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A Guide to Farm Succession Planning

Date: 
Author: 
Compeer Financial
Educational Opportunities: 
Articles
Interests: 
Grain, Dairy, Swine, Beef, Timber, Young, Beginning Farmers, Emerging AgriBusiness, Women in Ag
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Most all individuals contemplate transitioning their farm to the next generation. Areas to focus on when you begin farm succession planning are to educate yourself, work on communication, pencil out the cash flow, calculate the tax implications, and document the final plan. 

Educate yourself
The first step to get your farm transition plan off to the right start is to educate yourself as much as possible.  There are a plethora of seminars that financial planners and tax firms offer on the topic of succession planning.  Farm publications are continually addressing this important topic as well, which means there is no shortage of information on transition planning. 

Experienced experts who specialize in agricultural taxes should be resources you can rely on.  We aren’t saying your neighbor who transitioned their farm last year doesn’t have great ideas, but each and every plan is so individualized that what worked for them may not work for you. 

Communicate with heirs
The second step to starting the transition process is communication. This includes talking with your family and understanding their wishes. Be sure to consider both the on-farm and the off-farm heirs. Being fair to each usually doesn't mean being equal to each. 

Your family needs to sit down and discuss goals in a formal setting. That means putting aside the roles of mom, dad and children and taking up the roles of business partners. This structured meeting will give a chance for the son or daughter to not feel like ‘junior’ but rather a partner in making decisions that will help the farm succeed in the future. 

Know your financials
The third step in farm succession planning is to know the financial numbers. Previous years’ tax returns is a starting point to see the net cash the farm has produced. Be careful of the depreciation expense on the tax return, as the tax return often accelerates depreciation for tax purposes. A number to replace the tax return deprecation number is known as capital asset replacement allowance. When analyzing your tax return numbers, you could replace what is on the business schedule for depreciation and use typically 15% of the market value of your current machinery. 

Creating an up to date balance sheet is vital in order to know what assets are available for retirement and what remains for passing onto the next generation.  Being forth right with everyone creates a sense of trust and honesty.  A common misnomer is there are enough assets to give away and still be able to live comfortably in retirement. The first generation needs to help the second generation, while also protect their funds for retirement. 

If you look at the cash income the farm has been able to produce, one could try and forecast five years ahead to see if any efficiencies can produce extra cash income that will be needed to support multiple families. To provide a living for the retiring generation, a rental agreement or a sale would have to occur on some assets. That means a rental expense or debt repayment would have to be added to the cost of production. Penciling this out is critical to determine what is feasible for meeting the cash flow requirements

Tax implications 
Speaking of a possible sale, that leads us to another key point - tax implications of a transfer. The two most common ways around the tax implications are either by gifting a portion of the assets away or by your children inheriting the assets. With life time estate gifting amounts increased to $11.2 million for 2018, indexed for inflation, per individual for Federal rules, one can easily transfer a great deal of wealth and not have any Federal tax implications. This plan could possibly involve a rental/lease agreement and would need to look at long term care implications.

Inheritance
With careful planning, inheritance could be beneficial in the transfer of assets. Current tax reform retained the step up basis in place, allowing highly appreciated property to be stepped up to fair market value. This of course depends on how the asset is titled, but it can be extremely beneficial to many. Since most parents will not be able to gift or give the farm estate to the next generation, a couple of options could be a possible sale or rental agreement to provide funds for retirement. Selling the farm in one transaction or splitting it up on an installment sale can lead to different tax consequences.

Rental agreement
Furthermore, if the first generation wanted to give the second generation a chance to start gaining equity, another option is to rent out the land and buildings for a period of time while they sell the operational assets. This would provide retirement income for the first generation and a chance to cash flow the debt for the second generation. Each family will see different benefits by selling the farm or  renting it out. 

Get it in writing
Last but not least, to ensure that all this hard work and number crunching is worthwhile, the family needs to put this into a formal written plan. This will ensure two things. First, there is no misunderstanding of when all this will take place. Second, it will provide details of what should be done in the event of a death. 

The timing of a farm transition and the triggering events will need to be formally documented, usually by an attorney, to ensure everyone understands the plan and makes it a legally binding agreement. It is hard to imagine going through all the discussions and planning only to have it not executed. What would be worse is the gold old hand shake and unfortunately if someone were to pass and their final wishes aren’t followed. 

Take your time
When starting your farm succession process, remember it is just that - a process. One that should take a couple of years to discuss, plan and execute. No one should jump into a plan too quickly. You want to ensure that at the end of the day, we can all still sit down for Thanksgiving dinner next year.
 
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