Property Taxes: Farmers Must Plan Carefully to Keep Agricultural Homestead
With the first half of real estate taxes recently being paid, most of us probably took a good look at our property tax statements. For farmers, the Agricultural Homestead classification represents significant tax savings. There are a number of ways to obtain Ag Homestead – the most common being simply living on and farming the land. Farmers can even “link” farms together to extend the same classification to farms that are further away from the homestead as long as the parcels are at least 40 acres and within 4 cities or townships of the home farm.
Ag Homestead classification extends some other very important benefits. Most important for many farmers is the qualified farm property deduction. Under the Minnesota estate tax laws, a farmer can deduct the value of his farmland from his Minnesota estate tax return if it meets certain requirements. One of those requirements is that the farm is classified as Ag Homestead in the year of death. Those claiming the deduction in 2015 can deduct up to $3.6 million of farm land from their Minnesota estate tax return – a huge deduction! This just reinforces the tax savings from Ag Homestead classification.
However, county assessors have recently begun paying much closer attention to how agricultural property is owned. Unless the property is owned by the exact same ownership entity, or can qualify some other way, the property will lose its Ag Homestead classification. Without taking the homestead rules into consideration, many estate plans that otherwise make sense can disrupt this tax preferred status.
Take this common scenario: Husband John and Wife Daisy decide it is time to do some estate planning. They own a few hundred acres of quality farm land in Southeastern Minnesota. In order to avoid probate and to give them some flexibility in estate tax planning, they form trusts to hold their farm land. They put half of the land in John’s trust and half in Dorothy’s trust. This is probably an otherwise good plan from an estate planning point of view. Unfortunately, this plan can be very costly for their overall tax planning if it does not include solutions for real estate taxes.
Here’s the problem: Ag Homestead classification can only “link” to property that is owned by the exact same ownership entity. Instead of John and Daisy owning the property together, we now have two separate entities (John’s trust and Daisy’s trust) owning the property. Even though the properties have only been reallocated for estate planning reasons, the county assessor will remove Ag Homestead classification for one of the trusts. John and Daisy need to find a plan at the intersection of estate, real estate, and income taxes. Moving the farmland into revocable trusts for estate planning reasons is of little use if it will cost them thousands of dollars year after year.
This problem also arises when families put their farms into a corporation, LLC, or LLP. Putting land into one of these entities can be a great way for farmers to plan for taxes, centralize management, and transition ownership gradually. Without careful planning, all the land in the entity could be stripped of its Ag Homestead classification for the same reasons. Even though the properties owned by the different entities are part of the same farm, they do not qualify for “linkage”. Individually-owned parcels cannot be linked to partnership-owned parcels.
Losing Ag Homestead classification can result not only in thousands of dollars of extra real estate taxes year after year, but also the loss of potential estate tax savings. Often times, plans that are beneficial for estate planning, business, or other reasons fail to take into account real estate taxes. There are a number of ways to ensure that these plans do not disrupt the Ag Homestead classification. The best estate plans take into account real estate taxes and income taxes, as well as estate taxes.
Sometimes, parcels that are further away qualify for Ag Homestead but have not been properly classified. Any farmer owning parcels of at least 40 acres within four cities or townships of the home farm should check to be sure their property has the right tax classification.