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Critical Success Factors in Family Farm Transfer Planning

Learn about critical success factors in transferring ownership and management of a family farm. Understand transfer stages, tax implications of asset transfers, income tax considerations, and methods of transferring ownership. Explore sale, gift, and inheritance options along with the impact on income sharing arrangements.

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Critical Success Factors in Family Farm Transfer Planning

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  1. Don Hofstrand • Agricultural Economist www.extension.iastate.edu/agdm • Co-Director, Ag Marketing Resource Center www.AgMRC.org • dhof@iastate.edu • 641-423-0844

  2. Critical Success Factors(can you answer YES to these questions?) • Are the parents ready for a partner? • Is the child committed to farming? • Is the business large enough? • Do you have a Common Vision of your future together? • Can you live and work together? • Are the non-farming children supportive?

  3. Transfer Plan Transfer Stages Testing Commitment Established Withdrawal TransferOwnership Sale, Gift, Inheritance TransferMgmt. General Manager, Equal Voice DivideIncome Wage, Contributions, 50-50 Division, Lease

  4. Business Arrangements Transfer Stages Testing Commitment Established Withdrawal Multi-Person Spin-Off

  5. Transfer Period older party younger party Short Transfer Period time

  6. older party younger party time Transfer Period Long Transfer Period

  7. Multi-Person Arrangement Spin-Off Arrangement Two Basic Choices

  8. Business Business Business Multi-Person Approach P C P & C P C

  9. P Business Business Business Business Spin-Off Approach P C P C C

  10. Tax Implications of Asset Transfers Transfers Sale Gift Inheritance Transfer Taxes Sales Taxes Gift Taxes 1 Death Taxes 2 Income Tax 3 • Federal gift tax, no Iowa gift tax • Federal estate tax, Iowa inheritance tax • Federal & state income taxes

  11. Income Tax Implications Machinery Example $50,000 fair market value $30,000 income tax basis

  12. Income Tax Implications • Sale – tax paid Seller $50,000 sale value 30,000 basis $20,000 taxable gain* Buyer $50,000 basis *depreciation recapture & capital gains

  13. Income Tax Implications • Gift – tax postponed Donor $50,000 gift value (gift tax) 0 taxable gain Donee $30,000 basis

  14. Income Tax Implications Farmland Example $100,000 fair market value 60,000 income tax basis

  15. Income Tax Implications • Sale – tax paid Seller $100,000 sale value 60,000 basis $ 40,000 taxable gain Buyer $100,000 basis

  16. Income Tax Implications • Gift – tax postponed Donor$100,000 value (gift tax) 0 taxable gain Donee $ 60,000 basis

  17. Income Tax Implications • Inheritance– tax eliminated Decedent $100,000 value (death taxes) 0 taxable gain Recipient $100,000 basis

  18. General Considerations • Valuation • Appraiser • Dealer • Auctioneer • Disposal of machinery not wanted by successor

  19. Transferring Ownership(personal property) • Sale • Leasing • Gifting • Combinations

  20. Outright Sale • Simple • Tax consequences of seller • Depreciation recapture • Capital gains • Cash flow needs of buyer (third party financing) • New income tax basis for buyer

  21. Installment Sale • Payments spread over period of years • Spreads buyers cash-flow commitment • Tax consequences of seller • Depreciation recapture • Capital gains • Seller financed • New income tax basis for buyer

  22. Piecemeal Sale • Spread tax consequences of seller • Depreciation recapture • Capital gains • New income tax basis for buyer • Spreads buyers cash-flow commitment • Flexible—can vary sale amount from year to year • May use with a lease • If retired and not leasing out unsold machinery, cannot claim depreciation

  23. Gift • No compensation received by donor (giver) • No cash-flow commitment by donee (receiver) • Financial needs of donor • Equity issue with non-farm heirs • Gift tax consequences • $10,000 annual exclusion • No income tax consequences of donor • Donor’s income tax basis carries over to donee

  24. Combination • Sale/Gift • Buyer cannot afford to pay full value for assets • Seller cannot afford to give away asset • Better utilization of annual gift tax exclusion • Minimize sellers tax liability • Lease/Sale

