Legal and Management Aspects of Ohio Farmland Leases

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					                          FactSheet           Extension                                                              FR-0001-01




                            Agr., Env., & Devel. Economics , 2120 Fyffe Road, Columbus, OH 43210-1061


        Legal and Management Aspects of Ohio
                  Farmland Leases
                                    Robert D. Fleming, District Specialist, Farm Management
                                       Peggy Kirk Hall, Legal Educator, OSU Extension




F   arm lease arrangements are an important and common
    part of many farming operations in Ohio. According to
the Census of Agriculture, the percentage of Ohio’s leased
                                                                   payments or as a lump sum. Additionally, a cash lease may be
                                                                   structured as a flexible-cash lease or a hybrid-cash lease, which
                                                                   tie the amount paid to production or price fluctuations. In
farmland increased from 44% in 1987 to 47% in 1997. On a           Ohio, approximately 75% of land rents are cash rents.
county basis, percentages ranged from 42% to 71% in North-            The crop share lease. In a crop share lease, the landlord
west Ohio. In fact, less than 30% of cropland was farmed by        receives a specified share of the crop as the rent payment. The
a full owner of the land.                                          landlord may or may not also provide a portion of the labor,
   The increasing use of farm leases results from economic,        equipment, or supplies for the crop. The proportion of each
management, and legal concerns. From a tenant’s economic           party’s inputs usually determines the respective crop share.
and management perspective, it is often more efficient to
“control the resources” rather than own all inputs. Farm op-
erators may prefer to lease rather than own in order to control    Verbal versus Written Leases
more farm acres and spread fixed machinery costs over a               While farm leasing is common, putting the lease agree-
larger volume of output. From a farm owner’s economic per-         ment in writing is not a common practice in Ohio. Only 30%
spective, returns to farmland ownership are slightly lower but     of Ohio’s farmland leases are in writing. It might be uncom-
less variable than returns to common stock ownership, mak-         fortable or unheard of to do so, but both parties will benefit
ing it an attractive investment. Land ownership also can pro-      by reducing the agreement to writing.
vide a steady source of income for retired farmers. From a            Parties operating under a verbal agreement often make
legal perspective, a correctly written lease arrangement can       differing assumptions, do not address all of the burdensome
play a pivotal role in successful estate planning and manage-      details a lease arrangement entails, or do not remember pre-
ment of income taxes, Social Security benefits, and farm pro-      cisely the terms of their verbal agreement. A formalized,
gram benefits.                                                     written agreement forces the landlord and tenant to examine
                                                                   and foresee issues that might arise throughout the lease period
                                                                   and fully understand the rights and obligations of each party.
Types of Farmland Leasing Arrangements                             A written agreement can go a long way in preventing bitter-
   Generally, there are two types of land leasing arrange-         ness, misunderstandings, unfairness, and costly legal proceed-
ments: the cash lease and the crop share lease. The major          ings.
differences between the types of leases center around inputs,         Additionally, Ohio law will not allow certain types of leases
risks, and returns. However, the parties to the lease should be    to be enforced if not in writing and signed by the party against
aware that the type of lease entered into can affect estate        whom enforcement is sought, as explained later in this pub-
taxes, Social Security benefits and farm program payments.         lication.
For this reason, when deciding upon the lease arrangement,
both parties should consult their own attorneys, accountants,
or similar professionals to review the implications of the lease   Terms of the Lease Agreement
arrangement.                                                          While the details of a lease arrangement may differ from
   The cash lease. The cash lease involves cash payment of         farm-to-farm and from person-to-person, every lease agree-
a specified sum in exchange for the use of farmland. Typi-         ment should include the following basic lease provisions. The
cally, the sum is a fixed amount, either calculated by the acre    landlord and tenant should carefully review and address these
or for the total farm. A cash lease may be paid in periodic        terms, and include them in the written lease agreement. It is
                                                                                                                FR-0001-01—page 2



