Estate Planning for Farmers
A Sound Transfer and Estate Plan
Preserving Your Farming Legacy
Farming has been the cornerstone of our country for hundreds of years. Although the percentage of the population engaged in farming has decreased dramatically since our country’s founding, there are still two million farms operating over 900 million acres of land in the United States1, 98% of which are family farms2, with six million people living in households attached to a farm.
As a farmer or farm owner, you may have a stronger emotional attachment to your business than other business owners. This is probably because the farm has been in your family for generations and is also the location of the family home. To ensure that this legacy and business is protected for future generations, it is crucial that you do the proper planning.
1. Understand Everyone’s Goals
The key to a smooth transition, regardless of when it happens, is to understand everyone’s goals. Because the family farm is such a large and complex asset, it is necessary for everyone to be prepared for this transition (whether it occurs at your retirement or death).
It is important that you take the opportunity to sit down and evaluate your own goals for the future and your goals for your family and the business. Because the farm may be a substantial or sole source of income, deciding to retire and hand over control may be financially (and emotionally) difficult. It signals a new chapter in your life, and you may be wondering how you are going to financially support this new chapter without the income from the farm. A well-thought-out transition plan can enable you to transition out of the business in the way you want.
Especially if the farm has been in your family for generations, it is probably important to you that the farm continues to be operated by future generations. To accomplish this goal, there are several issues you should consider: What if not all of my children want to participate in the farming operations? What if someone in the next generation already has or could have creditor or judgment issues? How do I protect the farm and provide for my family? With the proper planning, we can help you address these concerns and achieve your ultimate goals.
The concerns of family members that are in line to receive the ownership and control of the family farm are likely to differ from yours. By wanting to continue the farming operation, it is clear that they value the legacy of the farm and the history it represents to the family, but they may have different needs.
With a highly valued asset, such as a farm, the next generation will want to receive it in a way that minimizes or eliminates transfer taxes. The last thing your family wants is to have to sell the farm to pay the estate tax bill upon your death. As they take on a larger role on the farm, the next generation may want to have more decision-making authority and even partial ownership. By planning ahead, we can help structure a transition that allows for a smooth transfer of control.
1 “Farm Income and Financial Forecasts for 2019,” U.S. Department of Agriculture, webinar transcript, slide 2 accessed August 14, 2019, https://www.ers.usda.gov/media/10186/farm-income-webinar-march-2019-transcript.pdf.
2 “America’s Diverse Family Farms,” U.S. Department of Agriculture, (December 2018), p. 3, accessed August 12, 2019, https://www.ers.usda.gov/webdocs/publications/90985/eib-203.pdf?v=9520.4.
Estate Planning Areas
Make a Plan and Keep It Up to Date
Just like a productive farming operation, a well-prepared estate plan needs to utilize the right tools, such as a will, trust, and powers of attorney, to carry out your objectives.
A properly executed trust and financial power of attorney will help protect you and the business should you become incapacitated or otherwise unable to manage the farm. As with any business, when the key person becomes incapacitated, things can go off the rails if there is no one ready to step up and take charge. These documents appoint a person, ahead of time, to make decisions on your behalf, instead of waiting until you become incapacitated and making your family go to court to appoint someone.
Upon your death, a trust helps to ensure that what is passed to your surviving spouse or beneficiaries is protected from future creditors or judgments. It also allows the assets to be distributed according to the terms of the trust without interference by the probate court. Not only does this create a smoother and quicker transition in ownership, but it also maintains family privacy and reduces expenses.
IMPORTANT: You need to make sure that you work with an experienced estate planning attorney to ensure that any trust that is created and funded with farming assets is structured in a way that does not disqualify or reduce any governmental farming subsidies you could be receiving.
If you already have an estate plan in place, then it is a good idea to review your documents on a regular basis. In life, there are many personal and legal changes (births, deaths, marriages, divorces, illnesses, bankruptcies, lawsuits, etc.) that can occur. Having outdated documents can sometimes be worse than not having any documents at all.
