Every farmer, when starting a farm business, has had to deal with how to finance his/her operation. Parental financing, the local bank or Farm Service Agency (FSA) financing and state government financing are all possible funding sources.
Possible funding sources
Parents often directly or indirectly help with financing. Many give direct help through gifting of assets such as feed, machinery, grain or livestock as well as possibly providing down payment money for land purchases. Others loan money to their children for various farming needs.
Important steps when lending money to children
- Write up a promissory note which stipulates the terms of the agreement including interest rate, repayment schedule and default remedies.
- Charge a reasonable interest rate which is similar to marketplace loans. You can charge less than commercial interest rates and also less than the applicable federal rates (AFR). The AFR change monthly and can be determined by contacting your accountant or checking with the Internal Revenue Service. If you charge less than the AFR, the difference will be considered a gift and may trigger gift tax consequences and Medicaid ineligibility - see your attorney or accountant.
- Expect and demand payments when due.
- Be prepared to write off the debt if it is not repaid. The Internal Revenue Service will not let you deduct it as a bad debt. Most bad debts to family members are considered gifts by the IRS and are not deductible to you as the lender. See gifting farm assets.
Direct lending of money to relatives is often the cause of broken relationships. Misunderstandings often occur. Proceed with caution when lending money to your children.
What about co-signing a loan?
Another way parents can help is to give a loan guarantee to the local lender through the use of a co-signature. One could also assign collateral to secure the loan for a child. If the child pays off the note as agreed, loan guarantees can work well.
However, if adversity strikes and the loan is not repaid by your child, you must be ready to make the payments.
If you decide to make a loan guarantee for your child, limit the dollar amount you will guarantee. Don't co-sign an unlimited loan. It's like signing a blank check. Ask the lender to notify you immediately if payments are not made on schedule.
A better approach than loaning your children money may be to encourage them to use FSA loans. You may be better off giving some cash or equity to your child so they can qualify for a FSA loan. Doing so can limit your risk of loss to what you gave your child rather than having to pay off an entire co-signed loan.
FSA has long been a source of funding for younger, beginning or low-equity farmers. Availability and terms of loans vary as programs are started and terminated. Contact your local county FSA office about your particular financing situation and current financing availability.
Local banks can be excellent sources of financing for young farmers. Young farmers are most successful getting loans if they start early in their career by borrowing money and repaying it in a timely fashion. Establishing a good credit history and a good bank relationship, even while in high school, can result in good financial support from that bank as financing needs develop.
In addition, many local banks will work with you and assist with acquiring a FSA or RFA loan. Check with your local bank about these options.
The 2017 Minnesota Legislature established a Minnesota Beginning Farmer Program for taxable years beginning after December 31, 2017.
Beginning farmer definitions/eligibility requirements
- Agricultural assets included for the program include agricultural land, livestock, facilities, buildings and machinery used for farming in Minnesota.
- Farm products eligible for production include plants and animals useful to humans and includes but is not limited to forage and sod crops, oilseeds, grain and feed crops, dairy and dairy products, poultry and poultry products, livestock, and fruits and vegetables.
- The individual seeking assistance for the beginning farmer program has to be a Minnesota resident seeking or has entered farming within the last ten years.
- They have to intend to farm land located within the state borders of Minnesota.
- They cannot be, nor can their spouse be, a family member of a partner, member shareholder, or trustee of the owner of agricultural assets from whom the beginning farmer is seeking to purchase or rent (refers to the IRS definition of lineal family members – grandparents, parents, children grandchildren would not qualify for the program. Nieces and nephews would qualify as a beginning farmer and would be eligible for the program).
- They must meet all the requirements outlined by and report to the MN Department of Agriculture (MDA), the “authority” and managing entity of this program.
- They cannot have a net worth greater than $800,000 as of August 1, 2017.
- The beginning farmer must provide the majority of the day-to-day physical labor and management of the farm.
- They must have adequate farming experience or demonstrate knowledge in the type of farming for which the beginning farmer seeks assistance from the MDA.
- The individual can enter into a land purchase or a land rental agreement under the rules of the program.
- They must demonstrate to the MDA a profit potential by submitting projected earnings statements.
- The person must also assert to MDA that farming will be a significant source of income for the beginning farmer.
