Who’s not interested in a price discount, right? The concept is common amongst most producers while purchasing seed or other crop inputs, but not so much when it comes to farmland. However, from an estate planning standpoint, the use of discounts is an underutilized tool for managing potential tax liabilities.
What are the potential tax liabilities? Federal estate tax is not much of a concern as the current exemption is $11.58 million per person before your estate becomes taxable. Uncertainty over changes in federal tax policy hangs over all of us. Some states also impose their own individual tax. The state of Illinois, for example, begins imposing a tax on estates over $4 million.
One Illinois couple I am working with owns a $10 million estate with an estimated tax liability of near $500,000. When they first contacted me they were planning to gift away $2 million of their land to their children. This would reduce the size of their estate to the $8 million state exemption available to them as a married couple. In their viewpoint, they would rather gift the kids some of the land now versus their estate incurring a half million dollar tax later.
First, we added advanced planning strategies to provide them more flexible tax planning through their respective estates. Now, various gifting strategies can be considered, but after several meetings with them and their family it turns out placing their land into an entity will serve them as a transition plan to their children. This entity also creates the opportunity for discounting the value of their farmland and remove the motivation for making a $2 million gift, at least for now.
You may ask: how? The answer is the IRS recognizes discounts for assets held in a closely held family entity for lack of control and lack of marketability. It is less desirable for someone like you, a non-family member, to buy “entity units” from them compared to purchasing an outright parcel of land. I have seen the legal community apply valuation discounts anywhere from 15% to 35% for this reason. A 30% discount on $10 million of farm real estate compresses the value to $7 million, all on paper, and keeps a half million of potential tax dollars in their pocket. An attorney once described it to me as a nerf ball. Imagine squeezing and compressing your farm’s value as you pass it down to the heirs of your estate, then releasing it to expand again after ownership changes hands.
There are many types of entities for you to choose from (trusts, corporations, limited liability company’s, etc). The long-term consideration for one is if you plan to leave your farm to multiple children.
The Illinois couple mentioned above has five children. Their wishes are for their children to share and share alike. Their estate plan left each of them an undivided one-fifth of their real estate. This was a potential pitfall for a farm transition plan gone wrong. Why? It only takes one owner of an undivided interest to force a partition sale on the entire family.
Alternatively, if the five children each own an equal share of a family entity this helps hold the farm together, decreases the likelihood of partition, while providing an ownership structure to help facilitate leasing and purchasing to stay within the family. The children will still maintain ownership and control but now subject to a majority vote of them, not each one of them individually holding this power.
Consider a land entity if you plan to leave your farm to multiple children. They are an excellent alternative to facilitate co-ownership of real estate, while containing many potential side benefits such as the entity discounting noted above.
Email your comments or questions to Mike at [email protected].