One of the more common challenges we face when planning for farm succession is the high value of farming operations. With much of Ohio’s better farmland valued at $6,000 per acre or more, and some tractors and combines costing several hundred thousand dollars each, it is easy for even a moderate sized farm to be worth several million dollars. This high value often makes it difficult for the next generation to come into ownership.
Consider the following example. Three brothers have farmed for 50 years, and through hard work and sacrifice, have built a farm worth $5 million. Three sons and daughters would like to continue the farming operation. The three children have been working on the farm for modest wages to help the farm continue to grow. As such, they do not have significant funds available to purchase the farming operation from the three brothers.
Even if they could buy the farming operation, the capital gains taxes would be enormous for the three brothers. While the brothers are willing to gift some ownership to the three children, making large gifts of ownership might be unfair to other children who are not on the farm. So how do we get the three children into a multimillion-dollar farming operation?
The answer is that sometimes we don’t. Instead, we start a new farming operation for the next generation. The old operation gradually transitions acres, livestock and other operations to the new farming operation. This transition may take a few years or 20 years — it just depends on the family and the farming operation. Establishing a new operation eliminates the need for the younger generation to buy into the existing operation or to be gifted significant ownership.
Using the example above, the younger generation establishes an LLC. In the first year, the three brothers allow the new operation to farm an 80-acre farm owned by the three brothers. The new operation leases the land and equipment from the three brothers, usually at below market value. In the second year, the older generation transitions another 100-acre farm to the new operation. Over a 10-year period, all the land (owned and leased) is transitioned to the new operation.
At the end of the 10 years, the brothers still own all their land and some equipment. The new operation started to buy some of its equipment along the way and now owns a significant line of equipment itself. The three brothers now provide labor to the new operation, but they’re are not tied down to the farm on a daily basis.
The goal of this strategy is for the older generation to gradually transfer the management and operations to the younger generation. The older generation maintains ownership of its land and maybe keeps some equipment to help manage income taxes. The older generation has accomplished the goal of most farmers — to go from being the decision-maker to the tractor driver.
The older generation will need to subsidize the younger generation. It is almost impossible to start farming today having to pay full price for land, machinery and inputs. The subsidies will usually be in the form of lower land rent, lower machinery lease rates, loaning of operating capital or some combination thereof.
If you are struggling with a plan to bring the next generation into your well-established, high-value farming operation, consider setting up the next generation with its own farming entity. This strategy is not without its challenges, but it does have the advantage of providing some amount of independence to each generation while essentially keeping the economies of scale that larger operations enjoy. Day-to-day business includes everyone still working together as a family to grow the family farm; but from a management and financial perspective, the transition is real, with both generations benefiting from the new roles.
Moore is an attorney with Wright & Moore Law Co. LPA. Contact him at 740-990-0751 or firstname.lastname@example.org.