Now more than ever, there is strong demand for a transition plan that can meet a family’s definition of a “fair” plan for land transition yet is flexible enough to change with the planning environment.
There are reasons to divide land among heirs, but often dividing is the beginning of a transition out of the family. The best plan to replace yourself is to find a way to get your land to the “farm heir.” This may not be financially possible for all families.
A land entity like a Limited Liability Company (LLC) or a Family Limited Partnership (FLP) can meet the goal of keeping land in the family without dividing it.
The land entity can be a “Swiss Army knife” plan that is flexible enough to work in almost any situation.
The manager is responsible for collecting rent, paying property taxes, paying debt payments and making decisions for management and upkeep. The net rent is distributed (after expenses) to the ownership proportionately.
An important objective is to provide an opportunity for current family members (and future family members who might not even be born yet) the opportunity to farm the ground without forcing them to buy it.
Most entities use the Iowa State Extension rental survey as a guide to set the family rent price. The last few years have brought the need to add a flex lease calculation for increased production, increased prices or a combination of both. Remember that just because prices are high does not mean profits will follow.
We sometimes get push-back from uneducated family members and advisers about the “issues” of multiple owners of family land: “What if there are 25 owners of this land?”
A good operating agreement allows permitted owners the option to sell. If there happens to be 25 owners, it will be because they want to be owners (otherwise, they would have exercised their “put” option to sell).
The combination of the “put” option for permitted owners (who don’t want to be) to sell and a “call” option to buy back non-permitted owners assures that this entity will be owned by family members until no family members want to own the land.
Every family has differing opinions on how to value the land for these options. The process to value the land in the future for each family can range from appraisal to a stated discount off appraisal to special use valuation.
Special use value is a formula for valuing land (that is to stay in the family) for a cash flow value. This formula is set up under section 2032(a) of the internal revenue code. This is the truest representative value of land (based on the land’s ability to cash flow without subsidization).
Thirty years ago when I started in this business, federal estate tax was enemy No. 1. At that time, the federal estate tax exemption level was $600,000 per person and the exemption did not carry over at the first death between spouses.
Today, this exemption level has increased up to $12,060,000 per spouse and it is possible for the unused exemption to carry over to a surviving spouse (portability).
This has lessened the perceived need for estate tax planning. However, the current exemption will automatically reduce back to 2011 levels ($5,000,000 plus inflation since 2011) on Jan. 1 of 2026.
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If your estate is taxable at the federal level (40% tax above the exemption amount), a land entity can position you to make gifts of equity to the next generation and allow discounts to reduce an estate (depending on the operating agreement and the experience level of the professionals who are completing the estate plan tax return).
A multiple member LLC files an income tax return but is a pass-through entity taxed as a partnership (members are typically a husband and wife).
Certain tax districts allow that a farmer can pay rent into their family land entity. This becomes a rent deduction on schedule F that can provide tax savings for some self-employed farmers. Check with your income tax advisor before assuming this benefit.
Many families are concerned about future medical expenses, divorces or other potential liabilities.
Although this happens in a relatively small number of cases, you can be confident in the worst-case scenario if your land is in a land entity with rules that require family ownership and terms for buyouts that will cash flow in the event of a forced buyout.
Sometimes the timing is not perfect to make a transfer, but it can be invaluable to have the structure in place so that when the timing is right, you will have the confidence to make the transfer.
Communication is an important part of averting current and future family issues. The problem with communication is most of my clients do not know what to say or do not know how to say it.
Having the structure of a well thought-out operating agreement gives a family the confidence to communicate your wishes and more importantly how the process will work for the heirs in the future.
Your children may not like your rules, but there is a much greater chance they will respect the process if the rules are well written and communicated.
Beginning in 2023, the state of Iowa has eliminated the state income tax on retirement income. This includes IRAs and pensions. It also includes rental income on land owned and farmed for 10 years by those age 55 years or older who are retired.
Unfortunately, the original tax law did not include rent from a multiple member LLC. Those who have established land entities to preserve future land ownership will have to weigh the loss of future Iowa Income Tax savings (3.9% of net income) against the other advantages that the entity brings to the table.
Rather than waiting until death and hoping the next generation figures it out on their own, the land entity offers the ability to begin making transfers to the children and the grandchildren while living so they can understand, appreciate and connect with the ownership of the land.
My sincere hope is that the two sides of any family land issue can negotiate an agreement, but if not, the main function of the “Swiss Army knife” land entity operating agreement is to have a set of rules to fall back on to mediate disagreements the way you would have wanted.
For 30 years, Steve Bohr has been a partner in the farm continuation firm of Farm Financial Strategies, Inc. For additional information on farm continuation issues or if you have a question, contact Steve via email at Bohr@FarmEstate.com or by phone at 1-800-375-4180.
