United States District Court, Central District of Illinois
January 19, 1993
HARLAN E. MOORE CHARITABLE TRUST, PLAINTIFF,
UNITED STATES OF AMERICA, DEFENDANT.
The opinion of the court was delivered by: Baker, District Judge.
This matter is before the court on cross-motions for summary
judgment. The plaintiff, Harlan E. Moore Charitable Trust, is
a qualified tax exempt organization and has filed this suit
seeking a refund of $19,824.71 ($16,033.66 plus interest) on
assessed income tax deficiencies it paid for the years 1986
The tax was assessed on rent from a farm the plaintiff owns
in Piatt county as an unrelated business income tax (UBIT)
under 26 U.S.C. § 512. The legal issue in this case is narrow:
whether the rent, in the form of 50% of the farm's production
under a crop-share lease, is non-taxable as a fixed percentage
of receipts or sales, or is taxable as an amount dependent on
the income or profits of the lessee.
The plaintiff argues the income falls within the
parenthetical exclusion of § 512(b)(3)(B)(ii)*fn1 as a rent
based on a fixed percentage of receipts, that is 50% of the
crop production. Alternatively, the plaintiff claims the crops
are excludable rent from real property under § 512(b)(3)(A)(i).
The government contends that the relationship between the
Trust and the farmer is not landlord-tenant but a partnership
or joint venture and the crops are not true rents. The
government asserts that, under 26 C.F.R. 1.512(b)-1, the farm
operation generates income, not true rents, that is not within
the modifications for rents. Alternatively, the government
maintains that the rent from the crop-share agreement is
dependent on the income or profits of the lessee, not on a
percentage of receipts or sales, and therefore the exception
in § 512(b)(3)(B)(ii) governs.
The Harlan E. Moore Charitable Trust was founded in 1976 and
has tax-exempt status under § 501(c)(3). The Trust owns a
400-acre farm in Piatt County, Illinois that is managed by
Daryl Mealiff of the farm management department at the Bank of
Illinois. Steven Dodge farms the land. Dodge and his
father-in-law entered into a crop share agreement with the
Trust in 1979.
According to the terms of the agreement, Dodge lives in the
farm house and works the land but does not pay any cash rent
to the Trust; instead, Dodge's rent is 50% of farm production
after the crop is divided at the grain elevator. The Trust and
Dodge have signed two leases, with essentially similar terms,
the first in 1979 and the second in 1989.*fn2
The lease refers to the plaintiff as "Owner" and Steven
Dodge as "Tenant." Dodge has possession and control of the
farmhouse and farm. The lease specifies the division of
responsibilities: the Trust pays the property taxes and
building maintenance expense and the tenant supplies all of
the labor, machinery, fuel and hauling expenses. The cost of
seed, fertilizer, limestone, herbicides, insecticides, soil
tests and grain drying are split equally between the Trust and
Dodge decides what seed to plant, when to apply fertilizer,
herbicides and insecticides, when to harvest the crop and when
to sell his half of the production. Deposition of Mealiff at
22-27; Deposition of Dodge at 12-17. Dodge and the Trust each
carry hail insurance for their half of the crop. Mealiff at
30-31; Dodge at 32. The Trust and Dodge are billed separately
for their portion of the shared costs. Dodge at 18. Mealiff
and Dodge intend the lease to create a landlord-tenant
relationship. Mealiff at 12; Dodge at 37. Neither party holds
itself out as the other's partner, nor has one paid the
other's expenses or undertaken the other's responsibilities.
Mealiff at 64.
A. Relationship between the Trust and Dodge
The government contends that the parties are not actually
landlord and tenant but in fact are partners or joint
venturers. The government points to the shared cost of seed,
fertilizer, herbicides and drying as evidence of the joint
venture. The most important element in determining whether a
landlord-tenant relationship or joint venture exists is the
intention of the parties. Petry v. Chicago Title & Trust Co.,
51 Ill. App.3d 1053, 1057, 9 Ill.Dec. 951, 367 N.E.2d 385 (2d
Dist. 1977). The burden of proving the existence of a joint
venture is on the party who claims the relationship exists. Id.
Landowners and farmers have undertaken crop-share
arrangements in Illinois for well over a hundred years.
Alwood v. Ruckman, 21 Ill. 200 (1859). Illinois courts find it
obvious that farming on shares creates a landlord-tenant
relationship. Baker Farmers Co. v. ASF Corp., 28 Ill. App.3d 393,
395, 328 N.E.2d 369 (3d Dist. 1975). However, an agreement
to carry on farming operations can become a joint venture. Id.;
Petry, 51 Ill. App.3d at 1057, 9 Ill.Dec. 951, 367 N.E.2d 385.
