Farm Land Assessment for Property Taxes

Revised January 2009

Contents
Use Value Assessment
The 1998 Supreme Court Decision
The Farm Land Assessment Calculation
The Base Rate
A History of the Base Rate
The Base Rate, Present and Future
Agricultural Assessments and Tax Payments

Use Value Assessment
Like almost every state, Indiana assesses farm land based on its use-value in agriculture rather than its market value. Farm land is the only major category of property not assessed at market value. Use-value assessment means that property is assessed based on its current use rather than its "highest and best use". Assessors define a property’s highest and best use as that which would provide the greatest return or most profits. In most cases agriculture is the highest and best use for land that is currently in agriculture. But sometimes, mostly where agricultural property is near developing areas, residential or business uses may be the highest and best use. Using the land for housing or business development instead of farming would bring a higher return to the land owner.

Farm land with development potential will sell for a higher price than if its highest and best use is agriculture. If this land were assessed based on market value, so that assessments were predictions of sales prices, the farmer would pay taxes on the land's development potential, not just its value in agriculture. Assessing based only on use in agriculture ignores the value of potential development. When the land has development potential, farm property taxes are lower with use-value assessment than market value assessment.

Opponents of use value assessment might argue that market value assessment at highest and best use is appropriate for farm land. Wealth, they might say, can only be measured by a property’s potential selling price. A farmer owning land with development potential is wealthier than if agriculture was the land’s highest and best use. The wealthier farmer should pay more in taxes. Supporters of highest and best use assessment would also argue that changing assessments with a property's use will influence the business decisions made by owners. Resources are used more efficiently when business decisions are made for business reasons, not to avoid taxes.

Supporters of use value assessment would argue that it is not fair for farmers to pay taxes on wealth that could only be realized if they left farming and developed the land. Further, they would argue that market value based taxes on land with development potential could be so high as to force the farmer to sell the land for development. This could push land to “premature” development, accelerating the expansion of urbanization at the urban-rural boundary. Use value assessment has sometimes been supported by "open space" advocates.


The 1998 Supreme Court Decision
On December 4, 1998, in the Town of St. Johns case, the Indiana Supreme Court found the state’s rules for assessing property unconstitutional. They required that new rules be based on “objectively verifiable data” with “meaningful reference to property wealth.” For most property that means assessing based on market value, the predicted selling price. This was the ruling that made the 2002-03 property reassessment so wrenching for taxpayers. Assessed values were changed a lot with the shift to market value, so tax payments changed a lot too. Indiana policymakers are still stuggling to adjust state and local taxation to this new assessment system.

However, the court also said that "focusing upon the taxpayer’s actual use of land and improvements, rather than the possible uses which potential purchasers may choose, is an altogether appropriate way to evaluate property wealth for the purpose of assessment and taxation. . . ." Use-value assessment is constitutional.

Sometimes residential property has a "highest and best use" more valuable than its use for housing. Residential neighborhoods near expanding commercial developments are an example. Sometimes commercial or industrial property might be more valuable in some other use, for example when old lakefront factories are converted to recreational use. The court found that in these cases, the residential, commercial or industrial property could be assessed based on its current use rather than its potentially more valuable use.

Such cases are rare. Development most frequently occurs where farm land is put to new uses. The court's approval of use value assessment was most significant for farm land assessment.

The Farm Land Assessment Calculation
Use value assessment of farm land in Indiana works like this. Each acre starts with a base rate, which is the same everywhere in the state.. For a decade prior to 2003, the base rate was $495 per acre. For taxes in 2003 through 2005, it was $1,050. In 2006 and 2007, it was $880. The base rate increased to $1,140 for 2008 taxes, $1,200 for 2009 taxes, and will increase to $1,250 for taxes in 2010.

To calculate the taxable value of a farm acre, the base rate is multiplied by a soil productivity factor, which was developed by soil scientists (agronomists) to reflect the typical crop yield of the soil type. Soil types have been mapped by the U.S. Department of Agriculture for every county. These soil types have been divided further by agronomists to identify surface texture, slope and erosion. Boundaries between these detailed soil types have been drawn on aerial photographs. As a result, each acre of farm land in Indiana has been assigned a soil type. About 25 years ago agronomists estimated the typical corn yields of the various soil types, and these were turned into productivity indexes. The most productive soil has the highest index, about 1.28, and the least productive soil has the lowest index, about 0.50.

