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June 2010 Archive for The Farm CPA

RSS By: Paul Neiffer, Top Producer

Paul is now part of the fourth generation in America that is involved in farming and hopes the next generation will be involved also. Through his blog he provides analysis and insight to farmer tax questions.

Lots of Corn - But We Need It

Jun 30, 2010

The USDA released their June acreage report today and the corn and wheat market rallied substantially based upon this report.  The actual amount of expected corn acreage came in about 1.6 million acres less than the trade expected and the amount of corn on hand was about 300 million bushels less than expected.

Backing into the usage numbers for the quarter, it appears that the amount of corn used in the quarter was about 25% higher than last year which would be an all-time record for that quarter.  What seems to be happening is that global demand and ethanol use is soaking up any record crop that the US is able to produce and as the world economy recovers, this trend will continue to accelerate.  All in all, any weather scare for this corn market will most likely cause prices to increase substantially.

The bean crop is the recipient of the extra acres that did not go into corn, and thus, any rally there might be tempered by the extra acres.  However, there is little margin of error for any weather issues.

Although the wheat plantings came in a little higher than expected, the total amount of wheat acreage is the lowest since 1971.  Wheat rallied over 20 cents on the day and we will see how this carries over in the next few weeks.

For more coverage of the plantings and stocks, please see the analysis at ProFarmer.com.

Is Farmland Too Good of an Investment

Jun 23, 2010

I have written many times about how farmland has been a good investment for at least the last 10 years or so.  Most of this data has been gathered from sources directly related to farming, however, I have started to notice a trend about reporting on farmland as an good investment in mainstream sources such as Business Week. 

This trend continues with a recent article in the Wall Street Journal about buying farmland for income.  The article indicates that by buying farmland, an investor should receive a current 3-5% yield plus up to another 5% in annual price appreciation over the term of the investment.  This comes from R. Dennis Moon with US Trust, a unit of Bank of America.

One of the challenges right now is finding quality land.  The supply is smaller than usual since farmers and their heirs are keeping the land they otherwise might have sold, in order to book the rental income.  The number of qualify farmland for sale appears to be down about 30-40% according to Loyd Brown of Hertz Farm Management, Inc. of Nevada, Iowa.  Even medium quality land is down by this amount.

Now that these articles are now starting to appear in main-stream sources, my contrarian sense is that farmland may be starting to peak as an investment for investors.  This may end up being good for farmers if the speculative pricing gets eliminated from land values.  We can wait and see how it turns out.

Working Capital - Lifeblood of a Farm

Jun 21, 2010

Dave Kohl is an ag economist who writes the Road Warrior of Agriculture columns for Corn and Soybean Digest. His columns are usually very insightful regarding economic issues related to agriculture. Back in March, he had an article regarding working capital being the financial shock absorber for farms and business.

Working capital is the excess of a farm's current assets over its current liabilities. Current assets are your short-term liquid assets such as cash, crop inventories, and receivables for crops sold. Your current liabilities are what you owe on a short-term basis such as notes payable to banks, accounts payable, wages and taxes payable and your current portion of any long-term debt payments. Many farmers forget to include this item when doing their current ratio calculation.

It used to be that the current ratio was very important to calculate. This number is based upon taking your total current assets and dividing by your total current liabilities. If this ratio was about 2 or higher, it was considered very good; between 1 to 2 was marginal to good; and below 1 was bad. However, we are now stressing that your working capital to revenue is a much more important metric to measure and strive for.

The problem with the current ratio is that it does not indicate how much working capital is available to fund your farm operations. For example, assume your annual farm revenue is $1 million. Assume you have total current assets of $250,000 and current liabilities of $125,000. Your current ratio is 2 to 1, which is considered good; however, your working capital as a percentage of revenues is only 12.5%. This means that you would need to have the ability to borrow from a bank to fund current operations until you are able to harvest your crop and convert it to cash.

Based upon information from FINBIN, the top 20% of crop producers had working capital divided by gross farm revenue ranging from 28% to 43% in the past four years. The average producers ranged from about 20% to 33%, while the bottom 20% were in the low 20% range for these four years.