[A] joint venture contemplates an enterprise
jointly undertaken; that it is an association of
such joint undertakers to carry out a single
project for profit; that there must be a
community of interest in the performance of a
common purpose, a proprietary interest in the
subject matter, a right to direct and govern the
policy in connection therewith, a duty, which may
be altered by agreement, to share both in profit
Petry, 51 Ill. App.3d at 1056-57, 9 Ill.Dec. 951,
367 N.E.2d 385
(citing Carroll v. Caldwell, 12 Ill.2d 487
147 N.E.2d 69
(1957)). One member of the joint venture is liable to
third parties for acts of the other venturer, especially
payment of debts. Baker, 28 Ill. App.3d at 396, 328 N.E.2d 369
In a joint venture as in a partnership, where one person holds
him or herself out as a partner, others who permit such holding
out are liable for the actions or debts incurred in the course
of the partnership. Id.
There is no evidence that the relationship between the Trust
and Dodge is a partnership or joint venture. The deposition
testimony establishes that both parties to the lease intend a
landlord-tenant relationship. Dodge makes the farming
decisions. Dodge and Mealiff are billed separately
for the shared expenses and never have assumed one another's
debts. The government has adduced no evidence that Dodge and
the Trust have held themselves out as partners or have assumed
the debts of each other. Although the government contends that
decisions made by mutual agreement between Dodge and the farm
manager evidence a partnership or joint venture instead of a
landlord-tenant relationship, there is nothing unusual about
an owner employing farm managers to supervise and protect the
owners interest. See Affidavit of C. Allen Bock.
The parties to the lease do not share in each other's
profits or losses and consider their relationship to be
landlord/tenant. There are no indications to the contrary. The
crop-share agreement generates true rents that qualify as an
exclusion under § 512(b)(3)(A)(i).
B. Crop share rents: receipts or profits?
In the alternative, the government claims that rent from the
crop-share agreement is based on a percentage of income or
profits and therefore not exempt from the UBIT under §
512(b)(3)(B)(ii). The Trust asserts that rent in the form of
crops is more analogous to receipts or sales within the
parenthetical exclusion of that same Code section. The court
agrees with the plaintiff. Although neither categorization is
perfect in this situation, the language of 512(b)(3)(B)(ii),
its legislative history and the few cases that have addressed
this issue indicate that rent under a crop-share agreement
should fall within the purview of the parenthetical exclusion
of § 512(b)(3)(B)(ii).*fn3
Before 1950, tax-exempt organizations were not subject to
unrelated business income taxes. In 1950, Congress imposed the
UBIT on certain exempt organizations but excluded "all rents
from real property (including personal property leased with
the real property), and all deductions directly connected with
such rents." 26 U.S.C. § 512(b)(3) (1954).
This broad exclusion lead to abuses. In 1969, Congress
responded to the inequity of taxing some exempt organizations
and not others and to cases such as University Hill,*fn4 by
extending the UBIT in 1969 to all exempt organizations and
through enactment of the current modifications in § 512(b)(3).
H.R.Rep. No. 91-413, 91st Cong., 1st Sess. (1969) U.S. Code
Cong. & Admin. News pp. 1645, 1692. The House Report intended
investment income such as "dividends, interest, annuities,
royalties, and most passive rental income [to be] free of the
unrelated business income tax." Id. The House Report on the
1969 amendment emphasized the damaging consequences "feeder
organizations" had on tax revenue and sought to eliminate the
unfair business competitive advantage some businesses enjoyed
by paying "rent" to a tax-exempt organization which in reality
funnelled money from the taxable entity to the exempt one. Id.
The Senate report incorporated the concept of "passive"
rentals but differentiated taxable rent that is measured by
the property's net income from excludable rent based on a
percentage of gross receipts. S.Rep. No. 91-552, 91st Cong.,
1st Sess. (1969) U.S. Code Cong. & Admin. News p. 2067.
Congress wanted to tax property rentals that are "measured by
reference to the net income from the property." Id.
Whether a particular item of income falls within any of the
modifications provided in § 512(b) is determined by all the
facts and circumstances of each case. 26 C.F.R. 1.512(b)-1.
Nowhere in the Code or Regulations is "rent" defined. United
States v. Myra Foundation, 382 F.2d 107, 109 (8th Cir. 1967).
Illinois, however, recognizes that rent may be paid as a
portion of the crops. Alwood, 21 Ill. at 201 (1859).
While the Code generally excludes "all rents from real
property" from the UBIT, it does not distinguish between
commercial and agricultural rental property.
The government contends that because net income for the Trust
and farmer may vary depending on crop yield, a rent based on
50% of production is income or profits. Yet, it is entirely
conceivable that the Trust may have a net loss from the farm
one year and Dodge will have net income for the same year, or
vice versa. Although the regulations do not contain an
illustration of unrelated business taxable income on point, the
regulations that correlate to § 512(b)(3)(B)(ii) are entitled
"Net profits," an indication that the Code is concerned with
rents calculated as a percentage of income after expenses are
deducted. See 26 C.F.R. 1.512(b)-1(c)(2)(iii)(b).
Under the lease, the Trust and Dodge each receive 50% of the
crop production as it is weighed and divided at the grain
elevator scales. While the yield may vary from year to year,
the amount each takes (50%) does not. The grain is apportioned
50-50 without regard to the Trust's or farmer's expenses. Each
entity sells its half of the grain independently and one does
not know what price the other receives for the grain. The
Trust and farmer have independent expenses and overhead that
determine whether each will make a profit or suffer a loss.
