Business Management: It‘s never too early to plan for a successful transition

By Susan Harlow

A turbulent dairy economy makes many things difficult for producers, including one of the most important decisions they’ll ever make: transferring the farm land and business to the next generation. And as dairy operations grow larger with greater assets, “it’s harder to transfer them, and you need more money to take over the business,” said George Twohig, a Chilton, Wis., agricultural attorney with Twohig, Rietbrock & Schneider.

Gordon Richardson and his two sons, Scott and Reid, are just part of a large family running a 105-year-old Vermont farm. Figuring out how to pass it along is complicated, Gordon said.

Bringing the next generation into the business often depends on the commitment of parents to transfer the farm at a price the children can afford, while making sure there’s enough money so the farm can retool and modernize for the future, Twohig said.

That’s different today than during the 1970s and 1980s. “With lower-value assets, little inflation and no influence from off-farm investors, you could sell the farm to your children outright at a reasonable price,” Twohig said. But now, land that was $1,000/acre is now many times higher in value.

Land is essential to a farm’s continued success, so producers are finding ways of effecting a transfer besides outright sale. “Today, more parents are bringing their kids in as partners and having them earn equity rather than buying equity,” Twohig said.

Crucial to any successful transfer between generations is good communication. “What makes a farm transfer not work is not the financial aspect,” Twohig said. “It’s the delicate nature of human relationships. Honest communication is important, and that they share values.”

Don’t procrastinate

Farm transfer is often a complicated affair and can take a long time. Bob Parsons, Extension economist with the University of Vermont Extension Service, and Mike Sciabarrasi, Extension professor with University of New Hampshire Extension Service, give workshops on farm estate planning. They emphasize the need for family discussion and communication – before it’s too late. Parsons tells the tale of a farmer who asked for assurance his wife would not sell the farm – as he was being wheeled in for open-heart surgery.

“(Estate planning) is one of the easiest things to put aside that there is – but it’s a very difficult thing to figure out,” said Gordon Richardson, a Hartland, Vt., dairy producer who has attended seminars with his wife, Pat. “One of the most important things is legal advice from people who know, because there are so many legal angles that it makes all the difference in the world.”

Gordon and his brother, James, are partners in the farm with Gordon’s sons, Scott and Reid. A number of family members, including grandchildren, help out.

The older generation is gradually turning the farm over to Scott and Reid by gifting the maximum annual allowance, based on the appraised value of the buildings, equipment and a herd of registered Jerseys.

They have yet to decide what to do with the real estate, which Gordon said is “the biggest problem.” That’s because there are off-farm heirs to consider: James has three daughters; Gordon has a son not involved with the farm.

One possibility is a trust. But Gordon believes the land should be controlled by those who farm, not tied up in a trust.

The number of family members and the farm’s landscape and location complicate the matter. The high, 450-acre hill farm would be almost impossible to dairy on a large scale. Yet, located just a few miles outside the affluent town of Woodstock, the Richardson Family Farm – Vermont’s Green Pastures Award winner last year – would bring a large chunk of money if sold for development. A “high-value, low-productivity farm,” Gordon calls it. “There just isn’t enough to go around that the pie can be doled out in too many pieces.”

The farm has been in the Richardson family for 105 years ago. Like his grandfather and father before him, Gordon is not relying on the farm for his retirement.

“Frugality has always been an important part of farm life,” he said. “I‘m not saying we’re not looking out for ourselves – but we don’t want a home in Florida.”

Communication is a critical component of estate planning.

In family meetings, both older and younger generations should identify and talk over their goals and objectives, Parsons said. They need to be realistic about the income the farm can generate. “If the farm could just barely support one family, how could it now support two?”

For effective family meetings:

• Use a facilitator – someone familiar with the family, such as Extension or agricultural agency staff, or someone from a lending institution.

• Set an agenda and stay on topic.

• Don’t get wrapped up in personal issues.

• Determine the major challenges – don’t try to solve all problems at once.

• Leave all grudges at the door.

Then, as producers consider estate planning, they’ll need to address major issues, including how to fairly accommodate off-farm heirs; potential business structures; and the elder generation’s retirement.

Give some thought to retirement:

• Decide on your vision and goals for retirement. Are they workable?

• Set a timetable for retiring to give the younger generation a roadmap.

• Answer questions: Where will you live? What will you need for health and long-term care? How much money will you need? Where will you get that money? Will you continue as owner and/or work on the farm? Or will you rent or sell farmland?

In today’s economy, securing retirement income can be difficult, Parsons said. The volatile market can mean investments lose value, and low interest rates may limit income. “You should be diversified in investments and expect volatility.”

• What about family relationships and support? Will you live with your children, maybe as part of a farm transfer?

If you are planning to transfer the farm to farming heirs, there are three basic options: sell it, give it or will it.

