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LUTZ BUSINESS INSIGHTS
farm succession planning + where to start?
curtis thompson, tax director
Farm succession planning can be intimidating but knowing what areas to focus on will help ease the process. Keep in mind there is no one-size-fits-all plan, and it will evolve over time. Multiple factors will determine how your succession plan will look.
Building a team to help you with succession planning is essential. This team should include your attorney, tax professional, financial advisor, and insurance agent at minimum. Open communication between your team and your heirs is a must to make the plan successful. Here are a few areas to consider when thinking about your succession plan.
When starting to look at transitioning the farm’s operations, there are multiple things to consider. Equipment is usually one of the first steps to think through. There are several ways to accomplish a successful transition of equipment.
The first option is an outright purchase of the equipment either on an installment sale or a lump sum.
The second option would be as the equipment is traded, the successor would pay the boot or trade difference. With this option, the successor could own the new piece of equipment outright by buying out the original piece of equipment, or the new piece of equipment could be partially owned by each based upon trade value and the amount of boot paid.
The third option would be to have the successor lease the equipment. The lease could include a buy-out at the end.
The fourth and final option would be to gift the equipment to the successor.
Each option has its own tax implications, so please consult with your tax professional before deciding which would be best for your operation.
2. Real Estate
The biggest asset on the majority of a farm operation’s balance sheet is real estate. When looking at how to transition the real estate to the next generation, there needs to be careful consideration as to on-farm and off-farm heirs. There are a few options to consider when transitioning real estate.
The first option is the parcel approach. With this approach, each heir would get their own parcel of land to do with what they want. This option can lead to heartache in a few ways. The first way is no two parcels of land are “equal,” and one heir may feel slighted that they received the lesser quality parcel of land.
This approach also puts the on-farm heir in a tough spot. The off-farm heir(s) could lease or sell their parcel(s), thus potentially putting the on-farm heir in a position that they must purchase that parcel or lose acres in their farming operation.
The second option is the equal share approach. In this approach, the land is usually deeded into an LLC while the first generation is alive. If the first generation is still operating the farm, they pay the LLC rent for the real estate, or the next generation would pay the LLC rent if they have taken over the operations.
Once the first generation passes, the second generation would inherit the LLC equally based on the number of heirs. There are several advantages to this approach. The first advantage is for estate tax purposes. Since the real estate is held in an LLC, the potential for discounting the value of that LLC is possible. This approach is also advantageous if one of the goals of the succession plan is to protect the on-farm heir. The LLC can be structured to keep the real estate intact.
The third option is the asset swap approach. This approach works if you have enough non-farm assets to give to the off-farm heir(s). Those assets could consist of rental properties, cash, life insurance, retirement accounts, etc. The on-farm heir(s) would receive the farm real estate, and the off-farm heir(s) would receive the other assets from the estate. This approach is usually coupled with one of the other approaches to get the on-farm heir more of the real estate if transitioning all of it is not feasible.
The fourth option is the gifting approach. This approach is reserved for two scenarios. The first scenario is if there are potential estate tax issues. At the time of this blog, there is discussion of significantly decreasing the estate exemption. If your estate is in danger of being subject to estate taxes, then gifting should be considered.
The other scenario where gifting makes sense is if the gift is to the on-farm heir and the first generation does not need that cash flow in retirement. Once that real estate is gifted, the rights to the income off that real estate are relinquished.
3. Cash Flow & Timeframe
When transitioning the farm’s operations, cash flow and timeframe are the two most important factors. A 100% transition in a one-year period is extremely challenging for both the successor and the predecessor. The successor now has all the risk, capital demands for equipment and real estate rent.
The predecessor will most likely have a large tax consequence due to the carry-over grain or livestock sold with minimal expenses against that income. The gradual transition of the farm is beneficial for both parties. It eases the capital demand for the successor and lessens the tax burden for the predecessor.
When the next generation takes over, they will be leasing/purchasing the equipment and renting the real estate. This becomes a balancing act as the predecessor determines what they need in retirement for cash flow and what the successor can afford to pay. This is the point where your succession planning team becomes beneficial to make sure everyone can accomplish their goals without putting strain on the other party.
There are many other aspects to a successful succession plan, but these are a few areas to consider when starting. If you have questions or want more information, please contact us.
ABOUT THE AUTHOR
747 N BURLINGTON AVE
PO BOX 1317
HASTINGS, NE 68902
CURTIS THOMPSON + TAX DIRECTOR
Curtis Thompson is a Tax Director at Lutz with over seven years of experience in public accounting. His experience includes tax planning, consulting and compliance for individuals and closely-held businesses with a focus in the agriculture industry.
AFFILIATIONS AND CREDENTIALS
- Amerian Institute of Certified Public Accountants, Member
- Nebraska Society of Certified Public Accountants, Member
- Certified Public Accountant
- BSBA, Peru State College, Peru, NE
- Hastings Give Day, Volunteer
- Our Lady of Assumption Catholic Church, Member
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