As more lenders use this metric in assessing farm operations, you need to know what yours is and what it should be. I would suggest that you strive for it to be at least 30% for most crop farm operations. Livestock operations would be about 5% to 10% lower.

Foreign Banks Continue Investment in Ag Sector

Jun 17, 2010

TierOne Bank of Lincoln, Nebraska was closed by the FDIC on June 4, 2010 and then sold to Great Western Bank of Sioux Falls, South Dakato which is a subsidiary of National Australia Bank, a large agricultural lender that has expanded its farm-based lending in the United States and appears ready to continue to expand into this sector.

TierOne Bank had 69 branches and about $1.9 billion in assets.  After the purchase, it appears that Great Western Bank will be about $7.5 billion in assets and most of this is based in the ag states of South Dakota, Iowa, Nebraska, Kansas and Missouri.

They are quoted as saying that they continue to want to acquire other farm-orientated banks in the Midwest.  With Bank of the West being owned by a French bank and the large Dutch bank RaboBank expanding in the US, this trend of banking to the farm sector by foreign owned banks will continue.  If the foreign banks have large capital cushions, then this will probably be a good thing for farmers.  If there capital cushion is low, then at the first sign on trouble, these banks may be the first ones to be sold or liquidated.

Go West - Corn Belt

Jun 15, 2010

As the old saying goes "Go west, young man, go west", the corn belt will probably be expanding at least 300 miles to the west over the next few years.  As part of the two-day agricultural symposium held in Omaha last week, this was one of the central themes of the meeting.

Drought resistant corn seed could expand the corn belt at much as 300 miles to the west.  Assuming that the depth of this expansion would be 500 miles north and south would put up to 150,000 square miles of additional area that could grow corn.  This is a gross area of about 96 million acres.

In addition, new non-thirsty corn varieties could let corn belt growers raise just as much corn with far less water for irrigation, while protecting non-irrigated fields from drought damage.

Echoing comments by several panelists at the conference, C.G. "Kelly" Holthus, chairman and CEO of Cornerstone Bank of York, Neb. said the future of agriculture looks bright.  He called today's farm economy "the golden age of agriculture".

William Wilson, a distinguished professor of agriculture from North Dakota State University, said Monsanto and other biotech companies are in the final stages of developing corn varieties to thrive in low-moisture conditions.  The seeds are due to come onto the market in about three years, he said, joining herbicide-resistant seed and other genetically modified crops that have improved farm yields and profits in recent years.

However, this does not mean that corn will stretch all 300 miles wide.  Farmers will decide what to plant based upon the financial yield that the various crops offer and other factors.

Food Demand Drives Farmland Prices

Jun 14, 2010

I try to skim a few of the major Mid-West farm cities and theOmaha World-Herald recently had an article on how food demand is driving farmland prices higher.  There was a regional conference in Omaha sponsored by the Federal Reserve of Kansas City.  The meeting brought forth various good nuggets of information about the rising demand for food and how it is affecting farmland prices.

In 2005, the world produced about 7 billion tons of food which is about on average a ton of food per person on the earth.  By 2030, which is only 20 years away, rising population will require another 3-4 billion tons of food to be produced.

This strong increase in demand encourages long-term investors to realize that good farmland is already in production and only marginal farmland will come into production over the next 20 years or good farmland will be taking away by suburban growth.  According to the speakers, this demand will cause farmland prices to continue to increase.

Farmers National Co. of Omaha reported that recent sales of good quality farmland reached $8,000 an acre in Illinois, $7,500 in Iowa and $7,000 in Nebraska.  Demand is high for ground that can grow corn and beans and prices are up since there is so little ground is for sale.

Even grassland values are drawing higher prices.  For example, grassland sold neer O'Neill, Neb. recently sold for $580 per acre, substantially higher than the recent sales range of between $385 and $450 per acre.

