I remember vividly the compass on the dashboard of my Grandma and Grandpa’s sedan. The movement of the compass inside the plastic sphere cover fascinated me.
Grandpa always knew where we were headed. I realized later Grandma was really in charge of directions no matter what the compass said.
Almost 40 years later, technology has brought GPS to our cars, tractors and even cell phones. I rely heavily on Diana, the British-speaking GPS voice in my truck that tells me every day how to get to my destination.
When the Smith family came to my office this week, they knew where they wanted their estate plan to go but didn’t know how to get there.
One of their children has farmed their land his entire life. The other two are not involved in the farm operation. Leaving the land to their grandchildren in a legacy trust is a high priority.
They don’t want their children (or in-laws) to dissipate what they have worked a lifetime to build. The Smiths do not want their children’s potential differences to put the farm operation in jeopardy.
They want all of their children to live off the income their land produces — just as they have for almost five decades.
Selling the farm outside the family is not an option for the Smith family. They want their son to farm the land.
After discussing traditional estate-planning issues (tax, administration and distribution), we spent the majority of our meeting reviewing different farm continuation routes they could take on their estate and succession-planning journey.
Their current route is the “no plan.” Most all of us would agree this is the road to nowhere.
Currently, all assets are divided via their will equally to their three children with no direction for the distribution of farm assets. This route would force the three children into business together.
Within one year of their death (average time for probate), their farming son would need to acquire the farm equity it has taken the Smiths 50 years to accumulate.
I was not surprised their current plan made no mention of the farm.
A majority of estate plans we read in our fact-finding process deal with the tax issues of planning. A minority of these plans mention the farm.
The Smith estate plan is in jeopardy of failing the goal.
The Smiths could leave the farm to their three children but make each child’s share of the real estate subject to lease-and-purchase options.
This route would allow all three children to own land, but require they either rent or sell it to their brother in the future.
This plan may not cash flow for the farming heir and it is unilateral (can be changed by one party at any time without the knowledge of the farming heir).
A shortcut may be to “price” the lease and purchase options. They may agree to a long-term, crop-share lease that will live beyond the parents or use the average rent published by Iowa State University Extension rental survey to set the future rent for their son.
They would more than likely set a price or use a cash-flow formula (Special Use Valuation) in a purchase agreement to “price” the land. These options could be bilateral (signed by both parties rather than in the will) and recorded at the courthouse.
The Smiths have sold 160 acres to their son for cash. They paid capital gains tax, but felt it was a necessary evil to allow their son to accumulate equity in the home farm.
They could take this route for their remaining land in the form of cash or contract sales. The Smiths were leaning toward this option when they first came to my office.
This route is attractive due to low interest rates (between 1 and 4 percent depending on term) and low capital gains rates (between 0-15 percent federal and more than likely 0 percent for Iowa income tax).
A shortcut could reduce the selling price to take advantage of the current $5 million lifetime gift exclusion for discounted sales and tailor an interest rate to fit the needs of the buyer and the seller.
A self-cancelling feature can be added to a contract sale if the seller wishes the contract balance to “cancel” at his/her death. Land also can be sold for a lifetime stream of payments that end at the death of the seller.
All of these options must be closely reviewed with a team of advisers including your attorney and accountant.
Some believe strongly family land is to be transferred (not sold) to the next generation. This route appealed to the Smiths as they could convey their land to their farming heir in a similar manner their parents passed land to them.
It would be possible to transfer the land to their son and transfer their life insurance and cash to their other children at their death to make this distribution fair.
They have enough life insurance to meet the cash need to make the distribution fair based on their “family value.”
A shortcut is to transfer the land to their son before death. This can be done outright (use the current lifetime federal gift exclusion of $5 million) or on a life-estate deed while living.
The Smiths would retain the income and use from the farm while transferring the remainder to their son. This shortcut will reduce their probate estate and reduce risk in the event of an extended illness or stay in a medical facility.
The final route we discussed was to establish a family entity (LLC, FLP, LLLP or a corporation) to own the land with lease and purchase options. The entity allows for partial ownership interests to be transferred while living.
This allows for significant estate-tax discounts and favorable gift transfers.
I call this strategy the “Ponderosa Plan” after the ranch featured on the Western TV show “Bonanza.” Little Joe, Hoss, Adam and Ben Cartwright owned The Ponderosa as a unit not be divided or sold.
Which route to take?
Detours or a lack of a plan can be a problem on any journey unless Grandma or Diana can keep you on track.
Although the Smiths came to my office leaning toward selling their remaining land to their son at a discounted “family price,” I believe they will take their plan on a different route.
Their final plan will depend on input from children and advisers at future planning conferences. I am confident their route, after exploring various shortcuts and detours, will take them exactly where they want to go.
This is the goal of an effective estate and farm succession plan.
For 19 years, Steve Bohr has been a partner in the farm continuation firm of Farm Financial Strategies, Inc. For additional information on farm continuation issues or if you have a question, contact Bohr via email at Bohr@FarmEstate.com or call 800-375-4180.