Investment | Income Producing Ranches and Farms
Since the Great Recession and the advent of near-zero interest rates—and especially with the upheavals in securities markets wrought by the coronavirus pandemic—we encounter more and more buyers who are looking for income-producing ranches and farms.
The buyers Fay Ranches works with have always wanted to know the expenses—taxes, insurance, lease fees, etc.—associated with ranches they were looking at, but they often were relatively unconcerned about those expenses. They were looking for a retreat, a place to relax and recreate, and a safe place in which to spend time with family and to create memories, and they were willing to pay for these experiences. Many of our buyers still have this mindset, and it’s a good—even necessary—approach when buying a strictly recreational type of ranch.
However, in recent years, more often buyers are telling us that they have money to invest but are not encouraged by prospects for securities. Cash may be wonderful “dry powder” to have in a portfolio, but at today’s interest rates it loses money after inflation and is therefore in a sense a guaranteed non-performing asset. Bonds also serve a valuable role, but they pay very little and will almost surely lose value when interest rates rise. Stocks inflicted pain and fear on many investors during the Great Recession and again, recently, in the market’s reaction to the pandemic. As a result, more buyers are looking at a farm or ranch not so much as an expense item—part of the cost of enjoying life—but as an investment that is an alternative to (and having value not closely correlated with) other possible investments.
It would be easy to assume that the sole advantage of an income-producing property is . . . the income. But there is much more to it than that, and many ranches produce only a small net income, yet are still very good investments. Here are some of the considerations:
Income Tax Deductions
If your ranch is recognized by the IRS as a business—i.e. as an entity intended to produce a profit (not that it has to produce a profit every year)—you suddenly have numerous deductions that you can take against your ranch operating income. Some of these are expenses that you would incur even if you didn’t run a business on the ranch, such as property taxes, insurance, mortgage interest, and upkeep. In addition, you can deduct expenses for legal and accounting fees, contractor services, salaries and wages, equipment purchase and maintenance, lease fees, irrigation district fees, vehicle mileage—any expense that is “ordinary and necessary” for the operation of your business.
It is very important to earn or preserve agricultural property-tax status. Property-tax rules vary from state to state, but in Wyoming, where I work, qualified agricultural land is taxed not on its market value, but rather on its production value—the presumed value of the agricultural commodities that can be produced. The result can be stark: the property tax on a good-sized ranch worth several million dollars might be similar to the tax on a nice house in a nearby town. Of course, if you lose your ag status, you pay the much higher rate not once, but every year.
If you run a business, you are eligible—and wise—to segregate your ranch assets, income, and expenses from your personal finances and from any other entity that you own or control. This helps you demonstrate to tax authorities that you are running a real business and not just indulging a hobby. It can also significantly help protect your other assets from claims against your ranch by creditors or litigants.
Ranches are often held as partnerships, limited-liability companies (LLCs), or S-Corporations. These may sound terribly complicated and expensive, but they don’t need to be. For instance, in Wyoming you can form a for-profit corporation or single-member LLC for $100 by filling out a brief form online with the Secretary of State’s office. With an LLC, net income flows directly to your tax return via Schedule C, so the income is always taxed in the year received. (Net losses can be taken against other income.) With an S-Corp, the income also flows to the owners as ordinary income, but you have some ability to “meter” the flow—with the downside that you need to file a separate return for your corporation. For more information, seek a qualified professional advisor. In Wyoming, real-state brokers are prohibited from “unauthorized practice of law,” to which I (not being an accountant) add “unauthorized practice of accounting.” However, all of our Fay Ranches brokers maintain expert layman’s knowledge of these subjects as they pertain to ranch real estate so that we can help clients identify areas in which they might want to seek professional counsel.
Having a ranch in a corporate structure is often helpful—and frequently used—in estate and succession planning, as current shareholders can convey shares to members of younger generations over time. This is a matter that particularly requires expert advice. Many who have tried to manage such processes on their own have come to regret their unadvised decisions.
Both agricultural production and wildlife habitat can be maintained and even enhanced through proper management practices. Fields and meadows that have historically been irrigated and farmed or grazed by livestock can become decadent if left unused. Fay Ranches can help connect clients with experts who are skilled at developing optimal management plans.
Types of Operation
The owners of income-producing properties often have a number of choices. Do-it-yourselfers may choose to run their own cattle herd (with or without hired help) or maintain and operate equipment to raise hay or other crops. Others may invite a rancher to bring in cattle to graze the owners’ property for an agreed-upon fee (often expressed as an amount per animal-unit-day on the property), with the understanding that the landowner will manage the cattle. Others will lease out the property and have little involvement, requiring the lessee to manage the livestock, maintain fences, control weeds, etc. Many production ranchers desire to lease land so that they can expand their herds without incurring the expense of acquiring more real estate. With considerate notice to current and former partners, a ranch owner may change the arrangement from time to time to suit personal and land-management needs.
With regard to hiring employees or contractors, it is usually a question of scale: With a small operation, ranch owners will not be able to hire help and still produce net income; as operations get larger, owners simply can’t do all the work themselves. Prospective buyers who know they will need help with ranch work will want to consult their brokers and advisors to “run the numbers” and ensure that the type of operation they envision makes sense financially.
In addition to income, there is the prospect of capital appreciation. Over reasonable timeframes, well-managed land almost always increases in value, especially if it is improved over time. If the time comes for owners to sell ranches that have appreciated, they may be able to defer capital-gains taxes indefinitely by reinvesting in another business property through an Internal Revenue Code Section 1031 exchange. The replacement property could be another ranch, or it could be a farm, an apartment block, a warehouse, a condo, or an office building—almost any real estate involving a business operation. The details of §1031 exchanges are far beyond the scope of this article. Suffice to say that they require expert legal counsel and involve strict time limitations.
A Real-Life Example
A few years ago, I helped a family sell a ranch that had extensive irrigated crop fields. They were on the horns of a dilemma: Because they’d had the property for many years and had significantly improved its production capacity, it had appreciated greatly, and they stood to realize a substantial capital gain. On the other hand, because they’d paid so little for the ranch and had increased its output, they were making over 30% per year on their original investment—after paying all expenses, including the salary of a full-time manager.
My wish for the readers of this article is that they may have a chance to encounter such a fortunate dilemma in their adventures in ranch real estate. I urge those thinking about a ranch purchase to consider an income-producing property for the reasons enumerated above. The financial benefits may well outweigh additional management considerations, allowing owners to, in accordance with the Fay Ranches slogan, Invest and Enjoy.
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