To calculate the assessed value of a farm acre, the base rate of $1,200 (for 2009 taxes) is multiplied by the productivity index assigned by the acre’s soil type. The result is called the “adjusted rate,” which is then adjusted further by an “influence factor.” Influence factors are percentage deductions that account for features of the land that reduce productivity. For example, tillable land subject to damaging floods five or more years in every ten receives a 50% influence factor deduction. Nontillable land covered with brush, scattered trees or other natural impediments receives a 60% influence factor deduction.

The result of this calculation, base rate times productivity index less influence factor, is the assessed value of farm land. For taxes in 2009, with the $1,200 base rate, the maximum possible assessed value is about $1,536, using the maximum productivity index with no influence factor. The minimum is about $120, using the minimum productivity index and the maximum 80% influence factor.

Special programs exist for other lands. Classified forest land, wildlife habitats and windbreaks may be assessed at one dollar per acre.

This assessment method is “use value” because, in any year, the only thing that makes the assessed value of one acre differ from another is productivity. Farm land in rural Warren County or downtown Indianapolis is valued the same way, even if it could be sold for tens of thousands of dollars for development.

The Base Rate
The assessment of a farm land acre starts with the base rate. Each year the base rate value is recalculated using an income capitalization method. This recalculation is known as "trending."

The income capitalization method divides the net rent or income earned on an asset by a rate of return or interest rate, called the capitalization rate. The result is an estimated sales price, the price an investor would pay to achieve a rate of return comparable to rates earned on other assets. If, for example, a property earns $100 per year in rent, and an investor expects a rate of return of 5%, he or she would offer up to $2,000 for the property. A 5% return on a $2,000 investment is $100. This approach is one of the three recognized methods of market value assessment, along with sales comparison and cost less depreciation.

The income capitalization method is used in most states to estimate farm land values. The general form of the use-value method is:

Use-Value = Net Income from Agriculture / Capitalization Rate.

This is a calculation of use value in agriculture because it considers only the income that can be earned from growing and selling crops. Potential income from other uses is excluded. If potential income from the highest and best use was estimated and included in net income, the equation would produce an estimate of market value.

Table 1 shows the calculation of the $1,200 base rate done for 2008 pay 2009 (which means the assessed value in 2008, on which taxes in 2009 are based), and the $1,250 base rate done for 2009-10. The method capitalizes cash rent net incomes and operating net incomes for each year, averages the two results to get an average market value in use, then averages these results over six years.

Table 1

Cash rent is taken from the Purdue Agricultural Economics Report on land values and rents. Net operating income requires an elaborate calculation (see below). The capitalization rate is an average of the Chicago Federal Reserve Board's real estate loan and operating loan interest rates. The net income from land is divided by the capitalization rate to give the market value in use. The cash rent and operating figures are averaged, and the six year average of these figures, rounded to the nearest ten, is the base rate.

The calculations use a six-year rolling average. This is done to smooth out wide fluctuations in the base rate (consider the jump from $1,407 to $1,882 and back to $1,177 from 2003 to 2005, for example). This means that farm income and capitalization rates from long ago still influence the base rate today. Data for the year 2000 will affect taxes paid in 2009, for example. This also means that the change in the base rate depends on a comparison of the year that is dropped (2000 for taxes in 2010) and the year that is added (2006 for taxes in 2010). The base rate increases from $1,200 to $1,250 in 2010 because both cash rents and net operating income were higher in 2006 than they were in 2000, and the capitalization rate was lower in 2006 than in 2000.

Net operating income is calculated from data on yields, prices and costs. Tables 2 through 4 show an approximation of these calculations, organized for clarity. Differences in rounding make these calculations slightly different from the actual results obtained by the Department of Local Government Finance.

Table 2

Yield per acre for corn and soybeans is taken from the National Agricultural Statistical Service (NASS), Indiana section data. Average price is the price per bushel of corn and beans is the average of the November price, the average annual price, and the average market price. These data are also obtained from the NASS

The product of yield and price is average gross income (there may be some rounding errors in Table 2). Variable costs come from the Purdue University Crop Guide. The Average contribution margin is sales less variable costs.

Table 3 shows the calculation of overhead costs.