WARNING: It may be tempting to title assets jointly with a family member or to execute a transfer-on-death deed to facilitate an “easy” estate plan. While these solutions will transfer the property to the survivor without much involvement by anyone else, these types of ownership are full of disastrous possibilities that could undo everything you have worked hard to build by subjecting the farm to the claims of the creditors of all the other owners, as well as yours.
Estate planning is just one prong in ensuring the survival of the family farm. It is important to make sure that the farming structure and operation is set up to accomplish the family’s objectives as well. The first step is to evaluate the current business structure being used for the family farm.
Most farming businesses, regardless of size, are held as sole proprietorships.1 It is likely you own the farming land and equipment in your own name (or jointly with a spouse) and possibly have mortgages or loans on these assets in your own name as well. Sole proprietorships are attractive because they do not require any filings, except for registering a trade name if you want to operate the business under a name other than your own. There are also no annual filing requirements or fees owed for this type of business structure. While a sole proprietorship is incredibly easy to form, since it happens by default, it also opens you up for unlimited liability since you and the family farm are considered to be the same legal entity. This means that your personal creditors could look to farm assets to recover judgments against you. It also makes transitioning the farming operation a lot more difficult should you become incapacitated or die.
Alternatively, a limited liability company (LLC) or a family limited partnership (FLP) can be formed to protect assets, reduce tax liability, and provide for an orderly transfer of control and ownership with minimal conflict between family members. Using these business entities, a management and decision-making structure can be established that will not only facilitate the current success of the farming business but also allow all the affected family members to feel assured that plans for the farm’s future operation will be implemented. A properly implemented decision-making structure can also provide continuity in operation should you become incapacitated and unable to participate in the farming activities. Tools such as a buy-sell agreement, management agreement, or employment agreements can be used to help facilitate this smooth transition. It is important to note that with either of these business structures, the proper business formalities must be followed, such as annual filings and payment of the required fees to the secretary of state, to maintain the liability shield around the family farm.
More than likely, the family farm is the largest asset you have. This can pose a challenge when funds are needed for your long-term care, providing an inheritance to a non-farming heir, and/or covering any state or federal tax liability that may be assessed on your death.
Your financial advisor, insurance specialist, and banker can assist you with securing lines of credit and the proper amount of disability insurance, long-term care insurance, and life insurance. While no one wants to have the conversation about possibly ending up in a nursing home or dying, the financial consequences of these events to a farming family can be more severe than they are for most families. Failing to plan ahead may require your family to sell the farm in order to pay for the medical bills, trust or estate administration expenses, or other debts when you become ill or pass away. By working with a trusted advisor team, you can protect your family and your business through all stages of life.
You may have heard about conservation easements in the news over the past few years and the tax benefits available through the use of them. But what are they and how can they benefit you?
Defining Conservation Easements
A typical conservation easement is created when a landowner makes an agreement (known as a “servitude”) with a charitable organization or government “land trust.” This agreement gives the organization or land trust certain rights to preserve and protect the land for public benefit. However, the original landowner normally retains the right to possess the land and use it for certain other purposes, including some commercial uses like logging or fishing.
As an example, let us say that a landowner inherited a large tract of land from a family member that can be seen from a scenic highway and provides a beautiful view of a mountain ridge from the highway. The landowner has a cabin on the property and would like to continue to use it during the landowner’s lifetime. But the landowner would also like to ensure that the land will never fall into the hands of a developer who would subdivide the property into residential developments, thereby destroying the beautiful scenic views from the highway. A conservation easement could be the best way to preserve the land’s beauty through an enforceable agreement with a governmental land trust or a charitable organization while still preserving the landowner’s right to possess and enjoy the cabin.
In general, a conservation easement is a tool used to protect natural resources such as rivers, lakes, beaches, and forests to preserve their natural beauty, create outdoor recreational and educational spaces, or provide and preserve sustainable habitats for native plant and animal life, while allowing the owner to maintain enjoyment of the property.