- The individual must agree to notify the MDA if they no longer meet the eligibility requirements within the three year certification period.
A beginning farmer may take a credit against the tax due for participating in a financial management program approved by MDA. They are eligible for allocation of a credit equal to 100 percent of the amount paid for participating in the program, not to exceed $1,500 per year. The credit is available for up to three years while the farmer is in the program. MDA will maintain a list of approved programs. The credit may be taking only after approval and certification by the MDA.
Tax credit for owners of agricultural assets and working with beginning farmer
An owner of agricultural assets who works with a beginning farmer, may take a credit against the tax due for the sale or rental of agricultural assets to a beginning farmer in an amount stipulated by the MDA.
An owner of agricultural assets is eligible for allocation of a credit equal to:
- Five percent of the lesser of the sale price or the fair market value of the agricultural asset, up to a maximum of $32,000.
Ten percent of the gross rental income in each of the first, second and third years of a rental agreement, up to a maximum of $7,000 per year.
Fifteen percent of the cash equivalent of the gross rental income in each of the first, second and third years of a share rental agreement, up to a maximum of $10,000 per year.
A qualifying rental agreement includes cash rent or a share rent agreement. The asset must be rented at prevailing community rates determined by the MDA.
The credit may be claimed only after approval and certification by the MDA. The owner of agricultural assets must apply to MDA for certification and allocation of a credit.
An owner of agricultural assets or beginning farmer may terminate a rental agreement, including a share rent agreement, for reasonable cause upon approval of the MDA. If a rental agreement is terminated without fault of the owner of agricultural assets, the tax credit shall not be retroactively disallowed. MDA will look at each party involved to determine no fault. If MDA finds that the owner of agricultural assets did not have reasonable cause for termination, the owner of agricultural assets must repay all credits received as a result of the rental agreement.
The credit is limited to the liability for tax as computed for the taxable year. If the amount of the credit determined for any taxable year exceeds the limitation, the excess is a beginning farmer incentive credit carryover.
Procedure when applying for a loan
1. Be well prepared
Whenever you approach a lender for money it is best to be well prepared. This is especially true if you are approaching a lender who does not know you or your business. To have the best chance of getting your loan, you should clearly and professionally show the lender where you stand financially and how the money will be used and repaid. You can greatly influence a lender psychologically if you are well prepared and present yourself and your case well.
2. What to prepare in advance
Your lender would like to see several statements. They include a net worth or financial statement, a projected cash flow, the last three year’s income tax returns and a complete business analysis if possible. In addition, your particular lender may have other specific requests for information such as a business plan including goals.
When applying for a loan to add a new enterprise or expand a current enterprise, be sure to have accurate cost data on assets you will be purchasing. Secure certified bids or good estimates and bring them with you.
If you have good records, assembling all of the above information is much easier. If you have a set of good records, you may wish to briefly show them to your lender during your presentation to further convince him or her of your business skills.
What it takes to get a loan approved
Not all loans get approved. Following are some of the most common reasons loans do not get approved.
- You are not able to provide a substantial part of the asset value from your own funds. Many lenders will have lending limit percentages on the market value of land, machinery, livestock and buildings. Lenders generally insist that you share a portion of the purchase and therefore share some of the risk.
- If your cash flow projections show a poor repayment capacity, getting the loan will be difficult.
- If you’re net worth is small and you have nothing to lose if you default on the loan, you will have a more difficult time getting the loan.
- If you have a history of bad credit or late payment on previous loans, expect some difficulty in getting a new loan. Bankers will check out your credit reports. Protect your credit rating by paying off all loans (including credit cards) on time.
- If your business profit projections show a low profit or a loss, your lender will also hesitate to give you the loan.
Where to get help understanding farm finances
- U of M Southwestern MN Farm Business Management Association (SWMFBMA). They can be reached at 507-752-5081.
- You can also purchase FINPACK financial planning software through the U of M's Center for Farm Financial Management. The software will enable you to complete necessary financial forms.
- Minnesota Department of Agriculture.
- Your accountant is another person who can help you prepare the above forms.
Caution: This publication is offered as educational information. It does not offer legal advice. If you have questions on this information, contact an attorney.
Reviewed in 2017