A contract for deed is a great tool in planning for farm succession. We use these in many plans when providing the farming heir with the option to purchase land and farm sites.
The benefits of a contract for deed are that they allow the client to set forth the manner for calculating the sale price, determining the interest rate, setting the term for payments, and stating the manner in which payments will be made. Essentially, the client is removing all the points of negotiation, so the future beneficiaries do not need to deal with these points of contention after the client is deceased. Secondly, the contract for deed is a tool, so the estate and family can self-finance the sale. This is helpful, because in many cases, a young beneficiary may not have the collateral or income to finance the purchase of the farmland.
A downside to the use of a contract for deed is that the beneficiaries who are receiving the payments will not receive a lump-sum payment soon after the client is deceased. Rather, they will receive small payments over the term of the contract.
One option to allow for a quicker receipt of funds is to provide a balloon payment within the contract. The contract for deed could state that equal payments shall be made annually, amortized over a period of 20 years, with a balloon payment after 10 years. This means the principal and interest are paid as if the contract will run for a 20-year period, but in the 10th year, the principal must be paid off. This is helpful to the buyer because during those first 10 years, they will ideally gain equity in the real estate. Then, in the 10th year, they will have the ability to finance with the bank to pay off the remaining amount.
Interest rate, purchase price
It is important for the client to consider how to determine the interest rate for the contract. Many times, a client will base the interest rate off the federal applicable rate. Essentially, the terms of the estate plan would say that the interest rate would be set at, or some percentage above, the federal applicable rate. The rate is not determined until the time when the contract is executed. They must at least charge interest set at the appliable federal rate.
The determination of the purchase price is also important. Many times, clients will base the purchase price on the appraised value, the real estate tax market value or a percentage of either of these.
Balzarini is an attorney at law with Miller Legal Strategic Planning Centers P.A., Tyler, Minn. Email your questions and comments to Miller Legal at email@example.com.