Brown & Associates - Attorneys & Counselors at Law, P.L.L.C.

TRANSITION PLANNING FOR THE SMALL FARM, RANCH OR BUSINESS
(3/18/01)

I'm a small rancher. How do I make sure there's something left
after taxes to pass on to my kids?

You are like many of my clients, farmers, ranchers or small business owners, who want to pass their property down to their children, but can't figure out how to do it.

Usually, the numbers just don't work out right. If, for example, your farm constitutes the bulk of your assets, how can you pay the estate taxes, leave the farm to the child who is working it, and still take care of your other children?

Let's start with the division of property among your children. I'm not forgetting about the tax problem, but I want to talk about the business transition part first.

There are several ways to skin this cat. Let's assume we're talking about the family farming operation above and let's further assume further that you have three children, only one of whom is actually farming with you.

One way of dealing with this situation is to transfer your farm to a revocable trust. Then, in your trust, provide that at your death your estate will pass equally to your children subject to certain funding provisions.

The funding provisions are the key to success in this situation. You can provide that the "working" child's interest will be funded out of the family farm. Then, if the value of the farm exceeds that child's share of your estate, you can add a "right of first refusal" purchase option. That is, the son working the farm can buy it from the other children according to the terms you have set out in the trust.

But how does this "buy out" provision work? How can I make sure my non-farming
children don't get the short end of the stick?

That's a valid concern, and it isn't always easy to address. For example, you don't want the child working the farm to have to buy out the other children at too high a value. All this will do is guarantee he (or she) will have to sell the farm, which isn't what you want.

One way of avoiding this problem is to provide in your trust that the farm will be valued at its "working interest" value, not its fair market value. By this, I mean you want the farm to be valued at what it is worth as a working farm, not what it would be worth in you cut it up and sold it to a real estate developer.

Okay--I understand the valuation part, but how do I make sure my other children
don't starve while they're waiting to be paid for their share of the farm?

I'm with you. You sure don't want the non-working children to have to wait for thirty or forty years to get their money. What can you do?

One thing you might consider doing is establishing a period of time for the payoff, subject to a balloon payment at the end. You don't want the "non-working" children to have to wait too long for their money, but by the same token, you don't want to put the "working" child in a bind by making him pay off the "non-working" children too early.

The way around this is to have the working child make regular quarterly or annual payments to the non-working children over a set period of time (usually 10-15 years), and then require him to pay them off at the end of that period. By then, he should have paid down the amount due enough that he can qualify for a bank loan.

All right, I'm okay with that, but what interest rate should I charge the working child?

You should specify in your trust how to calculate the interest rate to be charged during the initial 10-15 year period. I know, easy to say, but how do you do it?

There really are any number of ways of arriving at a fair rate. You might want to let your children agree among themselves. Then again, if your children don't get along that well, you might designate an arbitrator who will set the rate if your children can't agree.

You can always use the thirty (30) year limited resource rate then being charged by a financial institution, such as the FARM SERVICE AGENCY, for such farm land loans.

Actually, you can set the rate any way you want to, even if the rate you choose is below (or above) the rate then being charged in your area.

This just touches the surface of transition planning. Next week I'll talk about additional transition ideas, as well as ways of possibly reducing or eliminating the estate tax at your death.

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