In order for there to be a successful transfer of assets and management to the next operating generation, there are several things that should be considered. If they are ignored, the transfer could experience more stress than necessary. This article lists some of those considerations and outlines conversations and discussions that need to occur to have a smoother transfer from one generation to the next.
First, consider the financial needs of both generations.
The Older Generation: There need to be plans for the income that the older generation will be receiving. In some cases, the older generation assumes that the younger generation will pay cash rent to provide the income that they will need. That needs to be discussed carefully and openly.
The older generation might need cash to “buy our place in town,” or to fix up their current home to accommodate them as they get older. It is very typical for this generation to put off traveling until they are older, and now they want to be able to do so, which will also take cash and planning. The older generation will also want to consider how they plan to take care of the non-farmer/rancher children. This might include passing cash, life insurance, stocks, bonds and other non-farm operating assets. Please refer to Fairness in the Succession Planning Process for the discussion of the fair vs. equal argument for transferring assets to heirs.
The younger generation: The next generation of farmers and ranchers have their own financial needs that need to be met so they can appropriately maintain and grow the operation. Their lifestyle or family living expenses need to be realistic and financially met. How the next generation manages debt and their debt load will require strategic planning, marketing and management to help with a smooth transfer. There should be honest discussion about the labor needed and hours worked between the younger generation and the older generation, so the work expectations are met.
Second, there should be a defined path for the transfer of the operation.
Testing the younger generation to see if they want to farm or ranch
Control of the operation is very tough to give up for some farmers and ranchers. In some cases, the older generation wants to “test” the younger generation to see if they are willing to do all the tasks prior to their giving up control of the operation. This can be a double-edged sword. On one hand, you need the younger generation to work on the unpleasant, manually intensive tasks that become harder for the older generation. On the other hand, if you don’t allow the younger generation to move on to other tasks, they may not want to continue to work in what seems like a dead-end position.
A typical succession/management transfer has to be planned, which means that the plan should be written down with steps and dates outlined. It is unfair to all involved to have all the management transfer to the next generation all at once. This will disappoint both parties. The younger generation will be disappointed that the older generation doesn’t respect their autonomy to make decisions. The older generation will be disappointed that the younger generation does not do things the way that they would want them done.
The management probably should be transferred in stages. For example, give the younger generation one farm to manage, allowing them to make all decisions for that asset. They would, for example keep records and observe and track what went right and what didn’t go well. The next generation will learn faster and learn more from making their own mistakes than they will any other way. As they develop experience, more and more assets would be assigned to their control.
Machinery and Livestock Transfer
For machinery transfer, consider using the gift tax exclusion each year as you bring that next generation into the operation. In 2020, the gift tax exclusion is $15,000 for the year. However, dad and mom both have that exclusion. So, they can gift up to $30,000 as a couple to their son or daughter, or anyone for that matter. If the next generation is married, they can also gift the same amount to the spouse.
Generally, livestock transfers occur when offspring are born. For instance, 20% of the calf crop is assigned to the child who has helped with all the calving this spring. This will start his herd and ownership of livestock. This is just one way that the transfer is accomplished. There are other methods.
Most of the time, land transfer occurs when the older generation passes. The main reason that it occurs at this time is to avoid any problems with capital gains. If the land is passing via will, trust, limited liability companies or other structures, the succeeding generation generally receives the increased basis when the older generation passes and does not have capital gains tax issues.
Finally, if you want that next generation on the farm, write your documents to reflect that.
Sometimes problems may arise when farmland ownership is shared by on-farm and off-farm heirs. A buy-sell agreement can address these issues to ensure that the on-farm heir is able to successfully manage the operation over the long term. A buy-sell agreement can establish who has the right to purchase certain assets should you decide that an off-farm child would inherit farm ground that is integral to the farm operation. The buy-sell agreement can also state the on-farm child has a first right of refusal to purchase certain assets should the off-farm child or their descendants ever want to sell the asset. There are also certain structures such as trusts, limited liability companies and corporations that may provide certain direction for future generations on the use of the farm assets. A properly drafted buy-sell agreement can make it easier for the on-farm heir to purchase its farm based on its earning capacity rather than at the land market peak.
Consideration also needs to be placed in the use of cash rental/crop agreements between the on-farm and off-farm child so the terms are predetermined and the ground is not rented or leased to a non-family member. In some cases, the next generation on-farm child is given a discount from the appraised price for purchasing or renting/leasing with these agreements.
These are just a few documents which help preserve the farm operation by establishing guidelines that give the next generation a chance at succeeding.
Be sure that your family accounts for testing, management transfer, machinery/livestock transfer, land transfer, and write detailed documents as you discuss the smooth transfer to successors. Having these issues discussed and having well thought out plans will go a long way to insure that family farm continues successfully for another generation.