advisable to have an attorney for one party prepare the lease,      Legal Requirements for Enforceability
with a review by the attorney for the other party.                      There are a number of legal requirements that affect the
                                                                    enforceability of a lease agreement. Under Ohio’s “statute of
a) Date the lease is entered into.                                  frauds,” which prevents abuse of verbal agreements, a con-
b) Names and addresses of the landlord and tenant.                  tract lasting for more than one year must be in writing and
                                                                    signed by the party against whom enforcement is sought. A
c) Legal description of the leased property.
                                                                    verbal agreement can be enforceable if its duration is for less
d) Time period of the lease, including beginning and ending         than one year. However, the law recognizes one important
   dates.                                                           exception to this rule: the rule of partial performance. If a
e) Rental amount for cash lease; respective shares and con-         verbal agreement lasting for more than one year is partially
   tributions if a crop share lease.                                performed, it need not be in writing to be enforceable. That
f) When and how rent will be paid, and penalties for late           is, where one party has begun performing under the verbal
   payments. Who will carry insurance on the property and           agreement, the law will enforce the agreement even if it is not
   the crop.                                                        in writing.
                                                                        Additional requirements must be met if the agreement is to
g) When and how the lease may be terminated and require-            be binding upon anyone other than the original parties, such
   ments for notice of termination.                                 as future owners of the property. In such circumstances, the
h) Reimbursement provisions for crop nutrients and/or com-          lease must be in writing and signed by the parties, and may
   pleted fieldwork upon termination of the lease.                  also require witnesses, notarization, and recording. Recording
i) Process of measuring and maintaining soil fertility and pH       the lease in the county where the land is located provides
   levels.                                                          notice of the lease to persons other than the original parties.
j) Reimbursement provisions for a crop still in the ground          If the original parties do not wish to convey all the terms of
   when the lease is terminated.                                    the lease, they may record a “Memorandum of Lease,” which
                                                                    provides only enough information about the agreement to let
k) Desired or prohibited farming practices, including types of      a future buyer know that the land is under lease, the names of
   chemicals that may not be used on the property.                  the parties, a legal description, and the lease period.
l) Which party is responsible for controlling noxious weeds.
m) Which party is responsible for maintaining fences.                  The following chart summarizes the legal requirements for
                                                                    lease enforceability.
n) Whether the tenant has the right to make improvements
   and be compensated for improvements.
                                                                       Term                   Legal Requirements
o) Whether the tenant has the right to utilize improvements
   made by the landlord.                                               Up to 1 year            Verbal can be enforceable
p) Landlord’s right to enter the property for specific pur-
   poses.                                                              1 to 2 years            Must be in writing and signed
q) Landlord’s right to a security interest in the crops, or other                              by the parties
   provisions for ensuring payment.
                                                                       2 to 3 years            Must be in writing, signed by the
r) Statement of which party will participate in federal farm                                   parties, notarized, and recorded
   programs, including responsibility for eligibility and re-                                  in the county where the land is
   ceipt of payments.                                                                          located
s) Procedure for resolving disputes including the applicable
   state statutes.                                                     3 years or more         Must be in writing, signed by the
t) Statement that the landlord and tenant do not intend to                                     parties before two witnesses, no-
   create a partnership by entering into the agreement.                                        tarized, and recorded in the
u) Conditions under which the tenant may or may not sub-                                       county where the land is located
   lease the property.
                                                                       To avoid complications, the best rule to follow is to put
v) Acts of the tenant that would constitute default of the          any lease agreement in writing and have each party sign the
   lease.                                                           agreement before two witnesses. If the lease is to last for
w) How amendments or alterations to the lease may be made.          more than two years, the tenant should ensure that the lease
x) Tenant’s rights if the property is transferred or condemned      (or a Memorandum of Lease) is also notarized and recorded
   during the lease period.                                         in the county where the land is located, or the lease may not
                                                                    be enforceable against future landowners.
y) Signatures of the landlord and tenant.
                                                                                                                  FR-0001-01—page 3



