Agriculture Financial Planning
Farmers and owners of agribusinesses face unique wealth management opportunities and challenges. The term "wealth" to a farmer typically has little financial meaning. Their wealth is measured in the satisfaction of working the land to earn a living, raising
their family to succeed them, protecting their family values and sustaining their ability to work productively as an independent business owner. We know that farmers never really retires from farming, but we also know that they need a sensible wealth management
plan to effectively deal with the inevitable day when they can no longer work on their farm.
Developing the right agriculture wealth plan is a multi-dimensional planning process. It focuses on designing the right succession strategy to transfer the family farm to the next generation cleanly with clearly understood timelines.
If the farm business represents most of the net worth of the owner, working up the correct farm sales/purchase price and arranging financing terms that meets the needs of both sides of the family is an important component of the plan. There are estate, gift, investment, elder care, business and income tax considerations associated with farm transition planning to consider as well.
Farm Transition
Ask a farmer about his priority goal and the answer is usually the successful transition of the family farm to the next generation. For those farmers who have adult children interested in production agriculture, planning the transition cannot start too early.
Ideally, a farmer would start planning for the transition soon after taking ownership himself by investing outside of the farm by diversify his wealth. Creating a source of retirement income outside the farm will help ease the financial burden on the next generation when acquiring the farm.
Once the farmer's children reach adulthood and become involved in the farm business, it is important for the owner to grant increasing responsibilities to the children to learn good business decision-making skills. Gifting ownership of farm equipment and cattle is a good way for adult children to gain a sense of the responsibilities of ownership.
Farmers do not retire, but they inevitably lose the ability to work their farm. Accordingly, the family needs to have a labor plan after the parent generation can no longer provide cheap farm labor.
Moreover, the farm transition plan must carefully determine the appropriate price and timetable to transfer control of the farm to the children at a mutually feasible price and financing terms to ensure the financial needs of both families are satisfied.
Living arrangements, estate/income tax, long-term care concerns, and health insurance all must be considered as part of a comprehensive farm transition plan.
Like-Kind Exchange
A like-kind exchange is a tax reduction strategy employed when selling business/investment property. The asset class best suited for a tax-free exchange is business/investment real estate because it is an appreciating asset and the exchange rules are more lenient than for business assets. Asset appreciation, along with accumulated depreciation deductions taken on improvements to the real estate, constitute taxable income when the real estate is sold outright.
A like kind exchange is often referred to a "1031" exchange since this is the IRS code section that permits the deferral of capital gain and deprecation recapture on the sale of farm, business and investment real estate if certain rules are followed.
An attractive element to a real estate like-kind exchange is that the replacement realty does not have to be of the same type as the relinquished realty, but it must used as business or investment realty. For example, a farmer could sell his farm and purchase a shopping center via a 1031 exchange and achieve significant federal income tax deferral.
The degree of income tax deferral will be a function of several factors, including the purchase price of the replacement property and the amount of indebtedness on each property, among others.
The tax law regarding the standard delayed like-kind exchange is mechanical. A special escrow agent called a qualified intermediary holds the proceeds from the sale of the relinquished property. The replacement realty must be identified within 45 calendar days of the sale and the purchase of that specific identified realty must occur within calendar 180 days of the original sale for the exchange to complete and tax deferral achieved.
A "reverse" 1031 exchange is even possible, whereby the owner purchases the replacement property first, places the title in escrow, and then sells the relinquished property within the statutory allowable timeframe (180 calendar days).
State tax varies as to the deferral of state income tax due using a 1031 exchange. Seek qualified tax and legal counsel before considering a 1031 exchange.
Family Partnership
An advanced farm transfer strategy that re-organizes the larger and more complex family farm enterprises into a business entity with two classes of ownership – voting and non-voting – is the family limited partnership ("FLP"). The FLP can solve a host of difficult planning problems for the large family farm, but it is a complex planning tool requiring a skilled team of professional advisors to implement and a commitment by the farm owner to follow through on implementation.