As more people in the world move from rural to urban areas, their demand for animal products will increase.  One of the drawbacks of this move is that a pound of beef requires 1,800 gallons of water to grow while a pound of wheat only requires 180 gallons.  We will have to use water more efficiently in the future than we are now to keep up with this demand.

While many factors point toward health agricultural growth, there are serious challenges, including an imbalance in labor, environmental concerns, unwise public policy decisions in some countries and higher food prices that strain developing countries budgets.

Response to Russian Wheat Export Dominance

Jun 08, 2010
In response to my post from a couple of days ago about Russia's goal of wheat export dominance, Steve Mercer of U.S. Wheat Associates writes as follows:

On behalf of U.S. Wheat Associates, news that Russia has a single desk export state trading enterprise and is willing to consider export subsidies is not welcome for U.S. wheat farmers who believe competition should be based on quality and functional utility, not administrative pricing. On their behalf, USW is strongly advocating for the elimination of the monopoly powers of any grain export STE, including Russia's. We have asked that any consideration of Russia's accession to the WTO be conditioned on the elimination of their ESTE and any export subsidies. This is a priority issue for us and for the global competitiveness of U.S. wheat. Also, we continue to serve at the direction of U.S. wheat growers. Some quick examples include:
·Bringing a team of Egyptian officials that manage grain purchasing, food safety, and other agencies to the U.S. this month to meet with U.S. officials, learn more about our grain inspection and price discovery systems as well as to get an early look at crop quality;
·Recent buyers conferences with, and face-to-face trade service visits to Middle Eastern and North African grain buyers, including Egypt, Iraq, Iran, and Saudi Arabia;
·U.S. wheat is often not the low-cost supply, so we emphasize quality, choice, and our reliable supply to importers;
·USW is actively informing our customers that U.S. wheat currently offers excellent value
.

I think there are several good comments in this response and I hope the effort of U.S. Wheat Associates and other organizations like it will help increase our exports, but sometimes the bottom line is that wherever the crop is the cheapest, that is where the buyer will go. We shall see over the next few months how the decrease in the euro and increase in the dollar affects our exports, but it is nice to see the efforts of Steve and his group.

We appreciate all of the comments that you make, and I try to use them in a post whenever I can.

Farmland Investing Has Been Very Competitive with Other Investments

Jun 08, 2010

One of our readers sent me an e-mail yesterday regarding an article posted by www.farmgate.com regarding the return on farmland investment from 1970 top 2009.   This post was based upon the research done by Iowa State University.

Over the years farmland investment have yielded a very competitive rate of return compared to other investments.  However, about half of the return comes from appreciation in land, which can be unpredictable and it does not provide any cash to cover expenses or mortgage payments.

This research broke down the years between four distinctly different periods:

  • The farm boom period from 1970 to 1981,
  • The farm crisis from 1982 to 1987
  • The recovery period from 1988 to 2003
  • The Ethanol Boom from 2004 to 2009

During the farm boom period, an average farmer enjoyed 7.3% average cash rent return on their land and their land appreciated in value from an average of $392 per acre to $1,941 per acre or an average return of about 14.3%.  Therefore the total average return for this period was about 21.6%.

During the farm crisis, the average cash rent was actually at the highest average of about 8%, however, this was due to the decrease in land prices.  During this period, land values decreased from $1,941 per acre to about $786 per acre or an average negative return of (14%), which about wiped out the returns during the farm boom.  Overall average returns during this period was a negative (6%).

During the recovery period, average cash rents were about 7.25% and land prices increased from about $786 to $2,010 or an average increase of about 6% or a total annual return of 13.25%.

Therefore, the overall return during the 40 year period wsa about 6% from appreciation and 7% from cash rents for an overall annual return of 13%.

During the Ethanol Boom, the average cash rents was the lowest at about 4.4%, but the increase in price from $2,010 to $3,850 or 11.4% equals an average annual return of about 15.8%.

The best cash rent return was 9.6% in 1987 at the peak of the farm crisis and worst return was 2008 at 3.8% during the Ethanol Boom.  The best appreciation year was 1977 at 36.8% and the worst was 1985 at a negative 28%.

