Three Succession Solutions for Family Farms

August 18, 2016
Updated on October 9, 2020

Splitting up your family farm is not a simple process. You must determine how your family can sustain farm operations in later generations while dividing the estate equitably among your children. This gets particularly tricky when some of your children are working the farm and others are not. In addition, the USDA explains how the transfers of family farms may be subject to federal and state estate taxes. Thus, building a detailed succession and estate plan for your family farm is essential; a failure to do so puts both family harmony and your most valuable asset at risk.

How can you pass the farming business—and access to the land and equipment necessary to run it—to those family members active in the farm without neglecting those members who may not be involved with the farm’s operation? Fortunately, there are several ways to reach a compromise.

Family members can purchase the farm from you once you have reached retirement age, and the proceeds can then be incorporated into your estate plan and divided among all of your heirs accordingly. However, this can result in capital gains and recapture taxes, which reduce the value of what you can pass on once you die. It also requires that the family members purchasing the farm either have access to potentially large amounts of money or acquire debt to complete the purchase.

Alternatively, the family members who will continue operating the farm can purchase the farm after your death. This way, they can take advantage of estate planning rules to eliminate the capital gains tax, as the farm receives a step up in basis after your death. However, they may have to pay more to purchase the farm at your death instead of your retirement if the farm’s value increases during that period of time. To get around this, you could agree to give the purchasing family members a set price or predetermined discount ahead of time, factoring in your overall estate plan. (Whether they buy the farm before or after your death, you may also establish a mechanism to credit the purchasing family members with sweat equity that they have put into the farm or any rent they have paid to you to stay on the farm.)

You may also split the farm up, giving individual pieces out equally or giving each family member an undivided interest in all pieces of the property. You may then give specific family members the right to rent that property from the other family members for their lifetime or another specific time period. With this technique, specifically stating the mechanism to establish the rental rates in estate plans is crucial. The rate, for example, could be tied to the average for the county, plus or minus a percentage. The more specific the terms, the less room for ambiguity and family arguments.

No matter the option farm families ultimately choose, it is crucial to have a detailed, formal plan in place that outlines terms and, when possible, minimizes taxes. An estate planning attorney can help with this.