& Policy Update. August 23, 2018 Volume 18, Issue 8 FEATURED ARTICLES IT IS WHAT IT IS; WHAT ARE YOU GOING TO DO ABOUT IT?

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1 Graphic owner: UKZN SAEES: school website & Policy Update August 23, 2018 Volume 18, Issue 8 Edited by Will Snell and Phyllis Mattox FEATURED ARTICLES It Is What It Is; What are You Going to Do About It? - Jennifer Rogers Mid-Year Cattle Inventory Suggests Slower Expansion Ahead - Kenny Burdine The Future of Agricultural Machinery and the Economic Questions That Arise - Jordan Shockley 2018 National Land Values Summary - Steve Isaacs IT IS WHAT IT IS; WHAT ARE YOU GOING TO DO ABOUT IT? Our current agriculture economy is on the rocks. Producers are experiencing low prices, some areas have gotten no rain, we have rising or steady costs of inputs, increased labor costs, tariffs and trade agreement turmoil. all in all there are tight margins with little to no profits. Ag producers are currently facing all of these challenges. Unfortunately, there is no magic wand for anyone to wave that would fix any one of these issues, much less the entire list. If producers want to remain in business, how they address these issues and challenges will be vital. In a recent conference with Dr. David Kohl, Professor Emeritus of Agricultural Finance and Small Business Management and Entrepreneurship at Virginia Polytechnic Institute & State University, author of four books and more than 1,300 articles, he outlined four cornerstones for success: plan, strategize, execute, and monitor. Plan. A producer must take the time to think through their situation and develop a plan. Just as you need a plan on how many acres you are going to plant so that you can purchase enough seed, you need to plan to how to address the challenges you face. If you just go out and start planting, you are likely to run out of seed or purchase too much. If you just keep farming like always, you are gambling that it will all work out just right. You need to plan for cash flow needs, plan for operating loan needs, plan for loan repayments, plan how to market the crop, and plan for labor and machinery requirements. A plan will outline what you want to do and the things you need to make it happen. Strategize. Once you have the plan, you must determine how you are going to accomplish it. What steps will you take first? If you know how many acres of corn and beans you are going to plant, now you need to determine when and where you are going to start planting, if you need to work the field or spray it prior to planting, and who is going to do the work. With your strategy of how you are going to accomplish the task, it is important that you prioritize. What will make the most impact? What decision will get you the most gain? Set a couple of priorities, the things that you want to do first. You can t do everything all at once. If cash flow is one of your problems and the plan is to get a loan, the first strategy on the list should be to meet with the lender. If cash or financing are not available, you will not get very far with planting a crop. Execute. Sometimes the best laid plans stop there. If you never actually put the plan to work, you have accomplished nothing. In order to grow a crop, you physically have to plant the seeds. If you never plant, there will never be a product. This is the same with making decisions. Sometimes the strategized plan has some unpleasant steps, like talking to a landlord about lowering the rent, but if you never execute the plan and have the conversation, the rent will never be lowered. Producers must make a decision and follow through with it. Monitor. Even after a plan is made, and a strategy is developed and executed, you cannot stop there. You must monitor the situation. Is the plan being accomplished with the strategy that was determined? Should changes be made to the plan or the strategy? Did you accomplish your end goal? If you don t monitor the situation and the outcomes, you won t know what worked or didn t work. Without monitoring, you won t know what changes to the plan, strategy, or execution need to be made for the next time. Monitoring gives you valuable information to use in the future. The best information comes from your own experiences and records. In this current ag economy, producers cannot take the approach of it is what it is and there is NOTHING I can do about it. Producers must look for opportunities that will put them ahead in their operation. Sometimes the road will be bumpy, but with the right plan, strategy, execution and monitoring we can look toward a brighter, more profitable future. PAGE 2