Income Tax Benefits
In addition to the environmental and societal benefits that conservation easements can provide, there are significant tax benefits for those who create them. Congress has determined that certain landowning individuals should be incentivized with tax deductions to voluntarily engage in conservation efforts to benefit the general public. The federal tax code allows a conservation easement donor to take a charitable income tax deduction of up to 50 percent of the donor’s contribution base (adjusted gross income, less net operating loss carryback) for the taxable year. If the donation is large enough that there remains a surplus contribution, this deduction can be carried over for up to fifteen years, subject to the same limitations on the donor’s contribution base.
Additionally, if the donor of the property is a farmer or rancher, the donor can deduct up to 100 percent of their charitable contribution base. Certain pass-through entities, such as subchapter S corporations, partnerships, and limited liability companies, can also take advantage of the deductions available with conservation easements.
Some states like California also offer tax deductions for the creation of conservation easements. Check with your tax advisor to determine whether such additional tax benefits are available to you in your state.
Estate Tax Benefits
If a donor is not particularly interested in donating a conservation easement during life, the donor can do so at death as a part of the estate plan. This can provide significant estate tax benefits to the heirs of the property.
For example, a donor could create a conservation easement in the donor’s estate planning documents so that, at death, a conservation easement would be granted on a parcel of land worth $1.5 million. If the value of the conservation easement was $500,000 (meaning that the land was worth $500,000 less to a successor landowner due to the existence of the easement), then the federal tax code would allow the estate of the deceased landowner to exclude up to 40 percent (or $400,000) of the remaining $1 million value of the land. Note: this particular tax benefit is limited to a $500,000 cap on the excludable amount.
This is a simple example, but it helps to illustrate the important benefits that can be gained by including a conservation easement in your estate plan. Nevertheless, it is crucial that you seek sound advice from your tax advisor and estate planning attorney before determining whether this strategy will work for you.
The Mechanics of Conservation Easements
Though simple in theory, there are important requirements that must be followed in order for a conservation easement to be properly created and respected by the Internal Revenue Service (IRS) for the tax benefits detailed above.
First, the conservation easement must be donated to a “qualified conservation organization” such as a governmental entity (for example, a state land trust), a charity, or certain other tax-exempt organizations. Exactly who qualifies under this designation is spelled out in the federal tax regulations.
Second, the organization that is granted the conservation easement must have the resources to be able to enforce the restrictions placed on the land through the easement. It must also have shown a willingness to enforce such restrictions granted to it in the past.
Third, the easement must have been created so that it would last “in perpetuity,” or forever. This means that all future owners of the land will be bound by these restrictions. If the easement does not impose a perpetual restriction, then it will not qualify.
Finally, the conservation easement must be recorded in the local land records so that any interested party is put on notice of its existence.
Beyond the above requirements, it is crucial that an experienced and qualified appraiser be used to determine the value of the land versus the value of the land once the conservation easement has been granted. There is a history of unscrupulous appraisers and landowners abusing the provisions of the tax code by claiming much greater values on the land subject to the easements in order to inflate the amount of the charitable deductions available to the donor. The IRS has been cracking down on these abusive tax practices recently and aggressively reviewing appraisals that seem higher than the circumstances would normally justify. Appraisals should be backed up with thorough documentation. If these elements are not met, the IRS will not allow the available tax benefits.
Nontax Benefits of Conservation Easements
There are significant tax benefits available to those who create conservation easements with their land. But perhaps the most important aspect of the conservation easement is the creation of a lasting heritage and public benefit that you can leave to future generations by preserving the environment, natural resources, and the beauty and sustainability of the earth that we all share.
If you feel like you would benefit from this particular strategy, contact us today. We would be happy to meet with you about your situation to determine if a conservation easement would make sense as a part of your estate or tax plan. We have in-person and virtual appointments available.
Estate planning attorneys are occasionally asked by clients whether an estate plan can include a right of first refusal (ROFR) (sometimes called a first right of refusal) on certain items or parcels of property. The following example helps to illustrate the way this legal tool is used and why it might be useful in your own situation.
