Editor’s Note: This is the third installment in the three-part series.
I have found it helpful to apply the 5 Ws of farm succession to help family farms get started with discussion about future succession, to plan an effective family meeting or, today, the outline the best way transfer assets before the potential 2025 tax sunset.
As I mentioned in part two of this series on estate taxes, this is where the rubber meets the road.
Who? Who should get day-to-day operating assets, such as machinery and equipment, versus long-term family assets, such as farmland? Who are the future leaders in your family who can manage these assets?
What? Most advisors will recommend transferring long-term assets such as farmland that appreciate in value. This complements the ‘how to freeze’ the value of your estate we’ve spoken about. However, in some cases transferring equity in operating assets such as machinery and equipment may complement a farm transition plan, too.
When. As a general rule, tax laws, such as receiving a ‘step-up’ in cost basis, encourage folks to wait and transfer assets at the time of death. However, for others, the benefits of estate tax savings from transferring assets now will carry higher priority over step-up in basis, especially if the intent is for the family farm to never be sold.
Where? Every situation is different, but does it better complement your long-term planning to transfer assets to individuals, or to a trust for their benefit? Operating assets such as farm machinery are typically best owned outright. However, utilizing trusts to hold long-term assets such as farmland offers better asset protection and future estate tax planning benefits, too. Another alternative is to transfer “membership units” of a family entity, which sometimes offers the right balance of control, flexibility and asset protection.
Why? My family was motivated to do estate planning for tax reasons. Ultimately, however, the planning they did secured the long-term legacy and farm continuation goals they set out. Be careful not to let the tax tail wag the dog, though it’s perfectly acceptable to use taxes as a motivator to get started on your farm’s succession plan now.
How. Ultimately this comes down to how to transfer assets by sale, gift or a combination of both.
Sell or gift assets?
- Sell assets. The reason most farms are sold from an estate or the inheritors is because the farm just received a new step-up in basis. Now, the farm can be sold without any capital gain tax concern. However, transferring assets under capital gain treatment is an underutilized strategy. Don’t forget about a good old-fashioned installment sale. A properly structured private contract can offer win-win benefits for all parties.
- Gift assets. First, determine what you feel comfortable giving away and what income you need to support your livings needs. Creative strategies can be used to transfer discounted membership units of a family land entity, which can provide income through management activities. More advanced strategies can delineate voting from non-voting interests, which you can transfer to family members now or to a trust for the benefit of the family.
- Part sale-part gift. Perhaps my favorite strategy is when the seller of farmland uses part of their lifetime gift exemption to set the sale price of the farm at a level that leaves them an income stream through an installment sale. Often the goal is to have income equivalent to what their net land rental income would have been otherwise. This same strategy can be applied to stock ownership of a corporation and membership units of a partnership.
- Spousal transfers. You will likely hear or read about utilizing more advanced planning strategies such as intentionally defective grantor trusts. This is a type of trust that could be used in combination with any of the strategies above. One type of IDGT involves a gifting strategy between spouses.
Transfer for spousal benefit
A Spousal Lifetime Access Trust is unique in that it allows one spouse to transfer assets for the benefit of the other spouse, effectively removing assets and future appreciation from their combined estates. Unlike some other estate planning tools, SLATs specifically allow the beneficiary spouse to access income and principal during their lifetime.
This may be a consideration for high-net-worth families to help lock in current high estate and gift tax exemption amounts. If this sounds too good to be true, your intuition is correct. There is a reciprocal trust doctrine that says if these are not structured properly, assets in SLATs can potentially be subject to estate taxes. To avoid the reciprocal trust doctrine, it is crucial that SLATs differ in key aspects such as timing, trustees, beneficiaries and distribution terms.
As always, every situation is unique. Be sure to work with an estate tax specialist. It is never too early to get started, especially for families who may want to employ an advanced strategy such as a SLAT, since one of the spousal transfers should be completed by the end of this year.
Read more from the series:
Protect your estate before tax sunset
Use your lifetime gift exemption now?
Downey has been consulting with farmers, landowners and their advisors for nearly 25 years. He is a farm business coach and transition consultant with UnCommon Farms. Reach Mike at mdowney@uncommonfarms.com.