2 PAGE 2 MID-YEAR EFFECTS CATTLE OF THE INVENTORY TAX CUTS AND SUGGESTS JOBS ACT SLOWER ON FARM EXPANSION BUSINESSES AHEAD USDA s January Cattle Inventory Report suggested that growth in the size of the US cow herd was slowing. July s numbers The Tax Cuts and Jobs Act was passed December 22, The Treasury Department and the Internal Revenue Service must generally pointed in a similar direction. Both beef cow numbers and total cattle and calves were up about 1% from July 2017, now interpret the law and write the regulations. Most provisions will affect farm businesses beginning this year. Below are some which suggests a more moderate growth rate. This was coupled with a 2% reduction in heifers held for beef cow replacement. of the changes that affect farmers most. Beef heifer retention as a percent of beef cow inventory was 14.2%, which generally does not suggest expansion. While this is significant, I tend to put more stock in the January numbers than the July numbers and January heifer retention was still pointing Employee Withholding to some herd growth. With lower tax rates Federal income tax withholding from employee paychecks have dropped. The Treasury has released new withholding tables for employers. The new withholding rates are effective immediately and must be in use no later than Several factors drive beef cow numbers, with calf prices likely at the top of the list. Our current calf market is very similar to February 15, where it was last year. Given the much higher meat supplies and uncertainty on the international trade front, I actually think this cattle market has been incredibly resilient. While many producers aren t pleased with calf prices, I don t think calf prices are low 1031 Like-Kind Exchange enough yet to be encouraging liquidation at the national level. On the other hand, weather is becoming a growing concern for Like-kind exchange is repealed for equipment and livestock. It is limited to real property that is not held primarily for sale. Thus, many. all trades of equipment will be treated as a sale of one asset reported on Form 4797 and purchase of another asset subject to depreciation and cost recovery. While there are always exceptions, this has been an excellent year for forage growth in Kentucky. A quick glance at the drought monitor would suggest it has been a pretty good year for much of the southeast. However, dry conditions are becoming a larger Depreciation and Cost Recovery issue for a good portion of cattle country. Significant drought (and abnormally dry conditions) appears to extend from Missouri Most farm property now uses the 200% declining balance and a half-year convention. The amount of depreciation allowed is south to Louisiana and west from there, taking in much of the southern plains. While we don t get state-level estimates in July, it weighted to earlier years. New machinery and equipment has a shorter, five-year recovery period. New means that original is very possible that this might partially explain the decreased heifer retention. As we move towards fall, it will be interesting to ownership begins with taxpayer. Used machinery and equipment still has the longer seven-year recovery. see if we see much movement of cows, or increased cow slaughter, in the region. This has the potential to greatly impact beef cow numbers between now and winter. Section 179 Expensing The maximum amount that can be deducted is $1 million. This deduction begins to phase out at $2.5 million in depreciable Lastly, I would briefly comment on cattle-on-feed numbers. July 1 cattle-on-feed numbers were estimated to be 4% above yearago levels. I would remind everyone that cattle-on-feed numbers were up 9% in March. From a big picture perspective, feedlot purchases. inventory was going to be larger in 2018 because the 2017 calf crop was larger. But, feedlot inventories were also artificially Bonus Depreciation higher this spring due to poor wheat grazing conditions last winter, forcing a lot of calves on feed sooner than usual. It continues Business may write off 100% of most business investments for assets placed in service through The bonus amount is to appear that we have worked through a lot of that inventory. A summary of the mid-year inventory report can be seen in the reduced by 20% each year beginning 2023 until bonus depreciation is eliminated in This applies to purchases after following table. September 27, The deduction now includes used equipment, not just new purchases. USDA July 1, 2018 Cattle Inventory Estimates Interest Payments as % of Net interest expense in excess of 30% of the business adjusted taxable income is disallowed. Farming businesses may elect out (1,000 head) (1,000 head) 2017 by choosing to use longer depreciation on property with a 10-year recovery period or more. A business is exempt from the Total Cattle and Calves 102, , disallowance if average annual gross receipts for the prior three-tax year period exceeds $25 million. Average gross revenue for 2016 commercial grain Cows farms and was Heifers $1.1 That million, Have so Calved most Kentucky will be 41,600 exempt. 41, Beef Cows 32,200 32, Net Operating Loss (NOL) Milk Cows 9,400 9, Net Operating Losses may no longer be carried back and applied to offset prior year taxes. The NOL carries forward indefinitely, rather than the old 20-year Heifers rule. 500 Pounds A farm and NOL Over may qualify for a two-year 16,200 carryback. Any 16,300 NOL deduction during 101 the year is limited to 80% of taxable income For for Beef that Cow year. Replacement For Milk Cow Replacement 4,700 4,200 4,600 4, Domestic Production Activities Other Heifers Deduction (DPAD) DPAD is repealed for tax years beginning after December 31, Steers 500 Pounds and Over 7,300 14,500 7,500 14, % Business Deduction Bulls 500 Pounds and Over 2,000 2, A 20% Business Deduction Calves may Under apply 500 Pounds to income passed through an entity 27,900 or earned by 28,400 a sole proprietor. 102 The rules seem to be complicated. The deduction applies to Taxable Income, not Adjusted Gross, as did the DPAD. A last-minute addition to the law Calf Crop 35,808 36, allowed the deduction to be passed through from cooperatives. However, the wording apparently gives a greater advantage to those who sell through a co-op. Lawmakers are trying to address this unintended consequence. Cattle on Feed 12,800 13, Source: NASS, USDA

