Design your farm succession plan first, then gift farmland
The Problem (submitted by email from T.M.)
Our advisers recommended that we gift 40% of our land to our kids to reduce potential estate losses upon death. One son farms, and the other three have off-farm jobs. We have appraisals and plan to use some of our lifetime credit through the Form 709 gift tax return. What else should we be thinking about before making the gift?
I remember a Christmas morning several years ago. Our son was the first to open a gift under the tree. It was his dream Lego set. He raced to his room, slammed the door, and started playing before the wrapping paper even hit the floor! We were happy that he liked his gift, but we expected our family to share Christmas morning together, not in playful isolation. We quickly came up with rules about experiencing the joy of the gift while staying together as a family. I’d encourage you to do the same for your farm.
Be careful, though. I’ve seen well-intentioned gifts go bad when the gifting was not aligned with the farm succession goals. Here are some gifting dos and don’ts to avoid future problems.
Do quantify potential estate losses.
I get a lot of calls from farmers determined to gift their land away, only to discover that they’re way below the tax threshold. If you do need to reduce your estate, also consider entity discounts, special use valuation, and transferring nonfarm assets like cash and life insurance ownership.
Don’t forget about cost basis and depreciation.
There are some advantages to inheriting assets vs. receiving a gift.
Do establish operating rules and exit strategies first.
It’s pointless to close the gate after the cattle escape. Define the management rules, rental options, valuation methods, permissible owners, and buyout terms before you make the gift.
Don’t rely on the kids to “figure it all out.”
The kids can always choose to get along. The rules are there in case they don’t.
Do calculate your cash flow after the gift.
The net income off the land follows ownership. If you gift away 40% of your land, you may lose 40% of your income. Plan accordingly.
Don’t rely on your kids to gift back income if you need it.
Over time, their new income usually builds their lifestyle, not yours. Plus, what if they pass away and their estate automatically passes to a spouse? Will the in-laws (and perhaps spouse No. 2) take care of you?
Do analyze your remaining collateral position.
Do you have existing debt? Or do you want to buy more land someday? How will the balance sheet transfer impact your financing?
Don’t forget to talk to your banker.
Existing debt might need to be transferred with the gift or reassigned to other farms before approval.
Do consider your farming heir’s collateral.
Will your farming heir eventually collateralize his gifted land for expansion? That might be difficult if the land is split tenants in common between the siblings or comingled within an entity. Keep just his name on his deed if possible.
Don’t overlook the equity risk with the off-farm heirs.
What if the off-farm heirs want to leverage their land? Is that OK? Are there concerns about financial problems or divorce?
These issues are all solvable. They’re actually key decisions within your farm succession plan. Do you want to prevent good gifts from going bad? Then begin with the end in mind. Design your farm succession plan first. Then coordinate your gifting. Your kids will experience the joy of the gift while keeping the farm and the family together.