Termination of the Lease                                             wheat crop is often a local custom. Second, if the landlord
   A complex issue that often arises in a lease arrangement is       stands by and allows the tenant to plant the crop without
when and how the lease terminates. This issue is particularly        objection, the landlord cannot later claim the right to the crop.
difficult if the parties have not clearly agreed to an ending        Where the landlord knows of the planting and does not ob-
date for the lease. Where there is a written agreement, the          ject, the tenant will be permitted to harvest the crop after the
agreement should address the ending date as well as circum-          lease expires.
stances under which the lease may terminate.
   Where termination is not adequately addressed beforehand,
the type of tenancy the parties enter into establishes when the      Will I lose my farm program payments if I lease my land?
lease terminates and whether there must be notice of the ter-           For federal farm programs, a producer must meet eligibil-
mination. Two classifications of tenancies in Ohio law are           ity requirements to receive program payments. The producer
important to farmland leases: the “periodic tenancy” and the         must be a “person” who is “actively engaged in farming.” A
“tenancy for years.” The written agreement and/or the course         lease arrangement raises the issue of whether the landowner
of dealing between the parties will be helpful to determine the      is still “actively engaged in farming,” which requires certain
type of tenancy.                                                     commensurate contributions of land, capital, equipment, la-
   The periodic tenancy. A periodic tenancy is for an initial        bor, and/or management which are at risk. As a general rule,
period of time, but renews itself automatically unless one           a landowner renting land on a cash rent basis is not “actively
party gives proper notice to terminate the tenancy. A com-           engaged in farming.” On the other hand, a landowner leasing
monly used periodic tenancy is an annual lease that continues        on a crop-share basis may be able to maintain farm program
from year-to-year without requiring renewal by the parties.          payments if his or her profits are based on production, are
Often, this type of tenancy arises by oral agreement; however,       commensurate with his or her contributions to the operation,
a written lease can outline provisions for a periodic tenancy.       and are at risk. A landowner concerned about losing farm
   The tenancy for years. This type of tenancy lasts for a           program payments should consult with the Farm Service
specific period of time and automatically terminates at the          Agency about current eligibility requirements. Additionally,
end of the period. Unless the lease provides otherwise, no           the lease agreement should address farm program payments.
notice is necessary to terminate such a tenancy; the tenant’s
right of possession simply ends at the expiration of the pe-
riod.                                                                What are typical lease provisions for farming practices?
   Notice of termination. The lease agreement should state              A farm lease should include provisions for soil conserva-
the period of time required for proper notice of termination.        tion practices, fertilization and nutrient applications, noxious
A party must give the proper notice, or termination is not           weed control, and crop rotations. Each provision should ad-
legally valid. Unlike some states, Ohio does not define a re-        dress which party is responsible for the practice, restricted
quired notice period by statute, but case law suggests that a        practices or crops, sharing of costs for practices considered
party should give a written notice of termination at least three     capital expenditures, and reimbursement to the tenant for
months prior to the termination date. Be aware, however, that        unrecovered costs.
some courts have required a six month written notice of ter-
mination. Termination issues are important to landowners who
are considering selling or transferring through an estate.           What are the tenant’s rights when the landlord terminates
                                                                     the lease after the tenant has begun field preparation work?
                                                                        This is a problem that could be avoided if addressed in a
Common Legal Questions on Farmland Leases in                         written lease. Where there isn’t a written provision, the an-
Ohio                                                                 swer to the question depends upon whether the landlord had
                                                                     the right to terminate the lease and provided proper notice to
                                                                     the tenant, explained earlier in this publication.
What happens to a crop that is in the ground when a lease
                                                                        Generally, if the landlord did not have the right to termi-
expires?                                                             nate or did not provide proper notice to the tenant, the tenant
   A crop that is planted but not yet harvested when a lease         has two options. The tenant can either try to enforce continu-
terminates is referred to as an “away going crop.” Generally,        ance of the lease or seek compensation for field preparation
Ohio law provides that a tenant does not have the right to an        work. Both options may require legal action.
away going crop, since it would not be fair to allow a tenant
to benefit from the proceeds of a crop that the tenant knew
could not be harvested before the expiration of the lease pe-
                                                                     How are my Social Security benefits and income taxes
riod.
   However, Ohio law recognizes a few exceptions to this             affected by leasing my farmland?
general rule. First, if it is customary practice in the area where      For both Social Security and income tax purposes, it is
the crop is located for the tenant to harvest a crop after the       important to determine whether the landlord is “materially
lease terminates, then the law will consider that custom as          participating” in the operation. Material participation results
part of the lease agreement, and the tenant will have the right      when a landlord meets one of the four tests (2000 Farmers
to the crop. A tenant’s right to plant and harvest a winter          Tax Guide, p.80).
                                                                                                                                                 FR-0001-01—page 4



