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Land Contracts: Owner Financing With a Twist

In the spirit of examining ways to acquire land through seller-financing, it is time to take a look at land contracts.  The land contract is a variation of the owner-financed sale, with both mechanisms being a way for a farmer-buyer to come to terms with an owner-seller, independent of third-party bank financing or complementary to traditional financing.

Which one is it?

The primary difference between typical owner-financed sales and land contracts:  Owner-financing agreements transfer full title to the buyer, while land contracts do not.  USDA Farm Service Agency’s definition of a land contract is, “…an installment contract drawn between a buyer and a seller for the sale of real property, in which complete fee title ownership of the property is not transferred until all payments under the contract have been made.”

To start, think of land contracts as conventional purchase and sales agreements with a greatly extended time period before closing—instead of signing a purchase and sales contract and then taking 30-45 days to close the deal, land contract deals can, theoretically, take 30 years.  Five to ten years is a more common time frame, which involves a regular payment schedule concluded by a balloon payment.  The assumption is that in five to ten years, the farmer-buyer will have enough time to improve his/her balance sheet and credit to come up with other financing to make the lump-sum payment that finishes the deal with the seller.

The land contract can be seen as less risky than other types of owner-financing for the owner-seller because, legally speaking, if the farmer-buyer fails to make payments, it is easier to regain property that was never really relinquished in the first place.  In a land contract, the owner-seller does not give up “legal” title until all principal and interest payments for the purchase are made.

The owner-seller does, however, relinquish “equitable” title or the rights to possess the land to the buyer.  Still, it is easier to recapture “equitable” title in the event of default than it is to recapture both “equitable” and “legal” title as would need to occur after default within an owner-financed sale arrangement, where full title is transferred from seller to buyer at the outset of the agreement.

Without legal title, the farmer-buyer can’t encumber the property, unless otherwise stipulated in the agreement or in any subsequent modifications.  Basically, until all payments are made, he/she can’t use the real estate as collateral to obtain further credit.  While this puts the farmer-buyer at a disadvantage, it can add a level of comfort for the owner-seller.

A perceived lower risk in a land contract for the owner-seller can be an advantage for the farmer-buyer! –Especially when the appeal is the primary motivator for going through with the sale.  In other words, an owner-seller might be reluctant to finance a sale through a conventional owner-financed sale agreement or other arrangement.  The land contract, on the other hand, might be just the ticket.  Landowners might feel more comfortable knowing that legal title is retained while the land is “under contract” and payments are being made.

As in a normal owner-financed sale, other highlights for the owner-seller include spreading out capital gains taxes over time, and obtaining income through interest payments from the buyer.  (For more information about the tax implications of land contracts and other owner financed sales, see the IRS publication 537,  “Instalment Sales.)  A small caveat:  Land contracts do not typically contain “prepayment penalties” as do conventional bank mortgages.  The farmer-buyer is entitled to pay back the principal faster than expected, which would result in less interest paid to the seller.

If the farmer-buyer does not need to go into significant debt during the typical five to ten years before a balloon payment would be scheduled, equitable title might be all that’s needed to run a profitable operation.  The land contract provides the farmer with the fundamentally important legal protection that as long as the agreement is not breached, investments and improvements in soil quality and infrastructure can be made, tenure will be secure and ownership of any equity built up will be retained.  The farmer needs to be aware, however, that if he/she defaults during the land contract term and there is legal action taken to repossess the real estate, the improvements can become the property of the seller.

Time to consider the farm transfer?

Land Contracts allow for a great deal of flexibility and creativity in setting the terms of payment.  They allow both the farmer-buyer and owner seller to avoid the hassle and expense of most closing costs common in conventional mortgage transactions.  As noted above, land contracts give sellers more control than normal owner-financed sales.  For all these reasons, land contracts are often the preferred mechanism for transferring ownership of agricultural property from senior to junior generation within the farm family.  They can also be used outside of the family, but more legal oversight is needed, needless to say.

