In previous posts I reviewed options for transitioning your family farm business as well as your machinery and equipment. Elizabeth from Illinois emailed me asking about the transition options for her farmland. Here you go Elizabeth:
By far the most common method I run across is one generation leaving the next equal undivided ownership interests in all the real estate. This is the easiest way to treat your children equally as there is no concern over dividing up parcels of equal value. Although this is simple and easy, it is also a pitfall which can lead to problems later. With undivided ownership in real estate (as tenants-in-common), it technically only takes one undivided interest to force others into difficult conversations they may not want to have. For example, perhaps one of your siblings demands more rent for the farmland? Or, what if someone in the group wants to sell the land? This puts pressure on family members to get along, otherwise there lies the threat of a dreaded partition sale.
Sometimes this gives thought to dividing up the farms so the kids each own their own parcels of land. The potential problems of co-ownership go away and less chance of family arguments. However, designating separate parcels can also lead to problems. Maybe the land doesn’t divide well, or Mom and Dad aren’t excited about splitting up the family farm they spent their entire career putting together. Can your farm operation afford to divide the land base for economies of scale in the future? What if some in the family don’t rent their parcel back to those who are actively farming? What if they sell their parcel but don’t offer it back to the family first? This option could very well lead to even greater turmoil in the long run.
Consider a land entity
These concerns are supporting a trend for placing more land into a common family entity as part of a land transition plan. Examples of such entities are limited liability companies, limited liability partnerships, or family limited partnerships depending on the preference of your legal advisors. All are favored because of their ease for setting up and flexibility for changing or unwinding in the future. This is much different than having land inside a land trust or corporation where there is much less flexibility.
A common goal I hear expressed is to treat all the children as equally as possible, while also leaving some assurances to those in the family who continue farming. First, instead of leaving the children equal undivided interests in the real estate, it is relatively easy to give them equal ownership interests in a family land rental entity instead. The advantage of this entity is the provisions which can be established to address the assurances Mom and Dad would want to leave for leasing and purchasing the farmland in the future.
These assurances are more difficult to structure once we’ve given the children outright parcels of land.
Instead of one family member potentially forcing a partition sale on all the real estate, perhaps one of the provisions of the family entity is a percentage vote must be met before this can occur. If there are five owners and an 80% super majority vote, then it would take four out of five to agree before land gets sold.
Who is permitted to own your family land entity?
This is commonly set up as lineal descendants to help keep the farm in the family and also protect against the unforeseen events which can threaten the family farm (divorce, bankruptcy, lawsuits, or poor planning).
What if someone wants to sell?
It’s not a problem, but they must sell it back to the family under Mom and Dad’s family price and terms or those voted upon by the majority.
Lastly, a well written lease provision gives assurances for those in the family who continue to farm while also reducing the pressure of annual rent negations between family members.
One of my partners cleverly terms these various provisions “boomerang” rules where the intent is for the family farm to always come back to the family.
There are other advantages of a family land entity such as liability protection, more flexibility in gifting “units” versus gifting actual “acres,” and putting your estate in a position for discounts. Positioning your farmland for discounts may become more important if current estate tax exemptions are lowered in the future.
Consider transitioning parcels with the grain bins or outbuildings to your farming heir who will rely on them the most. This can be equalized with other non-land assets to the other children, depending on how you feel about sweat equity and ‘fair vs equal.’ Or, you can proactively sell parcels to those in the family who want to be landowners to give them the opportunity to begin making contract payments now.
This especially makes sense if they are going to be buying out other siblings one day in the future anyway.
Of course, there is the do-nothing approach, which typically defaults back to all your children inheriting equal interests in everything: not only the farmland but also building sites, residences, and any machinery, livestock, or grain you may own.
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].