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Passing on the farm

Peter Garrard Beck/Getty Images Father and son in field
FAMILY MATTERS: There are different rules and regulations to consider if you are leaving the farm to a family member or someone outside of your family.
Bottom Line: Whether keeping the farm in or out of the family, develop a plan for succession.

As retirement plans are being developed, questions often arise about transferring assets from one owner to the next. At a minimum, each step of succession planning should involve both legal and tax professionals to help guide the process along.

The age that a producer starts the transfer influences how the process proceeds. Some ag producers start planning in their 50s and early 60s, while others wait until they’re in their 70s.

Also, plans are different, depending on if the farm is being transferred to someone within or outside of the family.

One question often asked is, “How do I transfer the farm if no relative wants to take over?”

In North Dakota, a succession within a family has options that aren’t available to an operation being transferred to someone outside the family because of corporate farming rules in the state’s Century Code.

Farm succession examples

Take Farmer Joe, who is a sole proprietor. He wants to be out of production agriculture within five years and has a niece who would like to take over the farm. Due to their kinship, Farmer Joe has the option to set up a limited liability company for farm assets and include his niece as a partial owner even if though it’s a tiny percentage.

Full management control can transfer immediately to the niece, and her ownership percentage can grow in three ways: Ownership can be purchased, earned, or gifted. Eventually, ownership of the LLC will be 100% with the niece.

If Farmer Joe has no relation who wants to take over, this option is off the table in North Dakota.

An example would be a young neighbor who wants to obtain more land, equipment, breeding stock or facilities. Transferring assets would be done from a sole proprietor to a sole proprietor, either with a contract sale over time or a cash sale.

A sole-proprietor-to-sole-proprietor transaction is always available to related parties, but a farming LLC is limited by kinship.

Positives and negatives

A sole-proprietor-to-sole-proprietor sale is common and can take several forms, such as a cash sale or contract sale paid in installments. Note that different assets will fall into different asset categories when it comes to taxes and lending.

Machinery, for instance, is an intermediate asset that is depreciable for income taxes. Machinery will probably have term payments associated with them, regardless of whether the lender is the Farm Service Agency, a private bank, a credit union or an individual. A close examination of machinery values and purchase terms are very important.

A cash sale is simple. The buyer comes up with the cash, and the seller accepts the cash in exchange for the piece of equipment.

The buyer now has a value, or “basis,” that can be depreciated over time on the buyer’s income tax forms. However, the seller must claim the cash sale purchase price minus the undepreciated value of the “remaining basis.” In many cases, the seller has no remaining depreciation value left and must claim 100% of the sale price as recaptured depreciation. This is ordinary income, just like a grain or calf sale.

Machinery sales under contract over several years are handled similarly, in the fact that the entire sale price must be claimed in that first year of the contract. Thus, it has the same recaptured depreciation as a cash sale even though not all payment is received in that year.

Rentals differ

Machinery rental is handled quite differently. If machinery and land are under the same rental contract, the money comes in as rental income rather than ordinary income. The two types of income are handled differently on Joe Farmer’s income tax return.

Transferring land and raised breeding livestock are handled differently from machinery, as land is considered a capital asset. Gains, or losses in some cases, are calculated as the sale price minus the purchase price, or inherited value.

A positive number is taxed at capital gains rates rather than the ordinary income rates. A positive capital gain in land sales paid overtime are taxed based on the amount of principal paid within a particular year under the contracted scheduled payment.

Breeding livestock raised by Joe Farmer is similar but not identical. Costs for raising these animals have already been expensed in previous years. Principal payments on a contract of scheduled payments will be taxed as a capital gain. Purchased breeding stock like bulls will be taxed as recaptured depreciation, similar to machinery.

Many options and opportunities exist when making these succession decisions. North Dakota Farm Management Education Program instructors across the state can aid in making the decisions that are right for these situations, which are structured for individual circumstances.

Olson is a North Dakota Farm Management Education Program instructor; he is not a tax or legal professional. Consult a professional for specific rules, methods and filings for farm succession plans. To learn more about farm succession planning and other financial questions, visit ndfarmmanagement.com, or contact Craig Kleven, state supervisor for agricultural education, at [email protected] or 701-328-3162.

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