The crop-share agreement provides for pre-expense division of
crops and is akin to rent based on a percentage of
gross income, and more analogous to sales or receipts than to
net income or profits.
Only three cases have been cited related to the issue of
whether rent from a crop-share agreement constitutes unrelated
business taxable income for a tax-exempt organization.
State Nat'l Bank of El Paso v. United States, 509 F.2d 832 (5th
Cir. 1975); United States v. Myra Foundation, 382 F.2d 107 (8th
Cir. 1967); Independent Order of Odd Fellows Grand Lodge of
Iowa v. United States, No. 90-552-A, 1991 WL 487240, 1991 U.S.
Dist. LEXIS 14958 (S.D. Iowa Sept. 27, 1991).
The government contends the 50-50 split of the cost of seed,
fertilizer, herbicides and drying is evidence that the Trust
is involved in the "risks" of the farming business. The court
in Myra was presented with and decided that issue.*fn5 It
addressed whether splitting costs negated the taxpayer's
assertion of a landlord-tenant relationship and found
[Cost sharing] arrangements are not uncommon in
share farm leases. Modern agricultural technology
establishes that the use of improved seed,
fertilizer and weed spray will under ordinary
conditions materially increase the yield and thus
increase the net return of both landlord and
tenant substantially more than the amount
invested by each in such items. There is nothing
unusual about providing in leases for the
division of the cost of such items which increase
the return of both the landlord and the tenant.
Myra, 382 F.2d at 111.
The plaintiff has submitted affidavits from C. Allen Bock,
professor of Agricultural Law at the University of Illinois,
that state that the terms and conditions of the lease are
standard for crop-share leases in central Illinois and that
95% of the crop-share leases provide for 50-50 split of the
seed, fertilizer, herbicides and drying expenses.
The government has not supplied any counter-affidavits or
evidence and, as the court in Myra noted, it would be against
public policy to require a landlord to withhold application of
technological advances and watch the fertility and value of the
Undoubtedly, if the farm were leased to Dodge on a cash-rent
basis, the rent would be excludable under § 512(b)(3)(A). It
seems anomalous that identical activities undertaken on a
crop-share lease should be taxable. Given the long history of
crop-share leases in Illinois and without a clear directive
from Congress to the contrary, the court rules that division of
the crops under the crop-share lease is a receipt and not a
To prevail on a motion for summary judgment, the moving
party must demonstrate that there is no genuine issue as to
any material fact and that it is entitled to judgment as a
matter of law. Fed.R.Civ.P. 56(c); Celotex Corp. v. Catrett,
477 U.S. 317, 322, 106 S.Ct. 2548, 2552, 91 L.Ed.2d 265 (1986);
Herman v. National Broadcasting Co., Inc., 744 F.2d 604, 607
(7th Cir. 1984), cert. denied, 470 U.S. 1028, 105 S.Ct. 1393,
84 L.Ed.2d 782 (1985). In reviewing the motion, the court must
view all evidence in the light most favorable to the non-moving
party. Black v. Henry Pratt Co., 778 F.2d 1278, 1281 (7th
Cir. 1985). However, the court will enter summary judgment if
the non-moving party "fails to make a showing sufficient to
establish the existence of an element essential to that party's
case, and on which that party will bear the burden of proof at
trial." Celotex, 477 U.S. at 322, 106 S.Ct. at 2552. There is
no genuine issue for trial when the record taken as a whole
could not lead a rational jury to find for the non-moving
party. Mechnig v. Sears, Roebuck & Co., 864 F.2d 1359 (7th Cir.
The dichotomy of "receipts or sales" or "income or profits"
in § 512(b)(3) is imperfect in this situation; however, the
court is convinced that the parties intended to and did create
a landlord-tenant relationship under the lease. The rent paid
in the form of 50% of the crop yield is true rent and
excludable under § 512(b)(3)(A)(i). Additionally, it is rent
based on a fixed percentage that is established before either
party considers its independent operating expenses. Under all
the circumstances of this case, the court finds that the rent
paid in the form of crops are more analogous to receipts than
income or profits and are within the parenthetical exclusion of
Based on the language in § 512(b)(3), treasury regulations,
case law, the nature of the crop-share arrangements and the
relationship between the Trust and the farmer, the court
concludes the rents from the farm operation are true rents that
are based on a fixed percentage of receipts from the farm
production. The rental income from the farm operation falls
within the modifications of § 512(b)(3)(A)(i) and §
512(b)(3)(B)(ii) and is exempt under § 511(a)(1). Summary
judgment is granted in favor of the plaintiff and against the
IT IS THEREFORE ORDERED that plaintiff's motion for summary
judgment (docket # 6) is allowed and defendant's motion for
summary judgment (docket # 10) is denied. The clerk is
directed to enter judgment in favor of the plaintiff and
against the defendant. Each party shall bear its own costs.