Table 3

Overhead includes machinery costs, drying and handling, family and hired labor and property taxes. The data for all but property taxes come from the Crop Guide. The Department of Local Government Finance uses its own data to calculate the average property tax per acre of farm land. The figure for 2008 is an estimate made by the author.

Table 4 brings this operating data together with government payments and the capitalization rate, to calculate the use value of land.

Table 4

Government payments per acre are calculated using total direct government payments, less milk payments, divided by total crop land acres. Again, data are from the IASS. The total contribution margin takes the sum of the corn and beans contribution margins and government payments, and divides by 2. The net return to land is the total contribution margin less overhead costs. The capitalization rate is from the Chicago Federal Reserve Board. The net return to land is divided by the capitalization rate to give the value in use.

The results of these calculations track closely the market value in use, operating figure in Table 1, but they are not exact. The DLGF uses a different ordering of these calculations, which produces small differences due to rounding. An example of the DLGF's exact calculations are available on their website, under agricultural land reference materials.

A History of the Base Rate
Prior to the 2002-03 reassessment, the base rate was set by the State Tax Board (the predecessor to the Department of Local Government Finance), in consultation with an agricultural advisory council, composed of agricultural leaders, state and local officials, and others. Essentially, the base rate was a number negotiated by the interests involved, the assessors and the farmers. The base rate was set at $450 per acre during the 1979-80 reassessment, raised 10% to $495 with the 1989-90 reassessment, and left at $495 with the 1995-96 reassessment.

Though it was never explicitly tested in court, it seems unlikely that this method would pass the court's tests of “meaningful reference to property wealth” using “objectively verifiable data.” The Department of Local Government Finance abandoned the "negotiated" method for the 2002-03 reassessment.

The DLGF began using the capitalization method with the market value reassessment in 2002-03. The method was a modification of a method developed by two Purdue agricultural economists (their memo to the old Tax Board is available in the DLGF documentation.) The capitalization calculation used a four year average with data for 1996-99, which gave a base rate of $1,050.

This rate was more than double the then existing base rate of $495, and caused a large jump in farm land property taxes in 2003. An analysis of that reassessment showed that the base rate increase caused tax payments on agricultural business real property (farm land and structures) statewide to rise by 15.5%. Increases in some counties were much greater, in others it was less. Reassessment increased assessed values, but decreased tax rates, which is why the increase in farm land taxes was so much smaller than the increase in farm land assessments.

In 2001 the General Assembly passed a law (P.L. 198-2001) to require assessors to update property assessments every year. Indiana Code 6-1.1-4-4.5 reads (in part), "the department of local government finance shall adopt rules establishing a system for annually adjusting the assessed value of real property to account for changes in value in those years since a general reassessment of property last took effect." The idea is to update real property assessments each year, to meet the court's requirement that assessments bear "meaningful reference to property wealth." These annual updates are known as "trending" when applied to residential and business land and structures. Trending is not a reassessment, with inspections of every parcel of property in the state. It's just a tweaking of the assessment formulas so that assessed values keep up with changing market values.

Trending means that farm land assessments are updated every year along with assessments of other land and buildings. The adjustment of farm land values is easily done. The Department of Local Government Finance merely needs to recalculate the base rate using updated yields, prices, costs and interest rates.

Annual updates were scheduled to take effect for the March 1, 2005 assessment date, affecting tax bills in 2006. The DLGF issued a memo on January 7, 2005, certifying a new base rate of $880. This was a 16% decline in the farm land base rate, from the old value of $1,050. The new base rate would be used in the base rate times productivity factor less influence factor formula for each farm acre in the state. This would update farm land values. Unless (somehow) an acre's productivity or influence factor changed, the acre's assessed value would drop, and so would farm land tax bills in 2006.

However, it became clear that Indiana assessors were not ready to do annual updates for all real property. Updates had never been done before, the regulations governing updates had been finalized only in December 2004, and some counties were still trying to catch up with the assessment calendar after the difficulties of the 2002-03 reassessment. The possibility of another delay in assessments loomed, with local governments again scrambling to fund their services without property tax collections.

The General Assembly addressed this problem by postponing the starting date for annual updates to March 1, 2006, for taxes payable in 2007. This was accomplished during the 2005 legislative session, in Senate Bill 327, which became Public Law 228 when it was signed by the Governor.

