June 14, 2022
In my last post, What is the fair market value of a family farm corporation?, I shared an example of a family I worked with who owned 540 acres inside a C-Corporation. Similar to other families with a land corporation, they disagreed on how to value the corporation. Some in the family believed the value of their corporation stock was simply the value of the underlying farmland the corporation owned. This is rarely the case.
Another popular question I hear is, how can we get the land out of our corporation? Sometimes this may better complement the long-term succession plan for the farm, and if proper steps are taken now, it can certainly be done.
One option is to simply distribute the land and liquidate the Corp now. However, usually, it doesn’t take long to rule this out after gaining a tax estimate from your tax advisor of doing so. This can get a little ugly if the Corp has both low stock basis and owns land with low basis too.
This is why the more tax-friendly opportunity to liquidate a Corp is after the stock receives a new tax basis. Pro-active planning now will help facilitate this. Typically, we coordinate this with the owner(s) estate plan as the stock passes through their estate and gets re-valued. I will summarize below the steps we worked through with the family above to help implement this strategy.
First, it is important to understand the land and other assets inside a Corp do not get a new step-up in basis, only the corporation stock does. So, when the land is pulled out, this will still cause a capital gain. However, when a Corp, with a brand-new basis is liquidated (in the same tax year the land is pulled out), this will cause a capital loss. This capital loss from liquidating the Corp will help offset all or a large majority of the gain from pulling the low basis land out.
The key to this strategy is corporation stock and farmland are both taxed as capital gain assets. And, gains and losses from capital assets can offset one another. This does not work so well for grain or equipment which are subject to ordinary income tax. So, if your Corp owns other assets it is best to look for opportunity to whittle these out over time so the Corp is left owning land only. As always, please work closely with your legal advisors who know your basis levels and can prepare these tax estimates for you.
The next step is to make a tax election and convert your C-Corp to an S-Corp. Under current laws, C-Corp’s are taxed at a flat rate of 21% federal, plus 15% on any dividends paid out. S-Corp’s only have one tax as the income flows through to the owner’s individual income tax level. This flow through is important so that when the land is pulled out of the S-Corp and capital gain is temporarily recognized, it is done so at the shareholder level only (versus at both the Corp and shareholder level if a C-Corp).
There are two important rules to consider when converting to a S-Corp:
If there are retained earnings (profits not paid out), and you are not willing to pay them out then you must materially participate by custom farming or crop sharing.
There is a five-year Built-In Gains (BIG) tax holding period before any assets can be sold under the new S-Corp flow through tax treatment.
Consider this strategy if you own land inside a corporation, and you wish to distribute certain parcels outright to children, or restructure the ownership of the land to more commonly used land entities today. These final steps can also be included in the final distribution provisions within your estate planning documents. And, be sure to work closely with your legal advisors to avoid any missteps along the way.
Downey has been helping farmers and landowners for the last 22 years with their family farm transition, estate planning, leasing strategies, finances, and general land consultation. He is the co-owner of Next Gen Ag Advocates and an associate of Farm Financial Strategies. Reach Mike at [email protected].
The opinions of the author are not necessarily those of Farm Futures or Farm Progress.
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