A primary advantage of the FLP is the "freezing" of your estate value by transferring equity (sale or gift) to children in the form of limited partnership units. A limited partner has a legal right to partnership equity, but has no management or voting rights. The farmer retains full ownership of the general partnership interest, which controls 100% of the partnership assets and makes all business decisions.
Often, the general partnership interest represents just a small percentage of the value of the partnership yet it yields substantial control of the business entity. The FLP is a helpful planning device when a successful farmer with a substantial net worth has concerns about the next generation of ownership yet still needs to realize estate and income tax benefits from transferring ownership in the farm now rather than later.
However, the FLP must be run as a legitimate business or the income and estate tax advantages referenced above can be forfeited.
Special Use Valuation
In general, real property must be valued at its fair market value for estate tax purposes. Fair market value normally is determined by a property's "highest and best use," that is, the use that would make the property the most valuable. This is true even if the property currently is not being employed in its highest and best use.
A significant estate tax exception applies for closely held farms and other family-owned businesses called special use valuation ("SUV"). If all the requirements are met, the property will be valued in accordance with its actual (current) use. However, there is a ceiling to the amount of the SUV that can be deducted from the realty's fair value, which is periodically indexed for inflation.
The SUV enables farm families to pass farmland with high development value to their heirs at a reduced estate transfer value. While the SUV method can greatly reduce the taxable estate, the amount of the SUV estate reduction does not receive a step-up in basis when transferred.
There are restrictions associated with the SUV. To qualify for the estate reduction, the net value of the farm/business property must be at least 50 percent of the decedent's gross estate and at least 25 percent of the decedent's adjusted gross estate (the gross estate reduced by certain expenses). In addition, the decedent must have transferred the farm to specified close family relatives.
Finally, the farm/business must have been owned, and to a certain degree, operated by the decedent or a close family relative, for a specified period of years before the decedent died. The individual must farm the land and cannot cash rent the land to someone else for ten years subsequent to the SUV valuation date.
Clean & Green
Productive farm land generates more local tax revenue than it uses in services. The "Clean and Green" program is a Pennsylvania real estate property tax relief program designed to preserve farm and forest land and help create a fairer distribution of the tax base. It primarily benefits farmers by lowering their local real estate taxes (by lowering the assessed value) based on the use of the land and not its fair market value.
The Pennsylvania Clean and Green program was created in 1974 and it is administered at the county level. The state law provides lowers real estate tax assessments to property owners that maintain their land solely devoted to agricultural use, agricultural reserve, or forest reserve use. The program addresses the tax problem created when factors that influence land values impact a farmer's ability to productively work farm land.
Property owners are eligible to participate if they own at least ten acres of farm, forest or open land. Landowners who have less than ten acres can still qualify if they can prove they earn at least $2,000 of annual gross income from farming.
One disadvantage is the potential for a roll-back of property taxes savings that would be assessed if the property owner voluntarily abandons the Clean and Green program either through sale or subdivision of the land. These back taxes can apply for up to seven tax years plus interest, so it is important to consider your long-term planning goals for your farmland before joining this tax-relief program.
Conservation Easements
Protecting farmland and open space for future generations of your family or the public can be a meaningful legacy. However, few land owners want to make an outright gift of their land and a conservation easement can satisfy this planning goal.
A conservation easement is a legal transfer of land usage rights creating a legally enforceable land preservation agreement between a landowner and a municipality or a not-profit land trust/conservancy. The easment restricts real estate development, commercial and industrial uses and other activities. The restrictions, which are perpetual and binding on all future landowners, are spelled out in a legal document recorded in the local land records.
The public policy promoting conservation easements is protection of agricultural land and natural resources. The landowner gives up "development rights" on the land but retains other benefits of land ownership.
There are two different conservation easement programs. The first involves the sale of an easement in which the land owner is paid a dollar amount per acre to keep the land in agriculture in perpetuity. In Pennsylvania, the farmland must be located in an Agricultural Security Area and there is a 35 minimum acreage requirement. Each county has a ranking system to select the farms to enter their easement program each year.
The second type is a donated conservation easement in which the landowner grants a land easement to a land trust in exchange for a charitable income tax deduction. The donated easement can work in tandem with the easement sale to lessen the income tax impact on the easement sale.
