Farm Horizons, Aug. 2015
Are you ready to transfer the farm?
By Myron Oftedahl
This will be a continuation of last issue’s article concerning farm transfer and estate planning. It is a big subject with a lot of pieces and needs to be dealt with carefully.
The first question that you will need to consider is if there is a family member interested in the farming operation.
This could be son/daughter or grandchild or whomever, if there is an interested party in resuming the farm operation that will guide your planning in the direction of passing assets to that farming heir. If your children have no interest in the farm operation, then we need to consider things differently.
Before we go further, we need to separate farm transition or succession from estate planning.
Farm succession is a process of beginning to transfer assets while you are still alive and actively involved in the farming operation. Typically this would be transferring ownership of machinery over a period of years, dividing job responsibilities between yourself and the farming heir and mentoring the farming heir to take over the management responsibilities. There are some options as to how to accomplish this transfer of intermediate assets. We will explore that later.
Farm estate planning is for the transfer of assets after your death. Some of you are hoping to die on the farm, but we still need to do some planning. If we have no plan and no will, then the State of Minnesota has a plan for your estate. So you make the choice.
Often we work on them together, but I am becoming convinced that we are dealing with two separate topics and that we need to treat them separately. In saying this, I do recognize that transition planning and estate planning do have some connections but I believe that we need to decide the possibility of transition first and then create the estate plan accordingly.
Assuming that we have a farming heir, we need to mentor that person and give them responsibilities. One way to do this is to make a list of everything that needs to get done on the farm from operating a tractor, to picking rocks, to maintaining equipment, keeping records, selecting crop inputs, borrowing money, etc.
Take the next couple of mornings at breakfast and make a list of every job on the farm, now go through that list and write down which farm employee does that job the best.
Farm employee includes you, your spouse, your children, the hired man, anyone who does work on the farm. Does that person have full responsibility for that job? Or do they need your okay before continuing? Can you give them full responsibility? Are they approved to make a decision and spend money? Do they have a dollar limit? Is that person part of the management team or are they hired labor? I know of one family where the boys never planted until Dad died. Talk about a learning curve.
How can we transfer assets to the farming heir? One possibility is to transfer ownership when the farm is replacing machinery. Say that you are replacing a tractor, you would trade in the current tractor that you own and the farming heir would purchase the replacement tractor and begin to have equity in the farming operation.
So basically you are gifting the old tractor to the farming heir. Now you need to ensure that the heir has enough farm income to make the loan payments on that tractor. If the farm continues to make the payments, did we really transfer assets?
Another way to accomplish this transfer is to create a separate entity for the farming operation. This could be a simple partnership, an LLC, or one of the corporations.
In this case the entity will own all of the machinery, livestock, and grain inventories of the farming operation. Now we can simply transfer a percentage of ownership each year to the farming heir. We can also allow them to purchase additional shares if they wish. Sometimes this is an easier way to transfer machinery because we can transfer the same amount each year instead of trying to spread out the replacement of machinery.
Now let’s look at transferring the land. For now, let’s ignore the estate tax exemptions and look at this straight on.
My preference is to transfer the land through the estate, because now we get the stepped up basis on the value of the land. This is not an issue if the land continues in the farm operation and never gets sold, but if it should get sold, then capital gains is calculated on the difference between the sale price and the basis.
An example of this is that you paid $500 an acre for the farm, added $700 worth of tile and improvements per acre, your basis is $1,200 per acre. If you gift the land, then the basis continues to be $1,200 per acre. If it passes through your estate, then the basis becomes whatever the current land value is, so currently we could assign a basis of $6,000 per acre to land going through the estate.
This is simple if you have one child who also happens to be involved in the farming operation. What do you do if there is more than one child? If there are other non-farming assets that could go to the non-farming children, then you can pass those on to those children and the land to the farming heir. You are saying, that that is really not fair to the other kids.
Another option would be to transfer the land into an LLC. The farm pays rent to the LLC, the LLC pays the mortgage, the real estate taxes, and the insurance. Any money left, would then get divided between the children at the end of each year. One of the stipulations of the LLC would be to set the rental rate. The proceeds would be paid out according to the percentage of ownership. This can be done prior to the estate so that the farming parents have an income source for retirement.
I have given you some ideas. Now it is up to you to get some work done and develop a plan. You need a transition plan if you have a farming heir, you need an estate plan that includes a will, a power of attorney, and a health care directive. All of this requires time and will not get done overnight, but you need to make a commitment to spend a part of a day each week and month to work on this. You owe it to yourself and to your children.
The best legacy that you can give your children is a well thought out, written legal estate plan.
If you need help through this process contact any farm management instructor or others who specialize in farm transitions and estate planning.