Farm Estate Planning

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Did you know that now is the best time to make your farm estate plan because of the up and coming estate tax change?

This article is for anyone who owns a farm or ranch or is part of an agriculture business family. We’re going to demystify farm estate planning and show you that it’s not complicated and demonstrate why you need to take action and make your plan now - or after you finish reading this, that works too.

Buckle up, here we go.

The U.S. Department of Agriculture National Agricultural Statistics Service (NASS) reports that family-owned farms account for 97 percent of the 2.1 million farms in the U.S. Yet only 30% of these farms survive into the second generation, and only 12% are still operating by the third.

69% of the family farms surveyed expected ownership to continue into the next generation, but only 23% had a plan.

Farm Estate Planning - Why are Survival Rates for Farms so Low?

The primary reason farms don’t survive is because they don’t have a survival plan. Call it a financial plan or an estate plan, whichever term you prefer, the reality is over 75% of farms don’t have a plan, and the results of not having a succession plan usually ends in disaster.

If you think this information is here to scare you and get your attention, you’re right. Losing a multi-generational farm or ranch operation because of poor planning happens more than you’d like to imagine. It’s devastating to everyone involved to see decades of progress come to an unwanted end - especially when it could have been prevented.

The good news is, it doesn’t take much to make a solid plan that will ensure the farm’s safe transfer to the next generation. Additionally, a good farm estate plan can reduce and eliminate conflict within farm families. A plan addresses unspoken promises and uncertainty among farm family members by shining a light of clarity on the present and future. A good plan can heal relationship strains and get a lagging operation re-focused on what’s important.

Financial Planning for Farmers and Ranchers

You don’t know what you don’t know.

I don’t know how to run your farm operation efficiently. That’s not a surprise. And likewise, chances are you probably don’t know everything I know about farm estate planning.

Most of the farmers and ranchers I talk to realize that some planning needs to be done, but what the planning should look like, and the resources needed to get it done remains a mystery for most.

In the past, as recent as one generation ago, a farm succession was much easier, and many got away with little to no planning. Today, because of tax and regulation changes over the years, a farm succession with no planning can be costly to the point of making it impossible for most owners.

If you’re a farmer or rancher you’ve probably heard the expression that farmers are asset rich and cash poor. It’s true for many, and it isn’t a big deal - until you have a massive tax estate bill to pay during a farm transfer. Again, the good news is, a plan can mitigate the impact of transfer taxes and even help you become not only asset rich, but cash-rich too.

What is Farm Succession Planning?

At this point, you’re probably ready for some details. So let’s get into it. Like any subject, the best way to understand it is to break it down into its parts and steps.

Farm succession planning covers two things.

1. Transferring assets.
2. Transferring operations.

The farmland and the business are two different things. However, they both need to be addressed in coordination. The plan should work in harmony with both aspects, but different strategies will go into each area, and the specifics will depend totally on your situation.

Steps to Farm Succession Planning

Start with the end in mind...

The first step is to sit down with an experienced farm estate planner and have a discovery meeting. The planner will learn about what’s important to you. They’ll learn about who is involved in the operation, your family, and what’s involved in terms of assets, income, the land, and the business.

After learning about your long term goals and objectives the planner shows you how your current condition coordinates with your future vision. Most of the time there will be some big gaps between the way things are now and how they ought to be if you want your objectives and desires to be carried out. That’s normal though, and addressing it today, ultimately gets you to where you want to be.

Farm Transition Planning

If you’ve discovered that you want a legacy farm, (something that will stay in the family for multiple generations) your planning strategy will be different than if you plan to sell the farm at retirement.

If you’re planning on selling, you’ll want to maximize the value of the farm operation to get top dollar when you sell. If you’re transitioning the farm to a family member you’ll want to minimize the value so you can transfer the most assets with the least amount of tax.

Farm Succession Planning Resources

There are a lot of resources and case studies available to give you a sense of what succession planning can look like.

California Farm Link and the University of California Cooperative Extension have created a free Farm Succession Guide Book to help farm and ranch owners better understand all the details they need to know to get started.

How to Pass on the Family Farm

If you have made the decision to pass on the family farm to the next generation the process is something that plays out over many years. The inheriting generation needs to establish a firm financial footing and know how to effectively manage the business. The retiring generation needs to be prepared and willing to turn over control of the business and trust the successors will do well.

Factors to Consider Before Transferring the Farm Business

• Your financial security and retirement
• The financial position of the entering generation
• Your Social Security status
• Your Emotional readiness to transition the farm
• Your health

Key Questions to Ask Yourself Before Transferring the Farm

• Is the farm generating enough income to support an additional family?
• Are there farm income expansion possibilities?
• Is there a way to transfer the farm and keep everyone in the family happy? This includes exiting and entering families.
• Can you afford to give some financial assistance to the entering family?
• Are you willing to sell, lease, gift or otherwise transfer assets to the entering party at less than current market values?