To forever relinquish the legal right to sell your land for market value is not a casual financial decision and typically requires in-depth planning to arrive at the best easement decision for the landowner and family.
Developing the right agriculture wealth plan is a multi-dimensional planning process. It focuses on designing the right succession strategy to transfer the family farm to the next generation cleanly with clearly understood timelines.
If the farm business represents most of the net worth of the owner, working up the correct farm sales/purchase price and arranging financing terms that meets the needs of both sides of the family is an important component of the plan. There are estate, gift, investment, elder care, business and income tax considerations associated with farm transition planning to consider as well.
Farm Transition
Ask a farmer about his priority goal and the answer is usually the successful transition of the family farm to the next generation. For those farmers who have adult children interested in production agriculture, planning the transition cannot start too early.
Ideally, a farmer would start planning for the transition soon after taking ownership himself by investing outside of the farm by diversify his wealth. Creating a source of retirement income outside the farm will help ease the financial burden on the next generation when acquiring the farm.
Once the farmer's children reach adulthood and become involved in the farm business, it is important for the owner to grant increasing responsibilities to the children to learn good business decision-making skills. Gifting ownership of farm equipment and cattle is a good way for adult children to gain a sense of the responsibilities of ownership.
Farmers do not retire, but they inevitably lose the ability to work their farm. Accordingly, the family needs to have a labor plan after the parent generation can no longer provide cheap farm labor.
Moreover, the farm transition plan must carefully determine the appropriate price and timetable to transfer control of the farm to the children at a mutually feasible price and financing terms to ensure the financial needs of both families are satisfied.
Living arrangements, estate/income tax, long-term care concerns, and health insurance all must be considered as part of a comprehensive farm transition plan.
Like-Kind Exchange
A like-kind exchange is a tax reduction strategy employed when selling business/investment property. The asset class best suited for a tax-free exchange is business/investment real estate because it is an appreciating asset and the exchange rules are more lenient than for business assets. Asset appreciation, along with accumulated depreciation deductions taken on improvements to the real estate, constitute taxable income when the real estate is sold outright.
A like kind exchange is often referred to a "1031" exchange since this is the IRS code section that permits the deferral of capital gain and deprecation recapture on the sale of farm, business and investment real estate if certain rules are followed.
An attractive element to a real estate like-kind exchange is that the replacement realty does not have to be of the same type as the relinquished realty, but it must used as business or investment realty. For example, a farmer could sell his farm and purchase a shopping center via a 1031 exchange and achieve significant federal income tax deferral.
The degree of income tax deferral will be a function of several factors, including the purchase price of the replacement property and the amount of indebtedness on each property, among others.
The tax law regarding the standard delayed like-kind exchange is mechanical. A special escrow agent called a qualified intermediary holds the proceeds from the sale of the relinquished property. The replacement realty must be identified within 45 calendar days of the sale and the purchase of that specific identified realty must occur within calendar 180 days of the original sale for the exchange to complete and tax deferral achieved.
A "reverse" 1031 exchange is even possible, whereby the owner purchases the replacement property first, places the title in escrow, and then sells the relinquished property within the statutory allowable timeframe (180 calendar days).
State tax varies as to the deferral of state income tax due using a 1031 exchange. Seek qualified tax and legal counsel before considering a 1031 exchange.
Family Partnership
An advanced farm transfer strategy that re-organizes the larger and more complex family farm enterprises into a business entity with two classes of ownership – voting and non-voting – is the family limited partnership ("FLP"). The FLP can solve a host of difficult planning problems for the large family farm, but it is a complex planning tool requiring a skilled team of professional advisors to implement and a commitment by the farm owner to follow through on implementation.
A primary advantage of the FLP is the "freezing" of your estate value by transferring equity (sale or gift) to children in the form of limited partnership units. A limited partner has a legal right to partnership equity, but has no management or voting rights. The farmer retains full ownership of the general partnership interest, which controls 100% of the partnership assets and makes all business decisions.
