farm transition planning
We discussed long-term care (LTC) costs in our April 20 blog post and analyzed recent data to project that a 65-year-old Ohioan, on average, can expect about $100,000 in LTC costs, and double that for a married couple. In this post, we continue to examine LTC costs by addressing an important question for farmers: can the average farmer absorb this cost without jeopardizing the farm and farm assets?
First, we need to remember that any income received by the farmer could be spent on paying the LTC costs. Farm income, land rent, social security income, and income from investments can all pay for LTC costs. After income is used to pay for LTC care costs, non-farm assets, like savings, can be used to pay for the costs. It’s the portion of the LTC costs that income and savings cannot cover that causes farm assets to be at risk. For example, if the farmer has $40,000 in savings, using that savings to pay LTC leaves only $60,000 of farm assets at risk.
Let’s next turn to the risk to farm assets. While a farmer would never want to sell any farm asset to pay for LTC, their land is probably the last asset they would want sold. Most farmers would sell grain, crops, livestock, and machinery before they would sell land. So, if income and savings cannot pay for LTC care costs, how at risk is the land? Data can also help us answer this question. According to the Economic Research Service – USDA (ERS), the total amount of non-real estate, farm assets owned by farmers in the US for 2020 were as follows:
Financial Assets $92,013,020,000
Inventory (crops, livestock, inputs) $62,866,872,000
Total Non-Real Estate Farm Assets $533,688,897,000
The ERS further estimates that there were 2.02 million farmers in the US in 2020. So, on average, farmers owned $264,202 of non-real estate, farm assets. If income and savings are unable to pay for LTC costs, the average farmer would have an additional $264,202 of assets to sell before needing to sell real estate.
So, what does all this data tell us? On average, if farmers are forced to sell farm assets to pay for LTC, they will not need to sell their land. They may need to sell crops, livestock and/or machinery to help pay for the LTC costs but the land is probably safe. That is the good news.
The bad news is the above analysis is all based on averages. When dealing with large numbers, averages are very useful. We can say with some confidence that on average, a 65-year-old farmer in Ohio will spend around $100,000 on LTC. However, the numbers cannot tell us with any certainty what a specific farmer will spend on LTC. Farmer Smith in Delaware County, Ohio might never pay any LTC costs, might pay the average of $100,000 or they might be an outlier. An outlier is someone whose specific circumstances end up being significantly different than the average.
Being an outlier is what farmers are really concerned about regarding LTC. We all know someone, or have heard of someone, who was in a nursing home for 10 years. That’s close to $1 million in LTC costs. Few farmers have the income, savings and non-real estate assets to pay for $1 million of LTC.
So, what LTC planning for farmers really ends up being is protecting against the outlier scenario that puts the land at risk. Most 65-year-old farmers would probably sleep well at night if they knew they would only have $100,000 of LTC costs for the rest of their lives. That amount of LTC costs is probably not going to cause a farm liquidation. What keeps farmers up at night is the chance they will be the outlier and spend 10 years in an expensive nursing home.
The outlier scenario is important for farmers to understand as they develop their LTC strategy. For any risk management plan, the true nature of the risk must be understood and not just presumed. The fact is most farms can probably withstand the average LTC costs. It is also factual that most farms cannot withstand an outlier scenario of being in a nursing home for many years. This understanding is critical in developing a LTC plan. That is, the LTC plan should probably seek to mitigate the risk of being an outlier, not on being average.
Fortunately, there are strategies to help mitigate the risk of losing the farm to the outlier scenario, although each of the strategies have significant drawbacks. In future posts, we will discuss those strategies.
By Robert Moore, Attorney and Research Specialist, OSU Agricultural & Resource Law Program
Most farmers do a great job of managing their taxable income. They buy inputs or machinery to offset the current year’s income and wait until next year to sell the current crop. This strategy works well but it catches up to the retiring farmer. In the year of retirement, a farmer may find themselves with an entire year (or more) of crops or livestock to sell and no expenses to offset the income. Additionally, machinery and equipment that will no longer be needed for production will need to be sold. Selling all these assets upon retirement without offsetting expenses can result in tremendous tax liability.
One strategy for retiring farmers to consider is using a Charitable Remainder Trust (CRT). The CRT is a special kind of trust that can sell assets without triggering tax liability while providing annual income for the retiring farmer. The CRT essentially spreads out the income from the sale of the assets over many years to keep the farmer in a lower tax rate bracket. Also, the CRT allows the retiring farmer to make a charitable donation to their charity of choice.