Any farmer entering into a land contract should make sure to ask the all-important question: Is the seller’s land or farm encumbered in any way?  Is the land contract sale being used by the seller as a “wrap-around” to pay off a mortgage from another lender while the land is being sold land contract buyer?  This can be a dicey situation for both buyer and seller.  Take a glance at this online article about the risks of “wrap-around” mortgages.

In Vermont, buyers can access public records at the town office to research whether or not any mortgages or liens have been recorded specific to the property in question.  The buyer should also consult with his/her attorney reviewing the agreement to confirm that the seller will be able to transfer free and clear title to the buyer at the end of the payment period.

Another important consideration is whether or not the owner-seller is up to date on his/her taxes paid to the town on the property.  Again, this information can be obtained at the town office.  Insurance is another important issue; the farmer-buyer should ask the seller or his/her agent what kinds of insurance has been held on the property in the past.  This will give the farmer a sense of what kinds of prominent risks might exist in owning the property, and how these risks might be mitigated for what costs through insurance.

Who is responsible for tax and insurance payments during the land contract payment period?  This is another area where the flexibility of the land contract mechanism shines with flying color.   The farmer-buyer and owner-seller, when negotiating without an external lender, can be very creative in how they come to terms with who is responsible for taxes and insurance, when payments are made and how/if they will be managed by an escrow company.  A possible arrangement is to have the owner-seller pay the property taxes for the first five years while the farmer-buyer builds a stronger financial position.  After the fifth year, the farmer-buyer would assume all responsibility to make sure property taxes and insurance are paid and up to date.

Another option might be to have either the owner-seller or the farmer-buyer responsible for all property taxes and insurance stated in the agreement.  If the farmer-buyer is responsible for taxes, the drawback to the owner-seller is the odd chance that, in default, the owner-seller would have to sift through a legal mess to recover the taxes owed to the town.  The plus for the owner-seller in having the farmer pay all taxes throughout the contract term is obviously the lifted financial burden.

Remember, a plus for the seller can be a plus for the buyer and visa versa if it is the factor that helps an important farm acquisition deal go through!

Yet another spin on who pays property taxes/insurance is the model that USDA FSA’s Contract Land Sales Program requires of farmer-buyers and owner-sellers enrolled in the Program.  The Program, otherwise known as the Land Contract Guarantee Program, provides certain types of federal loan guarantees to owner-sellers in land transfers to beginning farmers through land contracts.

To be eligible for the Program, FSA’s requires that the maintenance of both annual property taxes and hazard insurance, if applicable, be the ultimate “responsibility” of the seller.  However, according to FSA, “Agreements regarding payment of taxes and insurance made between the buyer and seller should be part of the land contract.  FSA will not be party to this agreement as the land contract is between the buyer and seller only.”  (From a Sept. 2010 FSA Proposed Rule about amendments to the Program  )  In other words, it is up to the farmer-buyer and owner-seller to agree on when and how the the farmer-buyer will compensate the owner-seller to cover taxes or insurance.  The ultimate legal responsibility to make sure the required taxes and insurance are paid rests with the seller.

Click here for a summary of the Contract Land Sales Program written by the National Sustainable Agriculture Coalition.

Finally, there are many templates found and sold online for developing land contract agreements.  However, it is suggested that both farmer-buyers and owner-sellers seek the counsel of a qualified accountant and attorney before entering into any written agreement.


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Ben Waterman
Ben Waterman
Ben holds a B.S. in Conservation of Soil, Water, and the Environment from the University of Maryland. He became particularly interested in sustainable agriculture issues after working as a coffee farmer in Costa Rica and a dairy farmer in Russia. He and his wife recently returned from Malawi, where they served as agricultural extension agents in the Peace Corps. They are starting a diversified farm of their own in Johnson, Vermont. Ben is excited to be a new part of the Center's team in developing its Beginning Farmer and Land Access Program.

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