   The federal government does not classify lease payments                              will aid the landowner in this regard, since the lease provides
as self-employment income if the landlord does not materially                           notice to the tenant’s creditors that the tenant does not have
participate in the operation. The landlord does not pay self-                           complete ownership of the crop. Should the tenant sell the
employment tax on the lease income. If the landlord wants                               entire crop without distributing the landowner’s share, the
the income to qualify as self-employment income, the land-                              landowner has a legal claim against the tenant for conversion
lord must materially participate in the operation.                                      of personal property.
   Social security benefits may decrease if a landlord materi-
ally participates in the farming operation. Reduction or loss of
social security benefits in this situation is also dependent upon                       Summary
the age of the landlord and other income received. The land-                               A handshake is not enough! Two parties considering a
lord should consult the current social security regulations for                         farmland lease arrangement should fully consider the terms of
age and income limits.                                                                  their agreement and reduce the agreement to writing. Reli-
   Tax considerations in farm leasing are discussed in more                             ance on custom and traditions could cause problems, as the
detail in a subsequent fact sheet in this series.                                       assumptions may not be valid or fair under current economic
                                                                                        conditions. Instead, both parties should consult their attorneys
                                                                                        and accountants to draft or review the lease and consider its
Does the type of lease affect the landowner’s estate plan?                              implications for farm program payments, Social Security ben-
    The type of lease plays a role in the landowner’s estate                            efits, taxes, and security interests. A carefully planned written
plan because it could determine whether the landowner quali-                            lease will prove its worth for both the landlord and the tenant.
fies for federal estate tax reductions. One federal tax provi-
sion is “special use valuation,” which permits farmland to be
valued at a substantially lower value if specific provisions of
the tax code are met. Likewise, the “family owned business
                                                                                        References
deduction” allows a significant deduction of the estate’s value
if the decedent and the decedent’s family meet certain re-                              •     Ohio Revised Code, Sections 1335.04, 5301.01, 5301.08,
quirements.                                                                                   5031.25 (www.orc.avv.com)
    For both special use valuation and the family owned busi-                           •     McEowen, Roger A. and Harl, Neil , Principles of Agri-
ness deduction, the owner or a family member linear descen-                                   cultural Law, Agricultural Law Press, 1999.
dent (as defined by the tax code) must have materially partici-                         •     North Central Region Extension Publications
pated in the operation for 5 of the 8 years prior to the owner’s                        •     NCR75 - Fixed & Flexible Cash Rental Arrangements
death or retirement, and material participation by a family                             •     NCR 76 - Cash Farm Lease with Flexible Provisions
member must continue for 10 years after the owner’s death.                              •     NCR 105 - Crop Share Rental Arrangements
Therefore, material participation is a key concept in estate                            •     NCR 77 - Crop Share Farm Lease Form
planning, and a landowner planning to utilize these tax ben-                            •     NCR 148 - Irrigation Crop Share & Cash Rental Ar-
efits must consider “material participation” when entering into                               rangements
a lease arrangement.                                                                    •     NCR 106 - Irrigation Crop Share Farm Lease Form
    As of January 1, 2001, Ohio law will allow a family-owned                           •     “Farm & Ranch Lease Guide”, Doane Publishing Farm
business deduction to the extent the deduction is taken for                                   Legal Series, University of Minnesota Extension Service
federal tax purposes. Ohio also provides for special use valu-                          •     Producer Bulletins on Farm Leasing, National Center for
ation, but the state provision does not require “material par-                                Agr. Law Research & Information, University of Arkan-
ticipation.”                                                                                  sas
    An estate planning professional can provide invaluable                              •     Ohio Cash Rents, Ohio Agr. Statistics Service
assistance with determining how a landowner should struc-                               •     Center for Farm Financial Management “Fair Rent: A
ture a farm leasing arrangement to meet social security and                                   Land Rental Analysis”, University of Minnesota
estate planning goals.                                                                  •     Hall, Peggy Kirk, “Agr. Law Newsletters”, OSU Exten-
                                                                                              sion

                                                                                           This series of Fact Sheets is produced under the Acker
What rights does the landowner have in his share of crops
                                                                                        Professional Improvement Program, Department of Agricul-
under a crop-share lease?                                                               tural, Environmental, & Development Economics, The Ohio
   In a crop-share lease situation, the landowner maintains                             State University. Reviewed by Lynn Forster, Donald Breece,
ownership over his or her share of the crop throughout the                              and LeeAnn Moss of the Department of Agricultural, Envi-
lease period. The tenant may not use the landlord’s portion of                          ronmental, & Development Economics, The Ohio State Uni-
the crop as a security interest. A recorded crop-share lease                            versity.




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