Farm transition planning isn't something many farm families want to discuss. The process that creates a blueprint for a farm's future is often an emotionally charged issue, especially when family farmers face the challenges of relinquishing control to the next generation.
Some farm families use a gifting strategy to pass on assets. Gifting can have massive tax implications, especially when tax laws seem to change every few years. Financial, tax and legal professionals should be consulted prior to gifting assets as a part of your transition strategy, but families can begin by considering several pros and cons to this transfer method.
Pro #1: Future estate taxes could be lessened
While holding off on gifting assets like land or equipment until death currently helps cut out capital gains taxes from an intergenerational transfer, the estate tax can create its own challenges, especially given that the current $11.7 million exemption for 2021 is slated to revert back to an amount roughly half that in 2026.1 For large farm estates, gifting some assets now may help ease the overall tax burden of both parties involved in the process.
Con #1: Step-up in basis does not apply
Many farmers have an incentive to hold on to highly-appreciated assets like farmland because of the step-up in basis that occurs at death. If land or equipment are gifted during one’s lifetime, the same doesn't apply and that could lead to tax issues down the road. "A party receiving gifted assets during life will not receive a step-up in basis. The cost basis in assets that are gifted carries over to the new party. This could result in large capital gain taxes for some items sold by the recipient," says Ryan Patton, JD, MBA, of Nationwide’s Advanced Consulting Group. "If the gift is made to the receiving party after the death of the owner, the basis in that asset is reset based on the executor’s assessment of its current fair market value. This step-up in basis allows the receiving party to now sell that asset potentially free from capital gains tax."
Pro #2: Successor's borrowing capacity could increase
Most farmers rely on loans to cover operating expenses and capital improvements to their operations. And a farmer's ability to secure those loans may be improved after taking ownership of recently gifted farm assets. "Farming is a capital-heavy venture, generally requiring loans on a yearly basis for operations. For a farmer, this may mean using your farmland as collateral for a loan. These operating loans may be challenging to receive if that farmer does not have collateral to secure the loan," Patton said.
Con #2: Loss of control by the senior generation
Not all farm transitions are smooth. Some may involve conflict and tension when the next generation makes management decisions the senior generation may not agree with. "When an asset is gifted, it is no longer in the senior farmer’s control. It’s important to consider how family friction could impact the farm’s financial success." Patton said. With so many variables surrounding gifting assets during a farm transition, no two operations will go through the same process. Before considering a gifting strategy, consider its impacts with help from qualified professionals.