THROUGHOUT THE LIFE CYCLE OF FARM AND RANCH operations, it is important to examine the business structures and tools used to meet owner objectives. When owners of closely held farms and ranches objectives adjust, their role in the operations may shift to other family members or to outside individuals taking over the day-to-day operation. This can often take the form of new or modified lease arrangements of farm and ranchland. These leases come in several different forms and, depending on the type of leasing structure used, can have unforeseen tax consequences. By taking a proactive approach to these leases, Nebraska advisors can help their farm and ranch clients optimize their lease arrangements and meet their business, succession, and tax objectives. Three primary leasing arrangements are used in the agricultural industry: cash, livestock/crop share, and a range of hybrid leases falling somewhere in between. A typical cash lease involves a fixed dollar amount or a per acre/head rate that does not fluctuate with production. Livestock/crop-share leases involve the lessor receiving a portion of the commodities produced and sharing in the expenses of production. Lease structures are used to allocate the risk of production among the lessor and farmer/rancher with the lessor having minimal risk in fixed cash leases and completely sharing in the risk in livestock/crop-share leases. Hybrid leases can come in many forms, but often use a rent formula with a fixed and variable component based on production, changing the risk taken on by the lessor. Aside from risk allocation, there are several areas to consider when reviewing and advising clients on agricultural leases: (1) income tax, (2) self-employment tax, (3) estate tax, and (4) USDA program payments. Whether the lessor is treated as “materially participating” in the farm or ranch operation is another component that can affect the treatment of these areas. IRS guidance provides specific tests to help determine whether a lessor is materially participating in a lease, but it would generally include activities that would show significant involvement in the production of the farm/ranch commodities. Income Tax Advisors must consider how the different lease forms affect the deductibility of certain land-related expenses. Some major items may or may not be deductible by the lessor depending on the lease form used: Interest Expense – Interest expense is generally fully deductible under both cash and livestock/crop-share leases. Soil Fertility Expenses – Lime and other fertilizers may only be deducted if the lessor is materially participating in the lease, meaning these expenses are generally not deductible under cash leases and may or may not be under livestock/crop-share leases depending upon the lease terms. COUNSELOR’S CORNER OPTIMIZING YOUR CLIENT’S FARM LEASE BY NATE PATTERSON & NICHOLAS BJORNSON, KOLEY JESSEN 12 Nebraska CPAs
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