The Family Farm
Allen and Betsy have owned and operated a farm for decades. As they have aged, their youngest of three children, Chet, has helped them manage the farm out of the goodness of his heart. Over time, Chet has grown very sentimentally attached to the farm and would hate to see the farm be sold outside of the family upon the death of his parents. Allen and Betsy would also hate to see the farm leave the family, but the other children in the family have expressed no interest whatsoever in owning or participating in the farm’s management. As Allen, Betsy, and Chet have talked it over, Chet’s parents have made it clear to Chet that they want their children to receive equal shares of their accounts and property at their deaths. The problem, however, is that the farm is worth well over 50 percent of the value of all of their accounts and property. As a result, Allen and Betsy cannot just give the farm to Chet as his one-third share. Instead, the farm will likely need to be sold so that the money and property can be equally and easily divided (remembering that the other two children have no interest in owning any part of the farm property).
A possible solution to address this dilemma is for Allen and Betsy to provide Chet with a ROFR. This solution would ensure that Chet has the opportunity to purchase the farm property at the death of his parents, as long as his offer meets the conditions of the ROFR.
Estate Planning Document Approach
There are at least two approaches that Allen and Betsy could take to allow Chet a ROFR. The first approach would be to have their estate planning attorney create a ROFR provision in their wills or living trust documents. It might read something like this: “At my death, I instruct my Trustee (or Personal Representative) to provide Chet with the right to purchase the Family Farm under the same terms and conditions made by an independent third-party offer on the property. If Chet fails to exercise that right and enter into a contract to purchase the property after <x> number of days, this right terminates and my Trustee may accept the offer from the independent party making the initial offer.”
The language of the ROFR would likely need to be more precise and include much more detail than this sample language, but this is the basic idea. The ROFR would allow Chet to make an offer that would match an independent third party’s offer, which should reflect the fair market value of the property. By doing this, the other children receive some reassurance that the property will be sold at fair market value so that they get the full value of their one-third share of everything Allen and Betsy owned. Additionally, Chet is provided with a legitimate opportunity to purchase the property at fair market value and obtain ownership of land that has meaning to him beyond the monetary value of the property.
Of course, if Chet decides for whatever reason to not exercise his ROFR within the time period provided by his parents, then he is not locked into any sort of obligation. Rather, he could allow his right to expire or could waive his ROFR to speed up the property’s sale to the independent party and still receive his one-third share of everything his parents owned.
One main advantage of including this ROFR in Allen and Betsy’s estate planning documents is that if circumstances were to change in the future, Allen and Betsy could amend their estate documents to remove this provision. This preserves Allen and Betsy’s ultimate control of their farm property.
The second approach that could be used is a separate contract between Chet and his parents. If the farm was owned by Allen and Betsy’s trust, the trustee of the trust would be a party to the contract with Chet. In the contract, Allen and Betsy could grant a ROFR to Chet in exchange for an agreed-upon sum of money. Once the contract is signed, a Notice of Right of First Refusal could be recorded with the county recorder to put the public on notice that before the farm can be sold, it will have to be offered to Chet first according to the terms of the agreement.
This approach might be used if the parties wanted to provide greater assurance that the property will be sold to Chet and that Allen and Betsy will not later change their minds without the legal consequences of breaking a contract.
Get Competent Legal Assistance
A ROFR is a useful legal tool to ensure that certain types of property end up in the hands of those who value them most while balancing a family’s desire to fairly distribute accounts and property among other loved ones. However, ROFRs must be carefully drafted whether placed in a will or a trust or drafted as a contract. A poorly drafted ROFR can create more problems than it solves, so proceed with caution and make sure you consult with an experienced estate planning attorney. Such legal counsel can provide much needed guidance and drafting expertise when creating a ROFR for your situation. Give us a call today to discuss ways we can leave your hard-earned money and property to those you care about and in the way you want. We are available for in-person and virtual consultations.