3 PAGE 3 THE FUTURE OF AGRICULTURAL MACHINERY AND THE ECONOMIC QUESTIONS THAT ARISE I recently attended the 14 th International Society of Precision Agriculture where scientists and industry representatives from across the world came together to share and discuss their research and current trends in the area of precision agriculture. There were hundreds of great presentations covering a wide range of topics, but it was evident that one topic was at the center of the conversation, autonomous machinery. Autonomous machinery in agriculture is categorized as driverless tractors or robots performing common tasks in production agriculture. Autonomous machinery is not unique to agriculture. The automotive industry has been advancing autonomous technology for implementation on U.S. roadways and is being led by major vehicle manufacturers like GM, Ford, BMW, and Audi to name a few. The ride-sharing company Uber has already experimented with self-driving taxis in California and Arizona. In agriculture, autonomous machinery is not a new concept. Researchers across the globe have been developing prototypes for years, and now we are on the cusp of commercialization. Autonomous machinery has also been talked about widely in popular press recently. What is unknown is the design of autonomous tractors. Will they be small, one-row units that operate in fleets or swarms across the field similar to that developed by Fendt (AGCO) seen in Figure 1? Will they be large tractors with autonomous capabilities similar to what New Holland highlighted last year at the Farm Machinery Show in Louisville (Figure 2)? Alternatively, will they be somewhere in-between like the SeedMaster by DOT, which just had a limited commercial release this year for planting in Saskatchewan (Figure 3)? Regardless, a recent study conducted by Goldman Sachs expects autonomous agriculture machinery to be a $45 billion market in the next five years. Figure 1. Fendt (AGCO) Xaver autonomous robot prototype Continued on page 4

4 PAGE 4 Figure 2. New Holland NH Drive autonomous tractor Figure 3. SeedMaster by DOT autonomous platform and seeder As a top 25 college for precision agriculture, the University of Kentucky has been researching and designing autonomous machinery for over 15 years. From an economic standpoint, there are many questions to address with autonomous machinery. Can autonomous machinery be a profitable alternative to conventional farm machinery? What does the cost structure need to be to compete with conventional farm machinery? How will autonomous machinery impact labor markets, environmental quality, rural development, and more? What are the legal issues with autonomous machinery and how can we improve farm safety? These are just a few questions that require answers before full commercialization occurs in U.S. production agriculture. Ongoing research begins to address the first and second questions, can autonomous machinery be a profitable alternative to conventional farm machinery and what is the cost structure. Initial results indicate that autonomous machinery has the potential to be an economically viable alternative to conventional machinery in Kentucky with a favorable cost structure. Furthermore, initial results indicate that autonomous machinery could be more profitable on smaller farms in Kentucky (<500 acres). Due to the current size of farm machinery available to grain producers, smaller farms often have to purchase larger equipment than is required. Autonomous machinery (if small in scale) can provide an opportunity to capture economies of size in smaller operations, which is traditionally afforded to larger farming operations. As an economist, I do not know where the autonomous machinery industry will land in regards to the design of a driverless tractor. All I know is that autonomous machinery in agriculture is not some far-fetched idea; it is here, and is on the verge of commercialization. As the autonomous machinery market in agriculture evolves, stay tuned to see how we address some of the economic questions presented above.

5 PAGE NATIONAL LAND VALUES SUMMARY Each August, USDA releases its summary of agricultural land values. The publication and data are available at The per acre value for all US farm real estate increased 1.9% from 2017 to an average of $3,140/acre. Cropland increased by 1.0% to $4,140/acre and US pastureland increased by 3.0% to $1,390/acre. Kentucky s farmland values changed very little for Cropland increased 0.8% to $3,880, and pastureland dropped $20/acre to $2,740/acre, a 0.7% decline. Averaged across categories, farm real estate in Kentucky is valued at $3,440/acre, a 0.6% increase over The accompanying graphics help illustrate long-run trends in US and Kentucky farmland values. The first graphic is the year-to-year percentage changes for over a century. Notable events like the great depression and the farm financial crisis of the 80s are evident. The more recent great recession and the downturn in commodity prices are reflected in a couple of negative year-toyear changes and modest increases. 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% Annual Percentage Change in US Farm Real Estate Values % -10.0% -15.0% -20.0% The second graphic with long-run trend lines of land values suggest that modest increases in land values may not offset even the relatively benign inflation of recent years. The nominal values are the actual levels reported for that year. The real values are adjusted for inflation with serving as the base period for price adjustments. Continued on page 6

6 PAGE 6 The third graphic is nearly seventy years of Kentucky farm real estate values (nominal values only). The 80s farm crisis depressed Kentucky prices, but not as severely as on the national scene. The 2009 recession depressed national farmland values for only one year while Kentucky s values dropped in 2009, 10, and 11.

7 PAGE 7 College of Agriculture, Food and Environment Department of Agricultural Economics 315 Charles E. Barnhart Bldg. Lexington, KY Phone: Fax: Economic & Policy Update View all issues online at Educational programs of Kentucky Cooperative Extension serve all people regardless of race, color, age, sex, religion, disability, or national origin. UNIVERSITY OF KENTUCKY, KENTUCKY STATE UNIVERSITY, U.S. DEPARTMENT OF AGRICULTURE & KENTUCKY COUNTIES COOPERATING.