Succession Planning Transfer Strategies - Bequests at Death
THE COUNSELOR
Volume 11 • Issue 5 • May 2021
The Counselor is a newsletter of Hallock & Hallock dedicated to providing useful information on estate planning and business planning issues. This month's issue is the second in a series discussing transfer strategies that can be employed as part of a succession plan. If you are interested in learning more about the ideas and processes discussed in this newsletter, please contact us for an initial consultation.
In transferring ownership of a family farm or ranch from the current owners to the incoming generation, there are several strategies that people can follow :
Gift of the Farm or Ranch During the Owner’s Lifetime
Bequest of the Farm or Ranch at the Owner’s Death
Sale of the Farm or Ranch During the Owner’s Lifetime
Sale of the Farm or Ranch at the Owner’s Death
Each of these strategies can be valuable in its own right, however, more often than not multiple strategies will be employed, consecutively or concurrently, in the ultimate transfer of the business. Below is a discussion of the role of bequests at death as a strategy for transferring the farm or ranch to the next generation.
Bequests at Death
When transferring the farm or ranch through a bequest at death, your will or trust are normally the documents that will effectuate the transfer to the next generation. Unlike lifetime gifting, with a bequest at death the owner normally retains the asset in his or her estate until death. Some of the benefits of retaining the assets in your estate are:
Step-up in income tax basis (at least under current law);
Maintaining control;
Protecting the asset from the mismanagement of the next generation;
Lifetime income stream.
Some of the downsides of retaining the asset until your death are:
Potential estate taxes if your estate exceeds the applicable exemption;
Failure of the next generation to build equity;
Assets may need to be sold to pay long term care costs.
Tax Consequences - The Basis Step-Up
While transferring an asset during your life will remove that asset from your estate for estate tax purposes and long term care planning purposes, there is a downside. Under current law, assets held by you at your death receive a stepped-up income tax basis at death. The tax basis of an asset is, generally speaking, its cost. For example, if you purchased a parcel of farm ground for $100,000, your tax basis is $100,000. This tax basis may be adjusted over time. But, assuming it has remained the same and you subsequently sell the parcel for $500,000, your taxable gain is the difference between your adjusted tax basis and the sales price, or $400,000. When you give a lifetime gift of property, the recipient retains your basis. Therefore, if, instead of selling the farm ground, you give it to your daughter during your lifetime, your daughter’s income tax basis is the same as yours. This is known as carry-over basis. If your daughter then sells the property for $500,000 she will likewise have $400,000 of gain. If, instead of giving the property away to your daughter during your life, you give it to her upon your death, the potential gain or loss on the sale of the property is eliminated and your daughter takes the property with a new income tax basis equal to the fair market value of the property on your date of death. Therefore, if you pass the above property to your daughter at your death and the fair market value is $500,000, the new tax basis is $500,000. If she then sells the property for $500,000 there is no taxable gain – a potentially significant tax savings. In addition to this, assets that may have been completely depreciated can now be depreciated again.
As has been discussed in several of these newsletters, there are presently proposals to eliminate this tax benefit. If it does go away, there may be other reasons to hold on to the property until your death.
Retirement Income
Besides the stepped-up income tax basis, another significant reason for holding assets, especially the farm ground, until your death is an income stream in retirement. One common technique in planning is to transfer the operation to the next generation and have mom and dad continue to own the farm ground. The operation can then pay mom and dad a lease payment that provides an income in retirement. Often these lease payments will ultimately be addressed in the will or trust by giving the ground to the operator outright at your death or at least at a substantial discount.
As an additional benefit, while a payment of principal is not tax deductible to the operator, a lease payment is fully deductible. This means the operator only needs to earn $1.00 to pay a $1.00 lease payment as opposed to earning $1.25 or more to pay $1.00 of principal on a loan. Beyond that, the lease can last a lifetime, where you may outlive a purchase.
The Windfall
One concern that is often expressed is “we do not want our son or daughter to get a windfall and just sell the farm.” With proper estate planning, you can make sure your son our daughter receives the farm following your death, but that they do not have the ability to sell the farm without sharing it with your other children. This is done by retaining the land in trust for a period of years or putting restrictions in the deed.
While it can be tempting to hold tight to your assets until your death, there are many good reasons to begin divesting yourself of the farm while you are still alive. But there are also good reasons to hold some of the assets until your death. The answer is a well considered plan that takes advantage of the best of both worlds.
This Newsletter is for informational purposes only and not for the purpose of providing legal advice. You should contact an attorney to obtain advice with respect to any particular issue or problem. Nothing herein creates an attorney-client relationship between Hallock & Hallock and the reader.