Russia Goes for World Dominance - in Wheat!

Jun 07, 2010

I had a post from about two weeks ago about the USDA predicting that Russia would become a larger exporter of wheat than the US by about 2019.

Bloomberg Businessweek just wrote an article on how Russia is fighting for World Dominance - in Wheat!.  The article recaps that Russia is able to sell their wheat to Egypt for about 7% cheaper than what the US can sell it for.  During the last 11 months, they have garnered about 58% of the Egypt market versus about 40% for the year before.  Our share fell from 13% to 8%.

During the 1990's, Russia was actually a net importer of wheat due to their farms being so inefficient from decades of ruinous Soviet practices.  However, starting in 2002, the region emerged as major exporter by selling about 600 million bushels of wheat.

During the 2008 global grain rally, Swedish, British, Chinese and Korean investors have piled into Russian farmland.  Today, Russia exports about 14% of the world's wheat, up from 0.5% in 2000.  The US share has slipped from 26% to 19%.

Russia created a new state company, United Grain in 2009 to modernize the storage and shipment of wheat in a $3.3 billion overhaul.  United Grain is also pursuing more deals in Southeast Asia and Latin America which have long been strongholds for US and Australia growers.

Valars Group which is the third largest wheat exporter in Russia has spent $250 million on farmland and $108 million on equipment since 2006, the year it was founded.  One of their farms is about 100,000 acres and last year it yielded on average about 65 bushels per acre which is on par with our yields here in the US.  They are using New Holland tractors and combines instead of the old Russian machinery which now sits in storage all rusted out.

However, the Russians did buy their land and equipment at the peak of the market and they indicate that they are struggling to pay off their debts and may have to sell shares in the market to pay down the debt.  During the last year, wheat growing brought "zero" profit after the plunge in prices.  The Grain Union is asking for $320 million in subsidies to improve the profitability of exports.  Such state aid could help Russia's growers compete even more ferociously with the US on price.

You Can Use an IRA Too--Maybe!

Jun 04, 2010

My post from yesterday resulted in several comments and questions that I would like to respond to.

One comment is that code section 4975 deals with prohibited transactions regarding you and your pension plan or IRA. There are severe penalties for not obeying the rules regarding these transactions. However, if you obey the rules, the penalties do not apply to you. I sometimes find that other tax advisers are not comfortable with these rules and would rather not have to deal with these types of transactions; however, if you follow the rules and use a company that is extremely familiar with the rules, you should be in compliance.

The majority of these rules do not allow you to sell or rent land, equipment, etc., between your pension plan or IRA and yourself. However, in my post yesterday, the transaction described involved the purchase of the employer's stock directly from the employer to the pension plan. This is one of the transactions allowed by the code as long as you follow the rules.

Another question was whether you can use an IRA to do this. The general answer is no; however, in most cases, once you set up your 401(k) or other pension plan with your new corporation, you can roll over your IRA to the pension plan and then have it purchase the stock. This will allow you to use the IRA in an indirect way. Certain types of IRA rollovers may not work, so as in call cases with my posts regarding tax laws, talk this over with your qualified tax adviser. 

Another reader asked if you can purchase farmland using this method. The answer is yes, no and maybe. For it to be yes, the corporation would need to purchase the land if you are going to farm it. If you are simply purchasing the farmland to rent out to a nonrelated third party, you can use the IRA or pension plan to purchase the land directly. However, if you fund any of the purchase with debt, there are several rules that come into play. You cannot personally guarantee the debt. In most cases, it would need to be seller financed for the deal to work. If you personally are going to farm the land, then you cannot have the IRA or pension plan own the land and rent it to you.

Tap Your 401(k) to Get Started in Farming

Jun 03, 2010

I know that many of our readers currently have jobs not related to farming but would like to leave those jobs and start farming on a full-time basis. One of the major drawbacks of doing this is the lack of capital. However, many of you could have a substantial asset that you can tap to create the working capital needed to get started in farming. This asset is your 401(k) plan.

