Recent legislation introduced in both houses of Congress―the Enhancing Credit Opportunities in Rural America Act―would amend the Internal Revenue Code to exclude from the federal taxable income of FDIC-insured banks and savings associations the net interest income they earn on their agricultural real estate loans. Net interest income would be the interest income collected on agricultural real estate loans minus the interest cost incurred in funding those loans.
This tax exemption would apply to any loan secured by agricultural real estate or by a leasehold mortgage that has the status of a lien on agricultural real estate. Agricultural real estate is defined as “real property which is substantially used for the production of one or more agricultural products.” Presumably, the mortgage and therefore the tax exemption would extend to all permanent improvements on the agricultural land, including barns, other structures and machinery permanently installed in buildings or elsewhere on the property.
Most importantly, this exemption also would apply to single-family rural residences that are the principal residence of the owner/borrower, regardless of whether they are a farmer, rancher or otherwise involved in agriculture. The residence must be located in a rural area as determined by the Secretary of Agriculture, with a population of 2,500 or less, and not located within a metropolitan statistical area. This aspect of ECORA will help families to purchase a home in a rural area at a time when COVID-19 is encouraging many families to consider relocating away from densely populated urban areas.
How much a bank will lower its interest rate on rural real estate loans if ECORA becomes law will depend on factors such as the degree of competition among lenders in the bank’s market area, the cost of funds the bank has to attribute to its ag real estate loans, loan terms and the bank’s effective tax rate. A rate reduction of 50 basis points or possibly much more is quite likely. However much that rate reduction is, it will provide an important financial benefit to America’s farmers, ranchers and other rural residents at a time when American agriculture is enduring extremely stressful conditions.
Lower rates on their ag real estate loans will enable banks to compete more effectively against FCS lenders and will force FCS lenders to charge lower rates on their ag real estate loans to remain competitive. The profits FCS lenders earn on real estate loans always have been exempt from federal and state income taxation so even after charging lower rates FCS lenders will still enjoy substantial profitability on their ag real estate lending. Farmers, ranchers and rural homeowners will benefit greatly from the lower rates FCS lenders will be forced to charge.