The primary component of a CRT strategy is that a CRT does not pay tax upon the sale of assets. Due to its charitable nature, a CRT can sell assets and pay no capital gains tax nor depreciation recapture tax. The retiring farmer establishes a CRT then transfers the assets they want to sell into the CRT. The CRT then sells the assets. For the strategy to work, the trust must be a CRT. A non-charitable trust will owe taxes upon the sale of the assets.
The proceeds from the sale of the assets are then invested in a financial account. The farmer works with an investment advisor to determine the desired annual income needed from the proceeds and then an appropriate investment portfolio is created. It is important to note that income calculations must include leaving at least 10% of the principal to a charity. The farmer may not receive all the income or the trust will not qualify as a charitable trust. The term of the payments from the investment portfolio cannot exceed 20 years.
After the financial account is established, the farmer will receive annual income. This income is taxed at the farmer’s individual tax rate. By paying the sale proceeds out over a number of years, the farmer’s income tax bracket can be moderated. Selling all assets in one year would likely cause the farmer to be pushed into the highest income tax and capital gains tax bracket, so spreading out the income keeps the farmer in a lower tax bracket.
Another important component of a CRT is the charitable giving requirement. As stated above, the farmer must plan to give 10% of the principal to a charity. The funds are provided to the charity when the term of the investment expires or when the farmer dies. Depending on the performance of the investment, the charity may receive more than 10% or less than 10%. The farmer must be able to show that when the investment account was established, the intention was for the charity to receive at least 10% of the original principal.
Consider the following examples, one with a CRT and one without.
Scenario without CRT. Farmer decided to retire after the 2021 crop year. Farmer owned $800,000 of machinery and $200,000 of grain. Farmer sold all the grain and machinery before the end of 2021. Farmer owed tax on $100,000 of ordinary income due to depreciation recapture on the machinery and sale proceeds of the grain. Farmer’s tax liability was $450,000 for the sale of the assets.
Scenario with CRT. Farmer established a CRT and transfered the machinery and grain into the CRT. The CRT sold the machinery and grain but did not pay tax on the sale proceeds due to its charitable status. Farmer established an annuity to pay out over 20 years. Each year Farmer receives $65,000 of income from the CRT. Farmer pays income tax on the payment but at a much lower rate than the previous scenario. At the end of the 20-year term, a charity receives $150,000 (original 10% of principal plus interest).
As the scenarios show, A CRT can save significant taxes for the retiring farmer. Also, a CRT allows a retiring farmer to make a charitable contribution to their charity of choice.
A retirement strategy using a CRT is not without its disadvantages. One disadvantage is the cost to implement the plan. A CRT plan is complicated and requires the assistance of an attorney, accountant, and financial advisor. The combined professional fees could be $25,000 or more. Another disadvantage is the inflexible nature of the plan. The CRT is an irrevocable trust; once the CRT is implemented the plan cannot be changed. If the retired farmer finds they need more income than allocated from the CRT, they are unable to make such a change.
Anyone considering retiring from farming should explore the possibility of incorporating a CRT into their plan. CRTs can save significant income taxes and provide for charitable giving, but it’s not for everyone. The potential tax savings must be enough to justify the significant costs to establish the CRT and the farmer must be willing to give up control of the sale proceeds. Retiring farmers should consult with their attorney, accountant and/or financial advisor to assess how a CRT might fit into their retirement plan.
By Robert Moore, Attorney and Research Specialist, Agricultural & Resource Law Program
Anyone who has ever been an Executor of an estate knows how much paperwork is involved with administering an estate. The county probate court, which oversees the estate process, requires many filings to verify the assets the deceased person owned, determine the value of those estates and to ensure that the correct beneficiaries receive the assets. Typically, administering an estate requires the assistance of an attorney familiar with probate rules and forms.
Like any professional providing services, attorneys will expect to be paid for their estate administration services. Legal fees charged by an attorney for an estate must be approved by the probate court. Many probate courts have established a schedule of fees that provides a benchmark for attorneys. Basically, if the attorney’s legal fees are no more than the schedule of fees, the court will approve the fees. The approved probate fees vary from county to county but are usually between 1% to 6% of the value of the estate.