• Sale. Because of the size of today’s dairy operations, an outright sale is seldom feasible. Selling the farm piecemeal, as the buyer can afford it, is difficult to do with land. Selling in installments can spread income and taxes over several years, but the IRS requires at least a minimal interest rate.

If you want to sell the farm to heirs at a price below market value, consult an advisor first, Sciabarrasi said. If the value is too unrealistic, the IRS will likely consider at least a portion of the “sale” a gift.

• Gift. A person can give farm assets to family members, or anyone else, of up to $13,000 per individual each year. In addition, each person has the lifetime ability to give $1 million away without incurring gift tax.

• Inheritance. The estate pays any estate tax due. There is no estate tax for 2010. But in 2011, the federal estate tax reverts to any estate valued over $1 million, with a maximum rate 55%. The state estate tax rate depends on the state you live in.

Meanwhile, you may want to farm with your children or farm separately as you make the transition. “It’s not just a real estate change, but a change in labor and management responsibility and income,” Sciabarrasi said. “But both are moving the business from a parent to a child. When you do this, you have to remember it’s not just about property. You’re giving the younger generation some experience in management so they can someday run a business themselves.”

Options to consider:

Farming together.

1. Younger generation starts as an employee, gains management experience and some ownership of farm assets.

2. A business structure is formed with the older generation as they share management responsibilities and profits.

3. The older generation retires, leasing the real estate to the younger generation.

Farming separately

1. Younger generation starts as employee, gains some ownership of assets.

2. Younger generation spins off a separate business but shares equipment, land and/or labor with older generation.

3. Younger generation buys or leases original farm assets.

If assets are transferred gradually, it’s important that the first assets to be transferred are those that are more “portable,” such as breeding livestock and machinery, and could go to another business if the original arrangement doesn’t work out.

What’s fair? If farm owners have heirs who aren’t involved in the business, they face the fair vs. equal dilemma: What is equitable may not be fair and equal distribution is seldom ever fair. “The challenge is – you want to treat off-farm heirs equally,” Twohig said. “But if 90% of assets need to go to on-farm heirs, there’s often very little to transfer to off-farm heirs.”

Splitting up a farm, while it might be “fair” to off-farm heirs – will often mean the end of the farm. “If you are going to have multiple farmland owners, It’s essential that the operator of the farm be in control of the land,” Parsons said. This can be solved through a business structure that defines the role of various owners.

Business structures exist today, such as limited liability company (LLC), limited partnerships and, in some state, limited liability partnerships, that can help solve that dilemma, ease farm transfers and address tax issues. The main options are:

• Sole proprietorship

• Partnership

• Corporation. However, it’s never advisable to put real estate in a corporation. If the corporation is dissolved, you could take a big hit in taxes, Sciabarrasi said.

• LLC. An LLC is an entity legally separate from the owners which gives them the tax advantages and flexibility of a partnership. It requires the parties to have an operating agreement, governing what LLC members can do.

In transferring the farm to farming heirs while accommodating off-farm heirs, you can use a combination of business entities to make it work, Sciabarrasi said:

• Set up an LLC with farming parents and children. The LLC owns the inventory, breeding stock and machinery, and leases real estate from parents. The LLC can acquire more assets as needed. The real estate is addressed separately later.

• Or, combine business structures. An LLC or limited partnership that includes all the children and whose members own the real estate. Then, in a separate, farm-operating entity such as an LLC or corporation, the members include only farming children.

“So the farming heirs control the land (members) and off-farm heirs have some ownership (non-managing members of LLC),” said Sciabarrasi. “That way you distinguish between membership and control.” This type of ownership arrangement will allow non-farming members to share some of the farmland appreciation if it is sold, but limits them from having any say in the farm operation.

Another option is a trust, a legal entity that also exists apart from people who control the property. A revocable living trust enables more sophisticated planning and has advantages for farm transfers, Sciabarrasi said. For instance, the trust can control property during the trustmaker’s life and after death. Property in a trust doesn’t go through probate.

Finally, Sciabarrasi has these suggestions for a successful transition:

• Identify your business mission and goals.

• Identify a willing, capable successor.

• Encourage successors to gain experience off the farm.

• Give them an opportunity to learn management responsibilities.

• Identify realistic income from the farm.

• Don’t underestimate capital needs.

• Create a survival kit for your successor – an up-to-date will, property deeds and operating agreements.

• Communicate with family members not in the business.

FYI

• For more information see:

www.agtransitions.umn.edu

www.uvm.edu/farmtransfer/

www.farmtransfernewengland.net/

• Contact Bob Parsons at bob.parsons@uvm.edu or call 802-656-2109

• Contact Mike Sciabarrasi at Mike.Sciabarrasi@unh.edu or call 603-862-3234.


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