Naturally, the prospect of postponing the update distressed farm land owners. Farm land assessments were scheduled to drop by 16%, which would reduce the tax bills for most owners. Senate Bill 327 recognised this problem, too. Section 34 of that bill read, "for the property tax assessment of agricultural land for the assessment date in 2005 and 2006, the statewide agricultural land base rate value of eight hundred eighty dollars ($880) per acre is substituted for the statewide agricultural land base rate value of one thousand fifty dollars ($1,050) per acre. . . ." In other words, the annual update was postponed for all property except farm land. Farm land's first annual update would take place in 2005, for 2006 taxes. And, for good measure, the base rate was frozen at $880 in assessment year 2006, for 2007 taxes. The bill also required the DLGF to use a six-year rolling average of yields, prices, costs and interest rates, instead of the four years that had been used in past calculations.

Freezing the base rate at $880 for 2007 taxes turned out to be a tax break for farmers. Had DLGF recalculated the base rate for that year, it would have been about $1,040, an 18% increase over $880. Farm taxes were lower in 2007 than they would have been had the base rate been recalculated. However, this made for an even bigger jump the next year, when updates of the base rate resumed. In 2007 the DLGF set the base rate at $1,140, for taxes payable in 2008, a 30% increase over $880 (and a 10% increase over $1,040).

Now, near the turn of the new year, the DLGF issues a base rate for the next March assessment date, which will be effective for taxes in the year after that. In January 2008 the DLGF issued the base rate for the March 2008 assessment, to be used for taxes in 2009. The base rate increased to $1,200, up 5% from $1,140. Towards the end of 2008 the DLGF issued the base rate for March 2009, to be used for taxes in 2010. The value was $1,250, up 4% from the previous year.

The Base Rate, Present and Future
The base rate has increased from $880 for taxes in 2007 to $1,250 for taxes in 2010, a 42% increase in three years. What's going on?

The figures in Tables 1 through 4 tell the story. Cash rents are rising. So is the net operating income calculation. The capitalization rate is falling. The numerator of the capitalization formula is increasing; the denominator is decreasing, and that means the result--the base rate--must rise.

We can be much more specific. Each recalculation of the base rate drops an earlier year and adds a later year. The change from pay-2009 to pay-2010, from $1,200 to $1,250, dropped data for 2000 and added data for 2006. The six year average includes numbers for 2001 through 2005 in both years. So, any change in the base rate results from differences in the numbers between the year that was dropped, 2000, and the year that was added, 2006.

Table 1 shows that cash rent in 2000 was $101 per acre, and in 2006 it was $110. The capitalization rate was 9.56% in 2000; 8.17% in 2006. Net operating income was $60 per acre in 2000; $73 in 2006. The differences in each number helped increase the base rate.

The difference in net operating income can be analyzed in detail using tables 2 through 4. Yields for corn and beans were higher in 2006 than in 2000. The prices of corn and beans were higher in 2006 than 2000. Variable costs also were higher in 2006. The cost increase was not nearly enough to offset the price and yield increases, so the contribution margins for corn and beans increased.

Overhead costs were slightly higher in 2006. Government payments were down in 2006 compared to 2000. Overall, the net return to land was up from $61 an acre in 2000 to $73 an acre in 2006. This figure is divided by the capitalization rate, which was lower in 2006 than in 2000. The value in use for net operating income that was dropped from the 6-year average was $637 per acre. The value that was added to the 6-year average was $892.

The base rate will increase for taxes in 2010 because between 2000 and 2006, cash rents increased, the yields and prices of corn and beans increased, and the capitalization rate fell. Costs rose and government payments fell, but not enough to offset the net income increases and capitalization rate drop.

The data used to calculate the base rate for taxes in 2010 were from 2001 through 2006. We know most of these numbers through 2008. That means we should be able to predict changes in the base rate for taxes in 2011 and 2012. Table 5 shows these calculations.

Table 5

The base rate calculation for 2010-11 will drop numbers from 2001 and add numbers from 2007. Cash rent and net operating income were substantially higher in 2007 compared to 2001, probably due to the substantial increase in commodity prices in 2007 (see Table 2). The capitalization rate was only slightly lower in 2007 than it was in 2001. But 2007 cash rent net incomes increased over 2001 by 20%, and operating net income increasing by 198%. The base rate calculation dropped from the six-year average is $1,019; the base rate calculation added is $1,914. That causes the base rate for taxes in 2011 to rise to $1,400, up 12% from the 2010 value of $1,250.

