Purchasing farmland is an investment that pays off, but it’s by no means a simple strategy. However, if done correctly, buying farmland can generate income through crop production, a potential offset in yearly taxes, and investment portfolio diversification.
Investors must consider many factors before purchasing land to invest in or farm. Much of the end decision can come down to property taxes as they are irrefutable. You must understand and account for the reality of taxes when making farmland investment choices.
These are ad valorem tax, which means the specific amount is calculated as a fraction of an estimated asset value. Property taxes are assessed and levied by the governing authority of the jurisdiction where the land is located. Each county in every state has an Assessor or Director of Equalization that assesses or decides the value of properties located within their jurisdiction, including agricultural land real estate, residential dwellings, commercial properties, and permanent improvements.
Usually, a mill levy, rate of tax, or assessment ratio is determined and multiplied by the assessed value of a property. It is calculated as a percentage or fraction of the assessed property value and expressed as dollars of tax per $100 of assessed value or dollars of tax per $1000 of the assessed property value depending on the jurisdiction of the asset.
The purpose of property taxes
All proceeds from property taxes are part of the primary sources of income or revenue for local governments in the US. The specific amount taxed annually is adjusted depending on the local governments’ fiscal needs and the current inflation trends. Property tax proceeds are commonly used to support public safety providers, local school workers, maintaining public areas, and emergency response workers.
These taxes can be perceived as a necessary evil given the purpose mentioned earlier of these taxes. This because communities would lack affordable education, infrastructure, and basic safety unless property owners continue to contribute to such services through property taxes.
The impact of property taxes on farmland investments
This type of tax gets more attention and brings about many considerations, particularly when analyzed by farmland investors. During the evaluation of a property’s potential income and the rate of return, property tax is usually classified as an expense. For instance, if you buy farmland for $10,000 per tillable acre and you rent it for $300 per tillable acre, the expected growth return is 3% every year. On the other hand, if property tax is equivalent to $50 per tillable acre, then the net return is likely to drop to 2.5% annually.
Consider this real-world example. A 240-acre farmland (in South Minnesota) was bought in 2018. It had an annual property tax of $97 per tillable acre. However, according to the USDA, the county average cash rent the same year was $217 per tillable acre. According to these numbers, the property tax required was close to 45 percent of the annual revenue received. To an average investor, this farmland wasn’t a viable investment option because of this ratio since the buying price didn’t reflect the expected tax burden.
It’s important to mention that property taxes may not be a deal-breaker in every farmland investment deal but must be considered when determining a property’s value. This is because the net income of a given property directly correlates with the valuation process along with comparable sales.
Note that farmland with high annual property tax amounts without high annual revenue is likely to have low value. For example, suppose two farmlands have the same quality and revenue potential. In that case, the farmland with the higher annual property tax is likely to be worth less than the farmland with low taxes.
Property tax exemptions
Property taxes vary significantly across the United States. For example, according to a study completed in 2017, California farmland investors pay more on average compared to other states, with average annual property taxes of $17,299 per farm. However, keep in mind that these numbers are different in other states such as Iowa, where farmland prices and taxes have been stable for many years.
If your farmland investment meets specific qualification standards, there may be a few tax exemptions that could lower your property tax amount. Some of these exemptions include Military Exemption, Credit for Senior and Disabled Citizens Homestead Credit, and Disabled Veterans Homestead Tax Credit. Besides, there are other exemptions for conservation easements and enhancing wildlife habitats such as native prairies, wetlands, and forest reserves. Incentives and other similar programs are also available to prevent urban sprawl and promote renewable energy.
Investors can also appeal the total amount owed for the property tax if there’s a dispute or disagreement on the assessed tax rate or property value. All jurisdictions that levy property taxes are required to let property investors go to court to contest the tax amount or assessed property values. In this process, collaborating with an expert to oversee the appeal process is highly recommended. After all, disputing the property tax amount simply means you’re requesting a review, and you will not be penalized for taking this action.
The bottom line is; property taxes are a consistent and constant expense for property owners. They provide the much-needed funding to public services and are necessary when used in the correct way by the taxing authority. As a potential farmland investor, it is imperative to understand these expenses linked to your farmland investment and how they can affect the expected annual revenue and the rate of return on your investment.
Property taxes are part of public information, and you can easily acquire them from a county assessor. However, annual assessments such as irrigation assessments, drainage district assessments, and occupation taxes may not be as straightforward or easy to acquire as property tax information. If you ever need an expert in property tax analysis, don’t hesitate to contact Advantage Realty & Land Management. We will help you understand potential farmland investment opportunities better and learn how to maximize the net income and annual rate of return on your farmland investment.