A significant percentage of farm and ranch families desire to keep the family farming or ranching activity in the family for future generations. Certainly, for some, that option is not possible as there is no heir interested in continuing the farming/ranching activity into the future. But, for those families interested in maintaining a viable business throughout subsequent generations of the family what considerations should be made concerning how to accomplish that objective?
Obviously, tax issues play a major role in transition planning, but other issues are also present. Some issues can be addressed with careful planning. Other issues require the proper family chemistry. All issues require an openness to discuss and a willingness to work out.
Land Values
Land is typically the biggest asset in terms of value in a farm or ranch estate. So, a successful transition of the farming/ranching business must address the transfer of land ownership. Historically, land values more than doubled from 2000 to 2010, and continued to increase post-2010. From 2009-2013, the overall increase in agricultural land values was 37 percent. In the corn belt, from 2006-2013, the average farm real estate value increased by 229.6 percent. For the next couple of years, farmland values remained steady, but farmland values dropped from 2016 to 2020 by 1.3 percent, on average. Farmland values remained high in 2020, averaging $3,160 per acre, a small decrease of 0.8 percent compared with 2019, and rose throughout 2021 and 2022. Now, USDA says that the value of all land and buildings on farms averaged $4,080 per acre for 2023, up $280 per acre (7.4 percent) from 2022. The United States cropland value averaged $5,460 per acre, an increase of $410 per acre (8.1 percent) from the previous year. The United States pasture value averaged $1,760 per acre, an increase of $110 per acre (6.7 percent) from 2022.
Using the USDA numbers, a 640-acre crop farming operation would have land valued at approximately $3.5 million. Add to that number amounts for machinery and equipment; implements; buildings; livestock and other inventory; a home and other personal assets; and investments—the average farming operation is likely worth more than $5 million.
The current level of the applicable exclusion for federal estate tax purposes is $12.92 million. If Congress does nothing with respect to the estate tax, that amount will adjust for inflation in 2024 and 2025. Then it will revert to $5 million in 2026 with an inflation adjustment that will likely peg it around $7-$7.5 million. So, the “average” farm doesn’t currently have an estate tax issue, but if land and other asset values continue to rise, many farms and ranches could have such a problem beginning in 2026. You might recall numerous Democrat proposals to decrease the exclusion amount in recent years to the $3.5 million to $5 million range. A $3.5 million exemption as applied to a farm with an estate tax value of $5 million would trigger an estate tax bill of approximately $300,000, assuming planning steps were taken to minimize the impact of the tax.
If the farming operation is located in a state that also imposes tax at death, there would be an additional layer of taxation. The states in the heartland of crop and livestock production do not impose taxes at death (with exceptions for Illinois and Minnesota), but if the farm is in, for example, Massachusetts, the exemption is only $1,000,000 and the top rate of tax is 16 percent. So, that $5 million “average” farm could anticipate a tax bill in the “ballpark” of $300,000, again assuming steps have been taken to minimize the impact of the state’s death-related tax.
This all means that rising land values pose a transition planning issue both with respect to the prospect of estate taxation and the ability of the next generation to gain an ownership interest in the family business.
Common Objectives of Succession Planning
Based on my experiences working with farm and ranch families over the past 31 years, I have noticed certain common objectives when transitioning a business to the next generation. These include making sure the next generation starts off in a good financial position and creating a plan for the older generation of owners and managers to retire in the way they want to enjoy their success after years of hard work. Also, for those families that have both on-farm and off-farm heirs, an important goal is to separate the ownership/control interest of the on-farm heir(s) from the income/investment interest of the off-farm heir(s). Of course, all of this is to be done while simultaneously minimizing the tax impact of property transfers.
Ways Children Become Involved in the Farming/Ranching Operation
There are numerous ways the next generation can come into an ownership position of the farming operation. One way involves the long-term acquisition of farm assets while at the same time supplementing farm income with off-farm income. Another way is for a child to establish their own small farm business and gradually acquire farm assets by way of renting and ownership. Unless a health-sharing arrangement is entered into, off-farm employment may be necessary (particularly for a non-farming spouse) for participation in an employer-sponsored health insurance plan.
Other approaches to the transition matter may involve a sharing of labor and capital, or the parents loaning machinery to a child so the child can rent or purchase some land in the neighborhood and start a farming business. It is not unusual to see some equipment purchased jointly with a portion being depreciated on each of the parent’s and child’s depreciation schedules. This seems to be a rather common arrangement and often works well. However, a concern is that if an accident should occur, the court may find the two individuals are in a partnership and experiencing joint and several liabilities.
If the parents are at or are nearing the point at which they’d like to step back from being the primary operations of the business, the renting and/or purchasing of assets from the parents may occur. Or, some sort of entity is created with the parents and the child(ren) being owners in certain capacities. Usually when this is the way a child gets started in the business, two or more business entities are formed. A partnership, corporation, or LLC, is formed for the operating business and the real estate and possibly other assets are not placed into the operating business but are instead rented from the parent. Over time the child may also acquire real estate outside the operational business and rent that real estate to the business as well.
Conclusion
The value of farming operations has, in general, increased in recent years. This makes the transition planning aspect of estate planning more important for farming and ranching operations that have at least one family heir who will be operating the business into the next generation. But, transition planning is multi-faceted and I have only begun to scratch the surface with some basic thoughts on the process. The “dirt is in the details” and the complexity is tied to the factual situation of each family and their goals and objectives.
Written by Roger A. McEowen. Originally published on Sunday, August 20, 2023.
