(J.M.) HOW DOES RENTING VS. BUYING FARMLAND AFFECT ACCOUNTING AND TAX PREPARATIONS?
(T.B.) Whether farmers are looking to establish a land base to get started, expand or invest in the future growth of their operation, the decision to rent or buy farmland is usually on the table. There are many factors that should be considered when making these decisions, including how the purchase or rental payments will impact your bookkeeping and tax planning.
Cash flow needs to be the number one consideration. Regardless of whether you rent or buy farmland, the costs associated will need to be accounted for in your bookkeeping and included when you file taxes. The ability to service debt while still being able to cover living expenses is important. So, crunch your numbers, and if necessary, talk to your accountant to determine if you can cover the cost associated with rental payments or regular mortgage payments.
HOW ARE RENTAL AND FARMLAND PURCHASES FINANCIALLY ACCOUNTED FOR?
The costs associated with each are treated differently when it comes to tax time. You can write off interest on a mortgage, and this can easily add up to healthy tax deductions in the early days of a mortgage. But as the principle is paid off, your interest deductions against your income will decline.
Farmland rental is a straight-up expense and tax deduction. But you pay HST on the rent, and that can tie up cash flow. Renting does allow you some flexibility in tax planning though. If you have a year where you have a higher-than-expected income, you could prepay land rental for the coming year to claim the expense. It’s something to consider, especially if you have a good working relationship with your landlord.
WHEN DOES IT MAKE SENSE TO RENT VS. BUY FARMLAND?
There’s no easy answer to this question, but here are my top five considerations for farmers when it comes to cash flow, tax planning and accounting.
- Cash flow — Renting frees up cash that would otherwise be tied up in a land purchase or mortgage. You can farm more acres without tying up your cash flow in capital costs, like a mortgage. This is also the best option if you don’t have the financing available to buy land, but still want the economies of scale that comes from having more acres.
- Long-term land acquisition planning — If you know a landowner who is scaling down or retiring, offering to rent the land today might open the opportunity to purchase it later. The same approach can be taken if you’ve got your eye on a piece of land you’d like to purchase, but it is only available to rent right now — you could rent the land and build a relationship with the owner. I’ve seen farmland sell to long-term renters because the owner respects them and likes the way they take care of their land. These relationships can also mean first right of refusal if the land is put up for sale, giving the renter the first chance at buying.
- Flexibility — Depending on availability, farmers can quickly add or drop acreage by renting. As operations change, farmers can also move their land base to soil conditions or geography more suitable to their crops.
- Lower your risk — Farmland values continue to hold strong. And, while that makes for a good financial investment, if you’re concerned land prices are too high, or inflated, holding out on purchasing by renting might be the best option for you.
- Balance sheet — If you are looking to keep your debt-to-equity ratio low, renting can help you achieve that. Rent is a straight-up expense on a balance sheet, not a debt. And a low debt ratio is attractive to financers, so if you are looking to lease equipment or invest in other areas of the farm, renting can be the preferred option.
- Forced savings — Buying farmland, or building equity is a form of forced savings. Farmers are notoriously asset rich, but cash poor. So, if you have a hard time investing in savings, paying into a mortgage or buying farmland is one way to force yourself to invest. Following this approach, many farmers use their farms and farmland as a way to save for their retirement.
- Tax planning — Farmers have access to favourable tax treatments when transferring farm properties, for example, capital gains exemptions are a popular option. Investing in farmland rather than investing in other assets, like stocks and bonds or house rentals that don’t have tax preferential treatment will open more tax planning options down the road.
- Inflation hedging — Farmland values, along with every other expense on the farm, keep pace with inflation. That means rent keeps pace with inflation too. By purchasing farmland rather than renting, you can invest in an asset that is likely to grow in value, rather than paying increasing rental payments.
- Assurance — You have very little control over the land you rent. Despite any agreement in place, a landlord can sell it at any time or rent to others. Ownership offers certainty and assurance you will always have those acres to support your farm.
- Land management authority — As a renter, your hands can be tied if you want to improve the land or soil. Investing in tile drainage, clearing bush or even applying manure can be a gamble when it comes to investing in rented land because you never know if you’re guaranteed to realize the value of the investment. Buying farmland offers you the authority to make your own decisions and investments in the land. Buying land often makes more sense for farmers who also have livestock, providing a guaranteed land base for manure management. •