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March 24, 2021
Reader Question: “We always see a lot of estate planning that involves several children receiving land or equipment, even if they are not physically farming. We plan to transfer everything to our son and daughter-in-law who are physically farming. I can't seem to ever find good advice on how to transfer the farmland, equipment, and house to them without causing ourselves huge income taxes in the following years.
Can you guide me on how to best transfer or sell everything to just one child? Thank you!” - Karen
Answer: Karen, you are not alone in your dilemma in seeking good advice and information. Often times this advice leads to confusion over death and taxes or misconceptions about capital gains and basis step-up of assets.
Let’s take your question one at a time.
Personal residence. First, your house. The IRS recognizes a capital gain exclusion for selling your personal residence. So, if you’re ready to sell assets your house may be a good place to start to take full advantage of this tax-free provision.
Equipment. The sale of equipment is not as easy. You are subject to income tax recapture on all the depreciation you’ve taken over the years. For this reason, the sale of equipment is typically not a viable option from an income tax perspective. However, there are other strategies you can implement depending on your situation. For example, a lease to own (or rent to own) type of structure where your farming heir rents the equipment from you over a period of years. Or, some have simply gifted the equipment to the farming heir especially if this is what your final intentions are anyway. There are two levels of gifting. First, your annual gift tax exclusion of $15,000 per person per year. Second, your lifetime gift exemption ($11.7 million per person under current law). This is not only the amount you can die with without paying death tax, but also the amount you can gift away during your lifetime, tax free.
Sell farmland. Unlike equipment, farmland is a capital gain asset subject to capital gain taxes which are preferential over ordinary income (under current law). Let’s say you sell your farm to your farming heir for $8,000 per acre and it holds a cost basis of $5,000 per acre (the original purchase price or inherited value). This is a capital gain of $3,000 per acre subject to federal (and possibly state) capital gains taxes. Some states have exclusions to capital gains for family farms. Your federal capital gain rate is based on your individual income tax bracket. For example, at the 22% income tax filing bracket the federal capital gain rate is 15%. However, the capital gain rate at the 12% bracket (up to approximately $80,000 of taxable income for a married couple) is actually zero.
Part gift – part installment sale. Most family farms I work with don’t expect their farming heir to pay the same price for the land a neighbor may pay. This is okay. You can use a part gift-part sale strategy to set the sale price wherever you want. An installment sale allows the seller to spread any capital gain over the term of the contract. Many choose to back into this by setting the annual contract payments similar to what the land rent payments would otherwise be. Your farming heir can now earn equity with land payments vs. rent. The part gift in this strategy is using your lifetime gift exemption (as noted above) to discount the sale price. In the above example, you could discount your $8,000 per acre farm and sell it to your farming heir at its cost basis of $5,000 (a $3,000 per acre gift) and pay no capital gain tax, no gift tax, buy may pay some income tax on the interest portion of the installment sale. Typically, the lowest interest rate for family sales is the long term applicable federal rate (AFR), which is currently near 1.9%.
Gift farmland. Some wish to make a larger gift and gift the farmland. One thing you give up with an outright gift of farmland is an adjustment in cost basis (basis step-up) if it was otherwise passed through your estate and inherited. However, there is also a life estate gift where you still retain the income (rent) from the farm for your lifetime. The IRS considers this a retained interest gift. There is still a deed transfer to your farming heir just as with an outright gift. However, since you retain the lifetime income the IRS determines the “income” value you retained based on your age and actuary tables for estate tax purposes. Since the farm gets pulled back into your estate for this reason, it still receives an adjustment in basis and your farming heir will get a new basis for the land and other depreciable assets such as the house, structures, fence, tile, and fertility.
As with anything, please consult with your tax and legal advisors who are more familiar with your specific situation. Otherwise, please know there are options available if you wish to transfer assets now versus the uncertainty by waiting for later.
Downey has been helping farmers and landowners for the last 20 years with their family farm transition, 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.
Co-Owner, Next Gen Ag Advocates
Mike Downey is co-owner of Iowa-based Next Gen Ag Advocates. His passion for helping farmers and landowners stems from his own farm roots, growing up on his family’s grain and livestock farm near Roseville, Ill. He and his wife are also the founders of Farm Raised Capital, an investment community for farmers and ag professionals with common interests to grow and diversify their farm wealth with alternative real estate investments. Reach Mike at [email protected]
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