How to Divide Family Farmland Equally

What is fair and equal are often not the same thing

The easiest way to have farmland divided is within an entity like an LLC. The farmland is divided into different categories like farmable land, timber, marshland pasture, etc. The LLC can define the farmland and assign ownership percentages to specific areas that make up the entire farm.

What is fair and equal are often not the same thing. One child may have earned equity through staying on the farm over the years and working. It would be better for the longevity and profitability of the farm for the experienced operator to take control of the productive side of the farmland which maybe 50% in total. While other family members who have not had an active role may split up the remaining unproductive farmland.

Dividing farmland among heirs is subjective to a degree, but there are tools that can create documents that quantify the farmland and the role family members have played in creating and maintaining the value. Defining these areas within a farm and how the family members play a role today, is the best way to avoid future conflict.

What is a Farm Trust?

A farm trust is just another way to describe what the trust is related to. At the end of the day there are no farm trusts, but only trusts. With that said, a trust is a way to hold, manage, and distribute property. It’s like a custom-designed bucket that holds and takes care of your assets during life and then distributes them after death.

Trusts are often used as a primary component of estate planning strategy. Trusts have four basic elements:

1. Trust Property (farmland, farm business, or cash)
2. Trustee (farmer or a trusted representative)
3. Beneficiaries (children, business partners, or others)
4. Instructions for how the trust should be used and/or distributed

Types of Trusts

• Revocable Living Trust - Can be used during life and at the death of the farmer. It allows management of the farm in case of disability or incapacity. It can also allow an opportunity for a farming heir to buy into the business. It’s flexible, and can be amended before the farmer’s death.
• Irrevocable Living Trust - Can be used during the farmer’s life. It cannot be changed and assets cannot be reclaimed.
• Testamentary Trust - Becomes effective at the farmer’s death, and is most often created by a will. It’s used to minimize estate taxes and protect assets.

Revocable Living Trusts for Farm Transfer

Different trusts have different pros and cons, but in general, revocable living trusts can be useful as a primary tool for farm transfer. Farmers who use RLTs place their property into a trust “bucket” by formally transferring the title of their property into the RLT.

The farmer will still own the assets, but owns them through the trust instead of directly as an individual. While in the trust, the farm assets can be managed and transferred by the farmer.

• More Control over Distribution
  One of the big advantages of using an RLT is it can include provisions allowing junior farmers to progressively buy into the business by incorporating purchase agreements and other provisions into a trust document. Spreading out payments over time allows the next generation that might not have sufficient capital to buy in on terms they can afford while allowing the farmer a secure exit.
• Avoid Probate
  RLTs can also act as the primary estate planning tool, which allows the estate to avoid the probate process. This saves on expenses, delays, and makes for a smoother transition after death.

Does a Family Trust Protect Assets from Lawsuit?

A simple probate-avoidance trust can’t shield assets from creditors and lawsuits, however, there are trust structures devoted to asset protection. If you put your assets into an irrevocable trust - one you don’t control and can’t revoke - then the assets aren’t considered yours anymore and aren’t available to creditors or anyone suing you.

What Assets are Protected from a Lawsuit?

Some assets are exempt from both lawsuit judgments and creditor claims. These assets cannot be touched, and you will not lose them. Some exempt assets include ERISA qualified retirement plans and homesteaded property.

A homestead exemption helps shield a home from litigation following the death of a homeowner spouse or bankruptcy. The homestead tax exemption can also provide surviving spouses with ongoing property-tax relief.

What You Should Know About Farm Taxes

The most common questions farmers and ranchers have around farm estate planning revolve around taxes. Farmland owners need clarity about inheritance taxes, farmland gifting, capital gains taxes, tax incentives, and best practices to minimize tax burdens.

Although the topic of farm taxes may seem complicated at first, getting an understanding of terminology and your options will help you structure your farm estate in a way to minimize your tax burden while staying in compliance with the law.

Do You Have to Pay Inheritance Tax on Agricultural Land?

The short answer here is yes. However, there are ways to mitigate inheritance tax. At the time of death, the estate tax should be paid within 9 months. If your farm successors are faced with a one million dollar tax bill that could spell disaster, especially because all the farm’s value is typically stored in assets.

The good news is working with a financial advisor and proactively planning for the future, you can dramatically reduce or eliminate inheritance tax on agricultural land.

What is the Federal Estate Tax?

Also known as the “Death Tax,” the federal estate tax is a tax on your right to transfer property at your death. The total current value of all assets is called your “gross estate.” The property may consist of cash and securities, real estate, insurance, trusts, annuities, business interests, and other assets.

