The process of transitioning the family farm often begins long before any assets are moved from the retiring farmer to the successor. Generally, the succession plan is a done gradually and involves some gifting/discount by the retiring farmer and buy-in and time commitment by the successor farmer. When farmers are ready to begin the transition there are a few common strategies they can use that are highlighted below.
One simple way to start the process is for the younger farmer to begin purchasing new machinery and livestock as the older machinery needs replacement and livestock is sold. This can often be done more informally than some other succession techniques. For example, a dairy farmer could transfer every third calf born to the successor. Over time, this will move the herd to the successor and give the successor the cash flow needed to make other investments in the operation.
This same concept can be used in a more formal plan through the use of entities. As part of this, the family could establish a limited liability entity, such as an LLC, to hold operating assets. The interests in the LLC could then be gradually moved to the next generation. The retiring farmer can then transfer a small piece of the whole all at once rather than transferring the operation one asset at a time. The LLC also gives the retiring farmer more flexibility in terms of cash flow, taxation, buy-sell terms, and control of the operation. For example, the retiring farmer can transfer the economic rights in the entity to the successor while retaining the voting/controlling rights. This gives the successor a chance to learn more about the operation and start making decision, but the retiring farmer can still step in when needed. A buy-sell agreement between the members of the LLC is an important contingency plan when using an LLC. The buy-sell agreement covers situations like death, disability, divorce, or bankruptcy of a member.
Typically, the retiring farmer would retain the farm land and keep it separate from the operating entity. The operating entity would then rent the farm land from the retiring farmer. Sometimes the farm land is held in another entity, such as a limited liability partnership or LLP. However, farmers and advisers must plan carefully when changing ownership of farm land to an entity or trust to avoid losing agricultural homestead classification. Our previous post covered some of the pitfalls with entity ownership of farm land. If the retiring farm does decide to transfer the land to the successor, the retiring farm will also need to plan for capital gains taxes and any estate or gift tax implications.
Starting a farm succession plan can be an exciting and anxious time for the families involved. Establishing a well-thought out succession plan can make the process much smoother. As part of this process, it is also important to remember that the successor farmer should have an opportunity to form good relationships with lenders, suppliers, and farm advisers to support long-term success.
The attorneys at Ward & Oehler have been helping farmers with succession and estate planning for over 40 years. To speak to an attorney or to schedule an appointment, call us at (507) 288-5567 or contact us on our website.
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