Hiring the Field Work and Keeping the Crop

Three Ways to Get Land Farmed

A landowner who does not operate the land themselves has three basic agreements and they allocate risk very differently

low cash rent a tenant pays a fixed amount per acre and keeps the crop. The tenant assumes all price and yield risk and the owner receives a predictable payment

low crop share the owner and the tenant divide both the cultivation and the defined input costs according to an agreed proportion. The risk is shared

low custom agriculture the landowner pays an operator a per-acre fee to perform field operations. The landowner buys the inputs owns the crop sells it and retains all the revenue and all the risk

The Risk You Keep Is the Return You Keep

The table tells you who endures what. It's worth analyzing how you really feel in a good year and a bad year because the choice between these structures is not really a preference over paperwork

None of the following is a real farm.Treat the figures as illustrative and round chosen only to show the shape of the results

Take as an example a landlord with land under cash rent. The tenant pays a fixed sum per acre. In a year when yields are high and prices high the landlord receives that fixed sum. In a year when the crop is completely lost the landlord receives the same fixed sum. The payment does not move which is the goal of the agreement and the tenant has absorbed both results

Now put the same land under custom cultivation. The owner pays for the seeds fertilizers chemicals and operator's fees all of which is spent before anyone knows what the year will be like. In the strong year the owner sells a large crop at a high price and keeps everything above those costs which is a much better result than fixed rent. In the bad year the owner has already spent the money invested and has little or nothing to sell so the loss is real money coming out the door and not justa smaller profit

The proportion of crops is between them by construction. The owner finances a defined share of the inputs and receives a defined share of the harvest so that both good and bad years reach a fraction of the total intensity

Read all three together and the structure will sound familiar in any market. The landowner sold the property on a cash lease and received a secure payment. The custom farming landowner has bought it back and is paying for it on exposure. Neither is correct in the abstract. They are different positions and the correct one depends on whether the owner has the balance sheet and appetite to finance a bad year

Who Uses It and Why

Several situations point towards custom farming instead of renting

An owner who wants exposure. Someone who believes commodity prices will rise or who wants the operation to be treated as an active business rather than a passive rental takes the pick

A retired farmer. Someone who no longer wants to operate machinery but wants to stay in the business and retain the ability to resume or hand over the operation to a family member can step back without giving up control

Land that requires specific management. A landlord who follows certain conservation practices soil building programs or organic certification may prefer to direct decisions rather than expect the tenant to follow them

Absent owners with active intention. Institutional and family owners who want the operation to be managed to a standard rather than taken over by a tenant with a short-term lease

It's worth stopping at that third case because it's a control issue rather than a money one. Practices like building organic matter in the soil or taking the land through an organic transition cost something now and will pay for themselves over the years. A tenant with a short-term lease has no reason to finance them since the benefit comes after the lease ends and is applied to someone else's land. A landlord who wants those practices to be followed should include them in the lease andcontrol compliance or retain decisions and hire labor. Personalized agriculture is the second route

The Tax Consequence That Drives Many Decisions

An important reason to choose this arrangement is how the income is characterized

Cash rent is generally passive rental income. It is not subject to self-employment tax and does not count as farm income for various purposes

Income from custom farming in which the owner materially participates is generally active agricultural income. That subjects the owner to the self-employment tax and makes the owner eligible to receive provisions available to active farmers including certain program payments and most importantly for estate planning special use valuation of agricultural land

This last point has enormous importance in succession. Qualifying for the assessment of the agricultural use of a farm generally requires a material participation which passive cash income does not provide. Custom farming can preserve eligibility where renting would not

The trade is real. Active treatment costs self-employment taxes annually and can save a lot in estate taxes later

Material Participation Is a Test, Not a Label

The phrase carries a lot of weight in that trade so it is worth making clear that it is not something that an owner chooses by writing it on a form

Material involvement is a factual question about what the owner actually does. Generally speaking it asks whether the owner is really involved in the operation and its decisions rather than cashing a check. Making the decisions about crops and inputs bearing the cost of those decisions inspecting the land and being the person to whom the operator reports in every way. Signing a contract once a year and expecting a deposit points to the other

