Crop Share Agreements
/This post picks up where my last one on farm leases left off. A second type of farm lease is the crop share agreement. This is more flexible than the fixed cash rent lease. Under a crop share agreement, the landlord and tenant agree that rent will be paid in the form of a percentage of income derived from the subject property. For example, parties may agree that the land owner will receive 25% of the income from the land as rent payment. This typically assumes the landowner does not contribute toward any of the inputs for the land (seed, pesticides, fertilizer, etc.). In other crop share leases, the landowner may agree to pay for 33% of the input and then to accept 33% of the income. Crop share agreements differ from fixed cash rent leases in that the amount paid as rent will change from year to year based on the income derived from the land. A good year, with high prices and yield, will lead to a high rent payment. A bad year, in a drought or with rock bottom prices, will generate a low rent payment. A crop share agreement spreads the risk between the landowner and the farmer.
The tax treatment of income earned by a landlord under a crop share lease is largely dependent upon the landlord’s level of participation in the farming activities governed by the lease. If the landlord “materially participates” under the lease, any income from the lease is subject to self-employment tax. The landlord will report the income and expenses on Schedule F, IRS Form 1040. If the landlord does not materially participate, the income is not subject to self-employment tax, and the landlord will report the income and expenses on IRS Form 4835. Any net income or loss will be carried to Schedule E, IRS Form 1040.
A crop share agreement, like the cash rent lease, has benefits and drawbacks. A farmer will not be stuck paying a high rent per acre if the market crashes or the weather negatively affects the crops. However, on the other side of the equation, a farmer who obtains high yield or crop prices will be expected to pay more in rent than she did last year on the very same ground. This model typically calls for a more involved landowner who works with the farmer to maximize output.
A crop share lease may suit a landlord comfortable with the risk of variable income due to yield and price variation as well as changes in shared production-input costs. This could be a particularly important concern for landowners in retirement, who view the income from their agricultural land as an annuity. A landlord also must be comfortable making marketing decisions for their share of crops produced under the lease. This arrangement allows the landlord to time the sale of his or her crops for tax management purposes, whereas traditional cash leases are typically paid on set dates. Under this type of lease, a landlord must be confident in the farmer’s abilities and be able to collaborate with the farmer to make decisions on cropping practices.
A crop share lease may be right for a farmer content with sharing the fruit of her labor in return for increased protection from economic and weather-related factors beyond her control. Compared to cash rental agreements, less operating capital is required by the farmer in a crop share lease because the landlord shares in those costs. A farmer utilizing a crop share lease must maintain an accounting for shared expenses and be able to articulate realistic production goals to the landlord.
Since payments are not a fixed amount, the crop share agreement must explicitly provide the method of determining rent. This should include whether and to what extent the landowner will help pay for inputs, and what decision-making power each party holds. The agreement may spell out what crops are allowed on the property.