that apply to your situation.  Now is the time to get help from your advisor on how best to accomplish this.

Paul Neiffer, CPA

We had a reader ask the following question:

“Am I correct in that this accumulation of gifts during lifetime does not include those under the Annual Gift Tax Exclusion ($13,000)?”

It seems like most of my posts lately deal with estate and gift taxes, but this is a very important subject and with the end of the year less than two weeks away, we do not have much time to make major gifts.

As the question indicates, there  is both an annual gift exclusion amount and a lifetime exclusion amount.  These two items are mutually exclusive.  This means that any gifts  that fall under the annual exclusion amount will not reduce your lifetime exclusion totals. 

For example, in 2012, the annual exclusion is $13,000 which increases to $14,000 in 2013.  The  current lifetime is $5.12 million scheduled to drop back to $1 million on January 1.  If a married farmer has five children and ten grandchildren, he can give 15 gifts of $13,000 each to each child and grandchild or $195,000.  The wife can give the same amount.  This equals a gift of almost $400,000 in one year that still leaves their lifetime exclusion amount at the same balance. 

That is why we are able to transfer substantial amounts of land values to our heirs during lifetime by using appropriate discounts on LLC or LLP interests AND the annual exclusions.  In the above case, if the land was in an LLC and it was subject to a 35% discount, the farmer could gift $300,000 and his wife the same in gross land values and it still would not eat into his or her lifetime  exclusion.

Over time, the proper use of the annual gift exclusion amount can be extremely more valuable than the use of the lifetime exclusion amount.

Paul Neiffer, CPA

The IRS recently released Revenue Procedure 2012-41 that outlined all of the inflation adjusted items contained in the tax laws.

There were a couple of provisions related to gift and estate taxes that apply to farmers.

Beginning in 2013, you can now give up to $14,000 any individual(s) during the year and not have to report this on form 709.  If you give more than this amount, you are required to file a return, however, in most cases, this gift will still be free from gift taxes.  You could give $13,000 in 2012.  Although this amount is adjusted for inflation, it does not change until the amount increases by more than $1,000.  Therefore, the next increase will be to $15,000 and this will probably take three or more years assuming current inflation rates.

Another estate tax adjustment is in regards to special use valuation.  This relates to how much you can reduce your estate value for farmland (or other business real estate).  For most farmers that own a fair amount of farmland may qualify for this valuation method.  However, as discussed in previous posts, there are many requirements that must be met and you may decide not to use it.

For 2012, the maximum amount you could reduce your estate by was $1,040,000 up from $1,020,000 in 2011.  For 2013, this amount has increased to $1,070,000.

With the schedule reduction in the lifetime exclusion to $1 million beginning in 2013 (assuming Congress does not change it), the use of this special method to value farm property may increase dramatically.

Paul Neiffer, CPA

The Wall Street Journal had an article yesterday on how Chinese companies are continuing to invest in South America especially in buying up farm land to feed their people.  Through the twelve month period ended May 31, 2011, the China’s investment in Latin America had hit $15.6 billion.

During the last three years, more than 70% of their investments had been in energy and minerals, but farming is attracting more attention. 

This month, China’s largest farming company, Heilongjian Beidahuan Nongken Group signed a joint venture with Argentina’s Creud SA to buy land and farm soybeans.  Creud SA already controls more than 2.5 million acres of land in Argentina.  Heilongjian had already indicated back in March their intentions to purchase 500 thousand acres of land overseas during this year and Latin America is their primary target area.

They are also spending $1.5 billion to develop about 750 thousand acres of land in Rio Negro Province over a ten year period.  These developments will not be a direct purchase of land, but they will be in control of the production.

With the backing of the Chinese government, we will continue to see this type of investment going forward.

I noticed a post on the Iowa Farm Union that indicated 47% of the farm land in Iowa is owned by women.  I think this trend will continue and there may be a good chance that this percentage may be in excess of 50% at some point in the near future.  Women appear to express a desire for strong conservation in their stewardship of the land, but sometimes are not sure how to most effectively carry this out.  The Iowa Farm Union and other state organizations have several seminars devoted to this effort.

As a tenant farmer are you taking advantage of the differences between what is most important to men or women who own farm land.  What is most important to male land owners may not be most important to female land owners.  By knowing and understanding these differences, you can become a more effective farmer.

The new owner of the Whittemore Golf Course in Algona, Iowa has plowed it under to put in a corn crop for this year.  This nine hole course was originally built in 1969.  The new buyer decided that it would make more money as a farm than as a golf course.

This has caused some rift in the community since they now have lost their local course.  Here is an article on the change over.

I have a feeling that we might start to see more of this happen in smaller corn belt cities if corn and bean prices stay high and the golf participation continues to decrease.