Farm Land Assessment for Property Taxes

Revised February 2008

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.

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. 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. For taxes in 2008, it will increase to $1,140, and for 2009 taxes, to $1,200. Assessment of farm land starts with the same base rate everywhere in the state.

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 $1,140 (for 2008 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 2008, with the $1,140 base rate, the maximum possible assessed value is about $1,459, using the maximum productivity index with no influence factor. The minimum is about $114, 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.

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 on the asset 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 the calculation, the equation would produce an estimate of market value.

Table 1 shows the calculation of the $1,140 base rate done for 2007 pay 2008 (which means the assessed value in 2007, on which taxes in 2008 are based), and the $1,200 base rate done for 2008-09. The method averages cash rent over six years, averages net operating income over six years, and then averages the two figures together. This result is divided by an average capitalization rate over six years to get the base rate.

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 (1999 for taxes in 2009) and the year that is added (2005 for taxes in 2009). The base rate increases from $1,140 to $1,200 in 2009 because both cash rents and net operating income were much higher in 2005 than they were in 1999, and the capitalization rate was lower in 2005 than in 1999.

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. 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.

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 by dividing total direct government payments 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.

Annual updates should lessen the shocking effects of big reassessments on taxpayers. Since 1980 Indiana has gone six to ten years between reassessments. The next reassessment won't affect tax payments until 2012, nine years after the 2002-03 reassessment. When that many years of property price changes are incorporated into assessments all at once, taxpayers usually see big changes in their tax bills. Annual updates will chop these big changes into smaller pieces, and apply them one year at a time.

Farm land assessments would be 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. That's a 30% increase over $880 (and a 10% increase over $1,040). Farm land taxes in 2008 will go up (depending on how the General Assembly reforms property taxes during the 2008 session).

In January 2008 the DLGF issued the base rate for taxes in 2009. Again, the base rate increased, this time to $1,200, up 5% from $1,140.

The Base Rate, Present and Future
The base rate has increased from $880 to $1,200 in four 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 2007-08 to 2008-09, from $1,140 to $1,200, dropped data for 1999 and added data for 2005. So, any change in the base rate results from differences in the numbers between 1999 and 2005.

Table 1 shows that cash rent in 1999 was $99 per acre, and in 2005 it was $110. The capitalization rate was 8.77% in 1999; 7.22% in 2005. Net operating income was $36 per acre in 1999; $60 in 2005. 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 2005 than in 1999. The price of beans was higher in 2005 than 1999, but the corn price was a little lower. Variable costs were higher in 2005. This was enough to offset the yield increase in corn, making the contribution margin for corn smaller in 2005 than in 1999. But the yield and price increase in beans was much greater than the variable cost increase. The contribution margin for soybeans was a lot higher in 2005 than in 1999.

Government payments were up in 2005 over 1999. Overhead costs were slightly higher in 2005. Overall, though, the net return to land was up from $36 an acre in 1999 to $59 an acre in 2005. This figure is divided by the capitalization rate, which was lower in 2005 than in 1999. The value in use for net operating income that was dropped from the 6-year average was $410 per acre. The value that was added to the 6-year average was $817.

The base rate will increase for taxes in 2009 because between 1999 and 2005, cash rents increased, the yields of corn and beans increased, the price of beans increased, and the capitalization rate fell.

The data used to calculate the base rate for taxes in 2009 were from 2000 through 2005. We know most of these numbers through 2007. That means we should be able to predict changes in the base rate for taxes in 2010 and 2011. Table 5 has those calculations.

Table 5

The base rate calculation for 2009-10 will drop 2000 and add 2006. Cash rents and net operating income were higher in 2006 than they were in 2000; the capitalization rate was lower in 2006 than it was in 2000. Again, the numerator is up and the denominator is down. The calculation puts the base rate for taxes in 2010 at $1,250, up 4% from $1,200 in 2009.

The calculations produce a bigger jump in 2011, to $1,380, up 10%. The main reason is the very large increase in cash rent and especially net operating income, in 2007 compared to 2001. Table 2 shows that net operating revenue goes up because of a big increase in the corn and bean prices. The recent run-up in commodity prices will begin to affect the base rate for taxes in 2011.

These must be pretty good predictions because the data on which they are based is (mostly) already known. One figure that is not known is Government Payments figure for 2007. The rise in commodity prices is likely to reduce Government payments, but perhaps not to the zero figure shown in Table 2. If this figure is positive, the base rate in 2011 will be larger.

Calculation methods may change as well. The overhead cost figures for machinery and labor drop in 2007 (Table 3). This occured because of a change in the method in the Purdue Crop Guide. The farm size used to calculate costs was increased from 1,000 to 3,000 acres, and economies of scale reduced per acre costs. Lower costs mean a higher base rate. Perhaps DLGF will make an adjustment for this change in method; perhaps not. With an upward adjustment in costs, the base rate would be smaller.

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 the Table, if assessments of other property rise 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%.

This example ignores changes in deductions and credits, and of course does not reflect changes in tax policy that might be passed by the General Assembly in 2008. It says that a 30% rise in farm land assessments--as will happen with the base rate increase for 2008 taxes--will increase all farm land taxes substantially. But the increase in urban counties will be more; the increase in rural counties, less.