The specific tests depend on technique and facts and this is precisely the kind of question a landowner should talk to an agricultural tax advisor about instead of reasoning from an article. The reason for raising it here is more structural than technical: the estate planning benefit is not a feature of the custom farming contract. It is a consequence of the landowner behaving like an active farmer and the contract is what makes that behavior possible

An owner who signs a full custom farming agreement hands all decisions over to the operator and never visits has organized his affairs to resemble custom farming while operating like a landowner. This is the version that is likely to disappoint when examined

How the Fee Is Set

Custom rates are published by extension services in most agricultural regions based on surveys of what operators actually charge and are quoted per acre per operation: tillage planting spraying harvesting and transporting

Rates reflect the cost of machinery fuel labor and a margin. An owner can contract on a run-by-run basis or agree to a total grow fee that covers everything

The operator has no exposure to the crop. He is paid to do the work regardless of yield or price meaning he sells machinery and labor capacity rather than growing crops

This raises a simple question about incentives. An operator who is paid by the acre has no financial interest in performance which is why agreements often include a bonus tied to production converting part of the fee into a share

The Incentive Problem in the Fee

The incentive gap is not a theoretical concern because the quality of fieldwork is difficult to observe and manifests itself months later

Consider what a per-acre rate really rewards. It rewards acreage meaning the operator is paid the same for a careful pass as for a quick one. Planting depth seed spacing timing of spraying and the decision to wait a day to improve field conditions all affect performance and none of them change the rate. The operator absorbs the cost of doing them right in time and fuel and the landowner receives all the benefit

That's a classic misalignment and the usual remedies apply. A production bonus converts a portion of the fee into an action so the operator has money at stake in the outcome. Specifying standards in the agreement about deadlines and operating practices makes some unobservable behavior contractible. Repeat relationships do much of the work in practice since an operator who wants the acres again next year has a reputation risk that a one-season contract does not create

There is a limit worth mentioning. The more the fee becomes a share of the harvest the closer the deal gets to a share of the harvest and the more of that profit the owner has returned. An owner cannot have full exposure to a good year and a fully aligned operator at the same time because the alignment is purchased with exactly the advantage that was chosen to maintain the structure

The Machinery Economics Behind It

The reason why custom operators exist is the use of machinery

A combine used on a farm operates for a small number of days per year and has a very high capital cost. Spreading that machine over several thousand additional acres transforms the cost per acre

Custom farming is therefore often carried out by a neighboring farmer with capacity to spare which is why the arrangement is common in areas where farm sizes vary and some operators have expanded machinery beyond their own acreage

That also explains the availability restriction. Custom operators are busiest at exactly the times when the work needs to be done and an owner without a firm agreement may find no one available in a tight planting or harvesting window

Why the Operator Might Not Show Up

That availability restriction deserves more than a closing sentence because it is operational risk that most often turns a sensible deal into a bad year

The problem is that the agricultural calendar is common in a region and not staggered. The climate sets the planting window and the harvest window and sets them for all at once. Therefore the operator with spare machinery capacity has spare capacity in the abstract and is at full capacity precisely during the days when the work has to be done

Worse yet the operator has his own land. When the window is short and the machine can only be in one location the acres the operator owns and the acres he is paid a fee to cover are not equally attractive. The acres owned are dedicated to harvesting. Custom acreage carries a fee that does not change if the job is delayed by a few days

Lag in the calendar is no minor inconvenience in an agricultural year. Planting outside the optimal window and harvesting late cost the yield and the loss falls entirely on the owner who owns the crop

That's why the serious version of this agreement is a written agreement made well before the season specifying which operations are covered the time windows within which they must fall and what happens if they don't rather than a handshake with a neighbor who has a spare combine

The Bottom Line

Custom farming keeps the harvest inputs and risk with the landowner while purchasing field operations as a service which is the opposite of cash rent and sits between it and own farming. It suits owners who want exposure to commodities who are stepping back rather than leaving or who need active involvement for tax and estate purposes. The operator sells machinery utilization rather than farming skills so the performance incentive must be deliberately added if someone wants it.there.And the two things most likely to go wrong are the two that the contract must explicitly cover: an operator with no performance share and an operator whose own fields need the machine on the same day as yours