  25. Order of Asset Transfer Younger Party Older Party Asset Operations & Feeder Livestock 1 1 Breeding Livestock 2 2 Machinery 3 3 Buildings & Facilities 4 4 Land 5 5

  26. Decision Making Authority • General Manager • On-going decisions • Both parties • Major decisions • Final authority

  27. Decision Making Authority • Equal Voice • Both parties • Final authority • One party • Vote • Arbitration

  28. Transferring Management • Child’s goal = Develop management • Parent’s goal = Protect financial interest and desire for control • Traditional parent-child roles • “Taking Things Easier” • Training ground • Written arrangement • Consistency of goals

  29. Tranferring Management • Division of Responsibility • Enterprise division • Functional division • Management Styles • Analytical vs. interpersonal • Competitor vs. peacemaker • Withdrawing from Management

  30. Income Sharing Arrangements • Contributions approach – share income based on contributions • 50/50 approach – pay a return to resources and share residual

  31. Contributions Approach Child Parent Resources (Annual value=$100) Resources (Annual value=$50) Joint Operation 67% contributed by parent 33% contributed by child

  32. Contributions Approach Gross Income $300 67% to parent = $200 33% to child = $100 Direct Expenses $100 67% to parent = $67 33% to child = $33 Net $200 Parent = $133 Child = $67

  33. 50/50 Approach Gross Income $300 Direct Expenses $100 Net Return $200 Parent’s Resources (an. value) $100 Child’s Resources (an. value) $ 50 Net $ 50 ParentChild $ 25 $ 25 $100$ 50 $125 $ 75

  34. Business Concept Opportunity Cost Assume I can use a resource in both Enterprise A and B. If I invest in A, the opportunity cost is the income I forgo by not investing in B. If I invest in B, the opportunity cost is the income I forgo by not investing in A.

  35. What is the annual value (cost) of a resource used in a business venture? Income Sharing Arrangement

  36. Contributions Approach 109,000 156,000 Parent’s Share = 70% 47,000156,000 Child’s Share = 30%

  37. Contributions Approach(allocating income) Parent’s Child’s Gross Income $186,200 $79,800 Prod. Expenses -65,800-28,200 Return $120,400 $51,600

  38. Contributions Approach(cash flow) Parent’s Child’s Return $120,400 $51,600 Land Taxes -8,000 0 Land Debt -35,000 0 Machinery Debt -4,000 -3,000 Net Cash Flow $73,400 $48,600

  39. 50/50 Approach Gross Receipts $266,000 Production Expenses -94,000 Net Return $172,000 Parent’s Land -52,000 Parent’s Machinery -24,000 Child’s Machinery -6,000 Parent’s Labor & Mgmt. -33,000 Child’s Labor & Mgmt. -41,000 Profit $ 16,000

  40. 50/50 Approach(allocating income) ParentChild Land $52,000 $ 0 Machinery 24,000 6,000 Labor 23,000 33,000 Management 10,000 8,000 Profit 8,000 8,000 Total Return $117,000 $55,000

  41. 50/50 Approach(cash flow) Parent Child Total Return $117,000 $55,000 Land Taxes -8,000 0 Land Debt -35,000 0 Machinery Debt -4,000-3,000 Net Cash Flow $70,000 $52,000

  42. Parent’s Perspective Transfer their dreams Inspection tour Advice on raising children Social life Daughter-in-law Son-in-law Problem Areas

  43. Problem Areas Adult Child’s Perspective • Accept parent’s lifestyle • Marriage spats • Confidant • Baby sitting • Carrying stories

  44. Keys to Success • Strengthen Family Relationships • Improve Communication Skills • Recognize Individual Differences • Allow for Management Participation • Practice Family Decision Making • Encourage Diversionary Activities • Separate Housing is Required • Fit the Agreement to the Situation

  45. Keys to Success(continued) • Develop a Written Agreement • Update the Business Arrangement • More than One Child • Concerns of Off-Farm Heirs • Parents Without an Interested Child

  46. For More Information Ag Decision Maker www.extension.iastate.edu/agdm

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