It is important to note that the court approved probate fees are a benchmark, not a requirement. That is, the court is not requiring an attorney to charge those rates. Instead, the court is merely stating that fees that do not exceed the benchmark will likely be approved. It is up to each attorney to determine the fee structure to implement for their services. Some attorneys may use the probate rates for fees while other attorneys may bill based on an hourly basis.
Before hiring an attorney, Executors should have a thorough discussion regarding the attorney’s fee structure. The Executor should ask if the attorney charges on an hourly basis, flat rate basis or uses the county probate rates. Based on the fee structure used, the attorney should be able to provide a good estimate of legal costs for the estate administration. If the Executor has reason to believe the fees charged by the attorney may be too high, it’s helpful to consult with other attorneys who use a different fee structure and compare.
Consider the following examples:
- The county probate court allows a 2% legal fee rate for real estate that is not sold. Joe passes away owning a $100,000 house. Joe’s Will directs the house to be inherited by his daughter. The attorney assisting with the estate administration uses fees based on the county rate. The attorney will be entitled to $2,000 in legal fees.
- Let’s change the scenario so that Joe owned a $1,000,000 farm when he passed away. The attorney will be entitled to $20,000 in legal fees.
The above examples illustrate how probate rates work and also illustrates why executors should not automatically agree to pay the probate rates. In the examples, the attorney basically does the same work – transfers one parcel of real estate to the daughter. However, because the farm was worth ten times more in value, the attorney received ten times more in legal fees.
Let’s continue the scenario.
- The Executor thinks $20,000 in legal fees to transfer the farm may be too much. The executor finds an attorney that charges hourly for estate administration, rather than using the county rates. The attorney charges $200/hour and thinks it will take about 15 hours of work to have the farm transferred to Joe’s daughter. Executor quickly decides to hire the second attorney and saves $17,000 in legal fees.
Often, probate rates can result in reasonable legal fees. Charging $2,000 to transfer a $100,000 house is probably reasonable. In some situations, particularly for smaller estates, the probate rates may be inadequate, and the attorney may seek permission from the court to charge in excess of the rates. However, for farm estates, the county rates can result in excessive legal fees. Due to the capital-intensive nature of farming, farm estates will tend to have a much higher value than typical, non-farm estates. A modest farm estate of $5 million, at a 2% probate fee rate, will result in $100,000 of legal fees. An attorney charging $250/hour would have to bill 400 hours to make those same legal fees. A $5 million farm estate is not going to take 400 hours to administer.
Executors administering farm estates should carefully evaluate legal fees charged by the estate attorney. Applying county probate rates to farm estates can result in very large legal fees. Before agreeing to accept the probate rates as the fee structure, Executors should also inquire as to what legal fees would be if charged on an hourly basis. After getting an estimate of legal fees for both fee structures, the Executor can then make an informed decision as to how best to proceed with legal counsel.
In farm estate and transition planning, we caution against leaving farmland to multiple heirs as co-owners on the deed to the property. That’s because Ohio law allows any co-owner of property to seek “partition,” a legal action asking the court to either sell the property and divide sale proceeds among the co-owners or, in some cases, to physically divide the property between co-owners. If the goal of a farm family is to keep property in the family, co-ownership and partition rights put that goal at risk. A recent case from the Ohio Court of Appeals illustrates how partition can force the unwilling sale of property from a co-owner of the property.
The recent court case didn’t involve farmland, but concerned a home and four acres of land owned jointly by an unmarried couple, each on the deed to the property as co-owners with rights of survivorship. The couple separated and one remained in the home, but the two could not agree upon how to resolve their interests in the property. That led to a court case in which one co-owner asked the court to declare that the other had no remaining interest in the property. The other co-owner disagreed and filed a partition claim asking the court to sell the property and divide sale proceeds according to each person’s property interest. The trial court determined that each co-owner did have ownership interests in the property and ordered the property to be sold according to the partition law.
The trial court granted each party the right to purchase the property within 14 days before it would be sold, but neither exercised that right. After an appraisal, the court ordered the property sold and also ordered payment of the outstanding mortgage. That left the court with the challenge of determining how to divide the remaining sale proceeds according to each party’s interests in the property. A complicated analysis of payments, credit card debts, a home equity loan, rental value, and improvements to the property resulted in a final determination that granted one co-owner more of the proceeds than the other.
