Family farms, particularly in the Southeastern and Midwestern United States, are often maintained for generations. In many cases, these are one of or the dominant asset in the family. Family-owned farms and associated timberland are also a tradition for many private investors, which can be used for both commercial and recreational purposes.
As the number of heirs grows and family dynamics change, however, farm succession planning can be an extremely challenging task. There is no cookie cutter approach for estate planning, particularly for farms and farm assets, and typically farm transitions are a lengthy and complicated process. The over-arching goal is to avoid breaking up the farm upon the death of the older generation in order to pay estate taxes. Below is a brief list of key issues to consider in order to successfully transfer farm businesses, farmland and timberland interests with the goal of keeping these generational assets within the family.
Heirs, Taxes and Family Dynamics
The timeline of farm transfer should be driven by the scope of the farm, the type of farm assets such as land, timber, equipment and livestock, and the personal goals of the each generation, including parity for non-farming heirs. Large-scale family farmland succession involves legal, business and tax issues, as well as personal issues such as death, control and money, all of which should be treated with care. Some farm and timber heirs are land rich and cash poor, making the estate tax settlement particularly challenging. The use of lifetime financial transfers, such as taxable unified credit gifts and annual exclusion gifts, as well as life insurance proceeds on the older generation, are also part of a well-rounded estate plan.
Non-farming heirs may elect to be bought out in a manner that doesn’t break up the farm. One option is to establish a ‘rent’ to be paid to them over time. Additionally, non-farming heirs that maintain their ownership interest can establish a salary to the heir who is managing the farm.
Business Entity Transfer
Transferring the farm or timber business typically precedes transfer of the actual farmland or timberland, and restating the partnership agreement or operating agreement is likely the first thing to be addressed. Primary issues are management rights and income rights. To smooth out transfer of business interests from one generation to the next, a suitable business entity must be determined. Certain legal structures, such as LLCs, partnerships and corporations, allow easy valuation, ownership record-keeping and book-keeping to facilitate gradual transfers by use of units or shares. Trusts are also commonly used to prevent any heirs’ potential creditors and divorce, among other reasons, from putting in jeopardy the ownership of the farm. Conservation Easement sales or donations on farmland, timberland and/or wetlands can also generate cash to facilitate the family’s estate plan, as these ‘qualified’ sales/donations entitle the owner to a number of worthwhile tax benefits.
Farmland/Timberland Transfer – Discounted Sales
As mentioned earlier, lifetime financial transfers are important for farm estate planning, particularly in certain ownership structures where discounted valuations of 20%-40% due to a minority interest and lack of marketability assist in the process.
Farmland & Timberland as Alternative Investments
These types of assets are viewed as low-correlating diversifiers to traditional stocks and bonds, as well as to commodities, hedge funds and private equity, and serve numerous purposes as alternative investments. Agricultural and timberland are traditionally seen as inflation hedges through capital appreciation, and may also have the added benefit of income generation. Furthermore, farmland has traditionally been a strong investment as suburban development takes more and more cropland and timberland acreage out of commission despite rising global food demand.