Often, the general partnership interest represents just a small percentage of the value of the partnership yet it yields substantial control of the business entity. The FLP is a helpful planning device when a successful farmer with a substantial net worth has concerns about the next generation of ownership yet still needs to realize estate and income tax benefits from transferring ownership in the farm now rather than later.
However, the FLP must be run as a legitimate business or the income and estate tax advantages referenced above can be forfeited.
Special Use Valuation
In general, real property must be valued at its fair market value for estate tax purposes. Fair market value normally is determined by a property's "highest and best use," that is, the use that would make the property the most valuable. This is true even if the property currently is not being employed in its highest and best use.
A significant estate tax exception applies for closely held farms and other family-owned businesses called special use valuation ("SUV"). If all the requirements are met, the property will be valued in accordance with its actual (current) use. However, there is a ceiling to the amount of the SUV that can be deducted from the realty's fair value, which is periodically indexed for inflation.
The SUV enables farm families to pass farmland with high development value to their heirs at a reduced estate transfer value. While the SUV method can greatly reduce the taxable estate, the amount of the SUV estate reduction does not receive a step-up in basis when transferred.
There are restrictions associated with the SUV. To qualify for the estate reduction, the net value of the farm/business property must be at least 50 percent of the decedent's gross estate and at least 25 percent of the decedent's adjusted gross estate (the gross estate reduced by certain expenses). In addition, the decedent must have transferred the farm to specified close family relatives.
Finally, the farm/business must have been owned, and to a certain degree, operated by the decedent or a close family relative, for a specified period of years before the decedent died. The individual must farm the land and cannot cash rent the land to someone else for ten years subsequent to the SUV valuation date.
Clean & Green
Productive farm land generates more local tax revenue than it uses in services. The "Clean and Green" program is a Pennsylvania real estate property tax relief program designed to preserve farm and forest land and help create a fairer distribution of the tax base. It primarily benefits farmers by lowering their local real estate taxes (by lowering the assessed value) based on the use of the land and not its fair market value.
The Pennsylvania Clean and Green program was created in 1974 and it is administered at the county level. The state law provides lowers real estate tax assessments to property owners that maintain their land solely devoted to agricultural use, agricultural reserve, or forest reserve use. The program addresses the tax problem created when factors that influence land values impact a farmer's ability to productively work farm land.
Property owners are eligible to participate if they own at least ten acres of farm, forest or open land. Landowners who have less than ten acres can still qualify if they can prove they earn at least $2,000 of annual gross income from farming.
One disadvantage is the potential for a roll-back of property taxes savings that would be assessed if the property owner voluntarily abandons the Clean and Green program either through sale or subdivision of the land. These back taxes can apply for up to seven tax years plus interest, so it is important to consider your long-term planning goals for your farmland before joining this tax-relief program.
Conservation Easements
Protecting farmland and open space for future generations of your family or the public can be a meaningful legacy. However, few land owners want to make an outright gift of their land and a conservation easement can satisfy this planning goal.
A conservation easement is a legal transfer of land usage rights creating a legally enforceable land preservation agreement between a landowner and a municipality or a not-profit land trust/conservancy. The easment restricts real estate development, commercial and industrial uses and other activities. The restrictions, which are perpetual and binding on all future landowners, are spelled out in a legal document recorded in the local land records.
The public policy promoting conservation easements is protection of agricultural land and natural resources. The landowner gives up "development rights" on the land but retains other benefits of land ownership.
There are two different conservation easement programs. The first involves the sale of an easement in which the land owner is paid a dollar amount per acre to keep the land in agriculture in perpetuity. In Pennsylvania, the farmland must be located in an Agricultural Security Area and there is a 35 minimum acreage requirement. Each county has a ranking system to select the farms to enter their easement program each year.
The second type is a donated conservation easement in which the landowner grants a land easement to a land trust in exchange for a charitable income tax deduction. The donated easement can work in tandem with the easement sale to lessen the income tax impact on the easement sale.
To forever relinquish the legal right to sell your land for market value is not a casual financial decision and typically requires in-depth planning to arrive at the best easement decision for the landowner and family.