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INDIANAPOLIS (DTN) -- Admittedly, a farmer we'll call Zach probably isn't paying full market value for his uncle's share of an irrigated specialty farm, but the size and responsibility of his multi-million-dollar, 30-year note still keeps the young farmer up nights. Returns from the produce industry can swing wildly, based on weather damage, port strikes, the dollar's exchange rate, even migrant labor hassles. Farm lenders like to say Iowa corn growers can lose $100 per acre, but it's easy to lose $1,000 per acre some years in potatoes. Don't ask about apples, cherries, grapes and wine.
Conventional farm mortgages don't offer much payment flexibility, but Zach built in four "escape clauses" to skip some of his payments of principal should the farm suffer a rough year. Especially because it's family financing, he reserves that option for extreme cases only and says he would never want to elect that option two years in a row.
Fortunately for both the farm successor and the retiring generation, an installment payment plan eases some of Zach's anxiety -- as well as tax consequences for his uncle. Not only can a young farmer lock in an attractive interest rate with an owner-financed installment sale, but his uncle avoids a massive tax bill on his capital gains and knows that his heirs (Zach's cousins) will get a steady return in the long run. (For transactions in August 2015, IRS set the minimum Applicable Federal Rate for nine-year or longer debt at 2.82%, although a retiring farmer may want something higher like 4% to 5%, financial advisers say.)
"It's really a way to make a land sale affordable for a young farmer," said Chris Hesse, a Minneapolis-based CPA with CliftonLarsonAllen. "For a retiree leery of stocks or bonds, the note is an alternative investment with potentially less volatility."
Ron Hanson, a University of Nebraska professor who specializes in farm transitions, frequently sees family buyouts with preferential terms. They may build in a discounted market price when land is sold or require no down payment. Payments also could be minimal in years one through nine, with a balloon payment due in year 10. "By that time, the family member has nine years to build up equity and arrange a lender on the remaining balance," he said. "It doesn't become a cash-on-demand situation."
Death does not automatically erase a debt, but an owner could provide for that in their contract. Unless the installment contract has a self-canceling feature (a SCIN, self-canceling installment note), the liability is assumed by the person who succeeds to the asset upon death. With a self-cancelling note, the buyer of the property pays a premium for the cancelation feature. That premium could be an enhanced interest rate or an additional purchase price, Hesse said.
Except for family sales, seller financing virtually vanished after the farm crisis of the 1980s when farmland values burst and many buyers walked away from their contracts, returning title to the original owners. Now even arm's length installment sales should become more popular due to recent tax law changes and the current interest rate environment, Hesse and other CPAs say.
"If sellers are concerned about a steep fall in land values, I'd advise them to ask for a 30% or so down payment, enough so the buyer has skin in the game," Hesse added.