For the pay-2012 base rate, numbers from 2002 will be dropped and numbers from 2008 will be added. Cash rents were 30% higher in 2008 than in 2002. Commodity prices rose even more in 2008. The year 2002 saw low corn yields, while 2008 saw high corn yields. Variable costs increased substantially, but not enough to offset the increases in prices and yields. The capitalization rate was lower in 2008 than in 2002. The calculations produce a large jump in the base rate for 2012 taxes, to $1,690, up 21%. This will mean that the base rate for taxes will have nearly doubled between 2007 and 2012.

These must be pretty good predictions because the data on which they are based are (mostly) already known. All of the data for 2007 are known. For 2008, the Government Payments figure is estimated. The rise in commodity prices is likely to reduce Government payments, but perhaps not to the exact figure shown in Table 2. The 2008 property tax figure is also an estimate, but the rising base rate is likely to increase the tax per acre over 2007. Data for 2008 on prices and yields may be revised, and the fourth quarter capitalization rates were estimated. Still, we know enough about 2008 to be sure that the current calculation method will produce a large increase in the base rate for taxes in 2012.

Agricultural Assessments and Tax Payments
Changes in assessed values change tax payments. In Indiana, the local tax levies for the most part are controlled by state rules. Assessment increases, then, tend to reduce tax rates. Whether taxpayers see increases or decreases in property taxes depend on how much the assessed value of their property rose, compared to how much the tax rate fell. When the assessment increase is bigger the tax bill is more likely to increase.

This means that when the base rate goes up, tax bills on farm land are likely to rise more in urban counties than in rural counties. The reason why in shown in the example in Table 6. Farm land is a large share of total assessed value (A.V.) in rural counties--in some, like Benton County, around 40% of the total. Farm land is a tiny share of total assessed value in urban counties. It's only about 3% of A.V. in Tippecanoe County, for example. So, when the base rate rises, total assessed value increases substantially in rural counties. The base rate increases has little effect on A.V. in urban counties.

Table 6

In Table 6, if assessments of farm land rise 30% (as happened in 2008), but assessments of other property rise just 2%, total assessed value in the rural county rises 13%, but only 3% in the urban county. If the tax levy rises 5% in both, then tax rates will fall about 8% in the rural county (the 5% levy increase minus the 13% A.V. increase), while rates will rise 2% in the urban county. The 30% farm land assessment increase in the rural county produces "only" a 22% increase in taxes per acre in the rural county, because the tax rate fell. In the urban county, the tax rate rose, so the farm land tax increase is 32%.

Two new factors may affect farm land taxes in coming year. First, the recession which began in December 2007 is causing reductions in home values. With correct trending, lower home values in 2008 will mean lower assessments in 2009, which will affect tax bills in 2010. Farm land assessments will be rising while other property assessments may be falling. This will mean bigger tax bill increases for farm land owners.

The big tax reform of 2008 created new property tax caps. Tax bills on farm land will be limited to 2.5% of gross assessed value in 2009, and to 2% of gross assessed value in 2010 and after. Gross assessed value is the assessed value before deductions. Since farm land rarely gets deductions, it's the result of the base rate times productivity factor less influence factor calculation. An acre with a productivity factor of one and no influence factor would be assessed at the base rate. In 2009 the base rate of $1,200 means the tax bill on such an acre would be capped at $30 (2.5% of $1,200). In 2010 the tax bill would be capped at $25 (2% of $1,250).

It seems likely that few farm land owners will benefit from the tax caps. This is because most farm land is in unincorporated areas (outside cities or towns), and so tends to have lower tax rates. Further, the increases in the base rate will raise the caps on farm land. If the base rate is $1,690 in 2012, the 2% limit will cap the tax bill at $34. And, in rural areas, the rising assessed values of farm land will reduce tax rates (or slow tax rate increases). Farm land owners in counties with particularly high rates may see their taxes limited by the tax caps. Most farm land owners will have tax bills too low to be affected by the caps, even as their tax bills rise with the rising base rate.