Both parties appealed the division of proceeds to the Twelfth District Court of Appeals, unfortunately adding more cost and consternation to resolving the co-ownership problem. The court of appeals noted that Ohio law grants a court the duty and discretion to apply broad “equitable” principles of fairness when determining how to divide property interests among co-owners in a partition proceeding. A review of the trial court’s division of the proceeds led the appeals court to affirm the lower court’s holding as “equitable,” ending the three-and-a-half-year legal battle.
Ohio’s partition statute itself provides a warning of the risk of property co-ownership. It states in R.C. 5307.01 that co-owners of land “may be compelled to make or suffer partition…” While the purpose of partition is to allow a co-owner to obtain the value of their property interests, it can certainly force others to “suffer.” If a co-owner can’t buy out another co-owner, the power of partition can force the loss of farm property. As a result, family land can leave the family and a farming heir can lose land that was part of the farming operation. That’s most likely not the outcome parents or grandparents expected when they left their farmland to heirs as co-owners.
Fortunately, legal strategies can avoid the risk of partition. For example, placing the land in an LLC removes partition rights completely, as the land is no longer in a co-ownership situation—the LLC is the single owner of the land. The heirs could have ownership interests in the LLC instead of in the land, so heirs could still receive benefits from the land. The LLC Operating Agreement could contain rules about if and how land could be sold out of the LLC, and could ensure terms that would allow other LLC members to buy out another member’s ownership interests. An agricultural attorney can devise this and other legal strategies to ensure that partition isn’t a risk to farmland or farm heirs.
Whether it's to protect family farmland, bring future generations into the operation, address special needs like retirement, disability, or remarriage--taking legal steps now can make your goals for the future of your farm a reality. Farm transition planning is so important to keeping a farm and a farm family together, but it's easy to make mistakes that can bring unintended problems in the future. Consider this this list of seven common mistakes farmers make in farm transition planning:
2. Thinking joint property titles will do.
3. Overlooking expenses at time of death.
4. Assuming no federal estate taxes.
5. Trying to be fair to all beneficiaries.
6. Failing to consider disability as well as death.
7. Avoiding communication.
We'll discuss and address all of these issues in our "Planning for the Future of Your Farm" workshops this winter. We can help you get over that procrastination hurdle, develop your goals, deal with communication issues and understand legal strategies. Join me, attorney Robert Moore, and farm management educator David Marrison for either a day-long live program or a four-part live webinar this winter, where we cover these topics:
- Developing goals for estate and succession planning
- Planning for the transition of control
- Planning for the unexpected
- Communication and conflict management during farm transfer
- Legal tools and strategies
- Developing your team
- Getting your affairs in order
- Selecting an attorney
Dates and locations for the workshops are:
- Live Zoom webinar on January 31 and February 7, 21 and 28 from 6:30--8:30 pm.
- Because of its virtual nature, parents, children, and grandchildren can easily attend this workshop, regardless of where they live!
- Day-long in-person workshops:
- February 10, 2022--OSU Extension Greene County, Xenia, Ohio
- February 25, 2022--OSU Fisher Auditorium, Wooster, Ohio
- March 4, 2022--Wood County Fairgrounds, Bowling Green, Ohio
Pre-registration is necessary for all workshops. For registration and further information, visit this link: go.osu.edu/farmsuccession. Together, let's make 2022 the year that you make plans for the future of your farm.
Unfortunately, the death of a farmland owner can create conflict within a family. Often, transition planning by the deceased could have prevented the conflict. Such is the case in a family disagreement that ended up before Ohio’s Third District Court of Appeals. The case pitted two brothers against one another, fighting over ownership of the family farm.
When their mother passed away in 2006, the five Verhoff siblings decided to sell the family farm. Two of the brothers wanted to purchase the farm, but one of them was also the executor of the estate. The estate’s attorney advised the executor brother that he should not buy the land directly from the estate due to his fiduciary duties as executor. The attorney recommended that the executor wait and purchase one-half of the farm from the other brother after it was transferred from the estate to the other brother.