Here is how it works:

  • You will need to create a corporation (generally taxed as a C corporation).
  • This corporation will establish a 401(k) plan.
  • You will roll over your current 401(k) at the old employer into this new 401(k) plan.
  • The new 401(k) plan will then purchase shares in the new corporation and will become an owner of the corporation (this is very similar to an ESOP).
  • The money put into the corporation becomes the working capital that the corporation can use to purchase equipment, plant crops, etc.

There is no limit on how much stock the 401(k) can purchase. This means that, unlike borrowing money from a 401(k) plan which is limited to $50,000 or cashing in the plan and paying taxes and a 10% penalty on the funds received, you are able to maximize the amount of capital you can put into the farm business.

There is a recent article in Bloomberg Businessweek concerning this type of transaction. The primary point of the article is that the IRS has noted some abuses in this type of transaction. Some taxpayers have set up a corporation simply to purchase a motor home, etc. This will most likely get disallowed on an audit. However, if you are using the cash to create a farming entity and will be actively farming, there should be no issue with using your 401(k) to fund it.

As in all cases, you need to discuss this with your tax adviser. The article refers to a company that has helped do several hundreds of these transactions.

Law of Diminishing Returns

Jun 02, 2010
In my post yesterday, I indicated that maximizing your net return per acre is more important than getting the most yield per acre. One of our readers wrote a great comment regarding how his operation tries to maximize its yield to achieve the most net revenue per acre.

My post should have stressed that your farm operation should try to maximize your yield up to what I call the point of diminishing returns. For example, if you can increase your yield by an extra 10 bu. (for corn) by spending $15 on good seed or fertilizer, then your return at $4 corn is $40/$15, or 2.67 to 1. As you do your analysis for your farm, anytime this number is greater than 2, it makes sense to spend the extra money.

If the number is between 1 and 2, then you need to crunch your numbers and get comfortable with your probability of the extra yield happening. For example, if you think you can make an extra $20 per acre by spending $10, your ratio is 2 to 1; however, if the chance of this happening is 50%, your expected ratio becomes 1 to 1. At this point, you are simply at the break-even point and you are not receiving any extra to cover your overhead related to this extra cost.

If you were to chart your options related to maximizing your yield compared to your input costs, the return yield to cost would look very similar to the horsepower chart on my BMW motorcycle. As I add revolutions per minute, the horsepower output increases at about a 45 degree angle up to about 8,000 rpm.  At this point, as I add more revolutions per minute, the horsepower output slightly increases and then as I get near the redline, the horsepower starts to drop off dramatically.

In your farm operation, try to determine where the extra yield maximizes the return to the bottom line.

Net Revenue per Acre Is Better than Yield per Acre

Jun 01, 2010

I was watching "AgDay" yesterday and noted in the business section that Mark Gold of Top Third Ag Marketing was the guest and had a discussion on how gross revenue per acre is more important than yield per acre. His insight was that it can be more important to budget for getting top marketing dollars for your crop than to worry about the greatest yield per acre. With the improvements in technology, farmers can get great yields on their crops; however, if they end up with the bottom third for their price, they will end up net losers for the crop year.

I believe that you need to take this concept one step further and key in on net revenue per acre, not gross revenue. My definition of net revenue per acre is to take your gross revenues from crop sales and government payments and then subtract all direct input costs related to this crop. For example, let's take two farms. One farmer is able to achieve 175 bu. of corn per acre and sells it for $3.75. The farmer spends $300 per acre on direct inputs (fertilizer, oil and gas, labor, etc.). The other farmer gets only 160 bu. per acre; however, he sells it for $4.00 per bushel and spends only $250 per acre on direct input costs. Which farmer makes the most money?

The answer is the second farmer. Farmer No. 1 has gross revenue of $656.25 per acre and net revenue per acre of $356.25. Farmer No. 2 has gross revenue of only $640.00 per acre; however, his net revenue is $390.00 per acre, which is about $34 higher than farmer No. 1.

As you can see, a farmer needs to key in on maximizing net revenue per acre, not just the yield per acre.

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