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Family Business Matters 08/20 04:58
The Land Inheritance Conundrum
Estate tax mitigation strategies, like placing farmland in LLCs or trusts,
can reduce tax burdens but may complicate family relationships through shared
ownership and unclear exit strategies.
Lance Woodbury
DTN Farm Business Adviser
Many family farm and ranch owners inherited land from earlier generations.
It may have been the original homestead or land their parents or grandparents
bought when they began farming or ranching. I even know of two parcels won in
high-stakes card games.
This land passed as an inheritance often gave the next generation a
foundation to grow the business. What began as a quarter, or a section, has
likely grown into hundreds, if not thousands, of acres.
That land is now worth more. And, even if there aren't that many more acres,
the proximity to an urban area, or the development or recreational potential of
the land, can add significant value. If you have grown the business, your other
assets are worth more, too. Livestock, equipment, infrastructure -- it all adds
up.
For an increasing number of farming and ranching operations, this means the
prospect of paying estate tax upon the death of the senior generation, which is
triggered when an individual's assets exceed $15 million, $30 million for a
couple. It sounds like a lot, but every year, it takes fewer acres to reach
that threshold. Few family business owners relish the idea of their children
selling assets to pay estate tax.
Which leads back to inheritance. Many estate tax mitigation strategies
involve placing land into an entity, such as an LLC, and then giving "units"
(similar to shares) to your children during your lifetime. A related strategy
includes placing land in various types of irrevocable trusts. Your children,
instead of receiving an outright gift of land at your death, now receive
ownership, or become the beneficiaries of, land held together in an entity.
These strategies can help reduce the value of your estate in the eyes of the
Internal Revenue Service.
While these tools help mitigate estate tax, they come with challenges,
particularly if you are gifting ownership to multiple children.
Consider the following:
-- The gift takes place now, but the benefit comes later. Generally
speaking, most gifts are given for the recipient to use as they see fit. But by
placing land in a business entity or trust, the point is to do things now that
reduce the estate tax burden that heirs might have to pay later. The gift has
little "useful" value to the recipients today; it reduces the giver's estate,
which will translate into benefits for the recipients -- but not until the
future. This fact isn't always communicated well by the senior generation and
can create unrealistic expectations among heirs.
-- The gift creates a business partnership. By placing land into a business
entity or trust, and making people owners or beneficiaries, ownership is
transformed from physical assets to percentages. Siblings and heirs, kids and
grandkids become partners in an instrument in which they had little choice to
join. They may indeed be grateful for the gift but resentful of being
financially hitched to one another.
-- The gift needs an eventual exit strategy. Partnerships can be easy to
enter and difficult to exit. By creating a business tie among family members
through an entity or trust, the question should also be asked: "How do future
generations get out of business together?" We all know families torn apart by
emotional negotiations over inheritance. Give them a framework to sell their
interests to one another to reduce friction in their future business
relationship.
Giving land to future generations can be a wonderful blessing. But, when
coupled with some advanced estate tax mitigation strategies, it can complicate
the family relationship. Be sure to thoroughly discuss the pros and cons of
your ownership transition strategy with your advisers and family members.
Lance Woodbury can be reached at lance.woodbury@pinionglobal.com
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