Following a series of discussions between the two brothers, the executor brother sent half of the farm’s purchase price to the other brother and issued the farm’s deed to the other brother. Over the next eight years, the two brothers shared a joint checking account used to deposit rental income from the farmland and to pay for property taxes and utilities on the property. But when the executor brother asked the other brother for a deed showing the executor brother’s half-interest in the farm, the other brother claimed that the executor brother did not have an ownership interest. The money rendered by the executor brother was a loan and not a purchase, claimed the other brother. The other brother then began withholding the farm rental payments from the joint checking account. The relationship between the two brothers broke down, and in 2016, the executor brother filed a lawsuit to assert his half-ownership of the farm and his interest in the rental payments.
At trial, a jury found that the brothers had entered into a contract that gave the executor brother half ownership of the farm upon paying half of the purchase price to the other brother. The trial court ordered the other brother to pay the executor brother half of the current value of the farm and half of the rental income that had been withheld from the executor brother. The other brother appealed the trial court’s decision. The court of appeals did not agree with any of the other brother’s arguments, and upheld the trial court’s decision that a contract existed and had been violated by the other brother. Two of the arguments on appeal raised by the other brother are most relevant: that Ohio’s statute of frauds required that the contract be in writing and that the contract was illegal because an executor cannot purchase land from an estate.
A contract for the sale of land should be in writing, but there are exceptions
Ohio’s “Statute of Frauds” provides that a contract or sale of land or an interest in land is not legally enforceable unless it is in writing and signed by the party to be charged. The other brother argued that because there was no written agreement about the ownership of the farm, the situation did not comply with the Statute of Frauds and could not be enforceable. However, the court focused on an important exception to the Statute of Frauds: the doctrine of partial performance. The doctrine removes a verbal contract from the writing requirement in the Statute of Frauds if there are unequivocal acts of performance by one party in reliance upon a verbal agreement and if failing to enforce the verbal agreement would result in fraud, injustice, or hardship to that party who had partly performed under the agreement.
Based upon evidence produced by the executor brother, the appeals court agreed with the trial court in determining that an oral contract did exist between the two brothers and that the executor brother had performed unequivocal acts in furtherance of the verbal contract. The court explained that the executor brother had endured “risks and responsibility” by giving the other brother money with the expectation that he would receive rental income from the farm and own a one-half interest in the property. An injustice would occur if the verbal contract was not enforced because of the Statute of Frauds, as the other brother would receive a windfall at the executor brother’s expense, said the court. The court concluded that because the doctrine of partial performance had been met, the writing requirement in the Statute of Frauds should be set aside.
Did the executor brother violate his fiduciary duties by purchasing the land?
The other brother also claimed that the verbal contract was illegal because the executor brother made a sale from the estate to himself. According to the other brother, the sale violated Ohio Revised Code section 2109.44, which prohibits fiduciaries from buying from or selling to themselves or having any individual dealings with an estate unless authorized by the deceased or the heirs.
The court pointed out, however, that the executor brother did not buy the farm from the estate. Instead, the executor brother purchased the farm through a side agreement with the other brother who purchased the farm from the estate. The court noted that this type of arrangement could be voidable if other heirs challenged it. But since no other heirs did so, the court determined that the executor brother had not violated his fiduciary duties to the estate and allowed the side agreement to stand.
Estate and transition planning can help prevent family disputes
Imagine the toll this case took on the family. It’s quite possible that parents can prevent these types of conflicts over what happens to the farm when they pass on. An initial step for parents is to determine which heirs want to transition into owning and managing the farm, and what their future roles with the farm might be. This often raises other tough questions parents must face: how to provide an inheritance to children who don’t want the farm when other children do want the farm? Must or can the division of assets be equal among the heirs? What about other considerations, such as children with special issues or not having heirs who do want to continue the farm? These are difficult but important questions parents can answer in order to prevent conflict and irreparable harm to the family in the future.
The good news is that there are legal tools and solutions for these and the many other situations parents encounter when deciding what to do with the farm and their assets. An attorney who works in transition planning for farmers will know those solutions and can tailor them to a family’s unique circumstances. One agricultural attorney I know promises that there’s a legal solution for every farm family’s transition planning issues. Working through the issues is difficult, but identifying tools and a detailed plan for the future can be satisfying. And it will almost certainly prevent years of litigation.
The text of the opinion in Verhoff v. Verhoff, 2019-Ohio-3836 (3rd Dist.) is HERE. For more information about farm estate and transition planning, be on the lookout for our soon-to-be released Farm Transition Matters law bulletin series or catch us at one of our Farm Transition Planning workshops this winter.