Deductions when determining your “taxable estate” include mortgages and other debts, estate administration expenses, property passing to surviving spouses, and qualified charities. The value of some operating business interests or farms may be reduced for qualifying estates.

After a net amount is determined, the value of lifetime taxable gifts is added and the final tax is calculated.

How Do Farmers Avoid Inheritance Tax?

The Trump administration has doubled the estate-tax exemption to $22 million per couple. These numbers are only good for the next five years though, so now is the time to take advantage. The numbers will likely be reduced by half after 2025.

What this means is that you can gift up to $11 million per individual or $22 million per couple 100% tax-free. This is a massive opportunity for farm and ranch operations to avoid the often costly inheritance tax that comes with transitioning an operation within the family.

What is the 7-year rule in inheritance tax?

Some gifts are not exempt from inheritance tax nor immediately chargeable. They are potentially chargeable if the donor (the person making the gift) dies within seven years from the date of the gift. If the donor survives seven years from the date of the gift, then no inheritance tax will be paid.

If the donor dies within seven years of issuing the gift, the value of the gift will be offset against any of your tax-free allowances. If the gift exceeds the tax-free allowance, inheritance tax is payable at a rate that depends on the amount of time that elapsed since the date of the gift.

Are Farmers Tax-Exempt?

It depends on the area of taxation. Farmers pay income tax and property taxes, but farmers can get a tax-exemption for sales tax on qualified farm-related purchases.

• Seeds and Plants - the sale of seeds and plants are exempt from sales tax.
• Fertilizers - the sale of certain fertilizers is exempt from sales tax. Packaged soil amendments like hay, peat moss, and straw do not qualify.
• Farm Equipment and Machinery - as a general rule, the sale of farm equipment and machinery is taxable. However, the purchase of certain farm equipment and machinery is partially exempt from sales tax. Currently, the partial exemption is at 5%.

Tax Breaks for Farmers

There are a number of special tax code provisions related to farming that you should be taking advantage of if you qualify. Here are just a few you should be considering every year.

• Depreciation Deductions - farmers can take advantage of write-offs for property placed in service. A farmer can claim a maximum expensing deduction of $510,000 under Section 179.
• Crop Insurance Proceeds - purchased to protect against losses caused by natural disasters - such as hail, drought, and floods - or lost revenue due to declines in agricultural commodity prices.
• Sales Due to Weather - If a farmer sells more livestock and poultry than would normally occur in a year because of weather conditions, the business is granted a reprieve. It can postpone reporting the gain from sales due to weather until the following year.
• Net Operating Losses - if the deductions claimed by a farm operation exceed its profits, it may report a net operating loss (NOL). The NOL can be carried back for two years and then forward for up to 20 years to offset income in other years.
• Fuel and Road Use - Farm operators can claim a credit or refund of federal excise taxes on fuel used on farm for farming purposes.

Tips for Selling A Farm

If you’re reaching the end of your farming career and have chosen not to pass it on to the next generation you’re probably thinking about selling. Whether you’re trying to sell it independently or are using a real estate professional specialized in farmland there are some things you should keep in mind.

Gathering Information helps make Informed Decisions

The most important information to have clarity on is ownership. Who is listed on the deed as the owner? Can you legally sell the property? This one seems obvious, but often heirs try to sell land and the deed filed at the courthouse shows the parents as the owners. Typically, this can be easily corrected with some legal assistance.

Discuss the Sale with a CPA

A CPA will be able to help you understand the tax implications of the sale. At times, some individuals choose to exchange one property for another and are able to avoid capital gains taxes from a sale. This is called a 1031 exchange.

Know Recent Comparable Sale Prices

A farmland real estate professional can help you set a fair market asking price. Use an accredited rural appraiser through the American Society of Farm Managers and Rural Appraisers (ASFMRA) to get started.

Understand the Farm’s Characteristics

It’s important to know the total acres, cultivatable acres, timber acres, pasture acres, pond sizes, etc. Irrigation is another factor. Potential buyers may want to know when a well was installed, depth, pump size, casing size, and capacity.

Other Important Farm Sale Factors

Include the farm’s yield history, environmental factors, drainage, potential property uses, restrictions to use, recreational uses, mineral rights, air rights, easements, property taxes, and improvements made over the years. The more thorough you are, the better.

Conclusion and Takeaways

If you made it this far you’re probably seriously considering taking advantage of all the current advantages available with farm estate planning. Even if the conditions were not as favorable as they are with the generous tax exemption increase, farm estate planning is always desirable.

A quick recap….

Farm Estate Planning:

• Provides for your family after you die.
• Minimizes your expenses.
• Protects your farm and family from litigation and creditors.
• Gets your property to loved ones quickly.
• Saves your family from difficult decisions and conflict.
• Reduces your tax burden.
• Makes retirement easier.
• Protects your farm’s legacy.