legal groundwork
By Robert Moore, Attorney and Research Specialist, OSU Agricultural & Resource Law Program
The relationship between farmland owner and tenant often goes beyond just a business transaction. It is common for the tenant to lease the same farmland for many years or for the tenant/landowner relationship to span several generations. The relationship between the parties may evolve into one of great trust and respect – the landowner knowing that the tenant will treat the land like their own and the tenant knowing the landlord will always be fair with them.
Sometimes, when the landowner knows that their heirs do not have interest in owning the land, they will promise to give the tenant the first chance to buy the farm at landowner’s death. Tenants will always appreciate this gesture so that they do not have to outbid their neighbors at a public auction when the landowner dies. However, a mere promise is not enough. To protect the tenant’s right to purchase the farm, the landowner must take proactive measures.
Under Ohio law, and every other state, verbal promises regarding real estate are rarely enforceable. Because real estate is such an important asset, courts do not want to have to guess as to what a buyer and seller may have agreed upon. So, in most situations, if it is not in writing, a court will not enforce verbal promises regarding real estate.
Example. Landowner has leased her land to Tenant for 25 years and verbally promised that when she dies Tenant will get to buy her farm. Upon her death, her heirs do not want to sell to Tenant because they think they will get more at auction. Because Landlord’s promise was only verbal, the heirs can ignore Tenant and sell at auction.
So, what can be done to ensure that a landlord’s desire for a tenant to buy the farm is enforceable? The following are options available to Landlord and Tenant.
Will or Trust
The landlord can include a provision in their will or trust giving the tenant the right to buy the farm. Upon landlord’s death, the trustee or executor will be obligated to sell the land to the tenant. This is an easy solution to give the tenant a chance to buy the farm. However, it is not a perfect solution.
Wills and trusts can be changed at any time. The tenant has no guarantee that a landlord will not change their will or trust and remove the purchase provision. For as long as the landowner has mental capacity, they can change their will or trust anytime they wish. So, while putting the purchase option in the will or trust is better than a verbal promise, it is not a guarantee the tenant will have a chance to buy the farm.
Practice Pointer. When giving a tenant the right to purchase a farm, consider also providing them with a small amount of money from the estate/trust. By giving them even $100, the tenant becomes a beneficiary of the estate/trust and is entitled to be informed of all aspects of the administration. There could be some dispute as to whether the tenant is a beneficiary of the estate/trust if they only have purchase rights. A beneficiary of an estate/trust has certain rights that a mere buyer would not have.
Right of First Refusal
For the tenant, a better strategy may be to enter into a Right of First Refusal (ROFR) with the landowner. A ROFR is an agreement that gives the tenant the chance to buy land at the landowner’s death or before the landowner can transfer it. The ROFR includes a provision that makes it binding upon the landowner and their heirs so that the ROFR survives the landowner’s death. Upon the landowner's death and before the land can be transferred to heirs, the ROFR is triggered and tenant can decide if they wish to buy the land. The ROFR should be signed by both parties, notarized and recorded.
Example. Landowner wants to ensure that Tenant has a chance to buy her farm when she passes away. Landowner and Tenant execute a ROFR that states upon Landowner’s death, Tenant will have a chance to buy the land at appraised value. The ROFR is made binding upon the Landowner’s heirs and recorded. When Landowner dies, the purchase provision in the ROFR will be triggered and Tenant will have an opportunity to buy the land.
The disadvantage of the ROFR for the landowner is that it cannot be changed. The ROFR is a contract and once signed cannot be changed without the tenant’s consent. If the landowner wants to keep the option to change their mind regarding the sale of the farm, they should not enter into a ROFR but opt for the will/trust strategy instead.
Purchase Terms
Regardless of which of the aforementioned strategies are used, time and effort should be spent specifying the purchase terms. The will/trust or ROFR should include specific language addressing the following:
- Identify the Property. Use parcel numbers, legal descriptions, FSA farm numbers and/or acreage to specify what land is being offered for sale. Do not leave any room for misunderstandings of what land is being offered to the tenant. Avoid using only farm names to identify (i.e. “Smith Farm”)
- Purchase Price. Clearly state how the purchase price is determined. If by appraisal, consider using a licensed, certified appraiser to avoid any perception that the appraiser favors one party or the other. Also consider including a three-step appraisal process allowing either party to get their own appraisal if they dispute the original appraisal. A flat price can be used for the purchase price but the parties risk the flat price not adjusting to market conditions. The landowner may also include a discount % on the purchase price to help the tenant.
- Deadlines. The purchase terms should give the tenant a specific number of days to decide if they want to purchase the farm. This term should begin to run after the purchase price has been established. The tenant should be required to exercise their purchase option by giving written notice to the estate/trust. A closing date should also be set, usually a specific number of days after the tenant has provided the written notice to purchase.
- Other Purchase Terms. Include any other purchase terms like title insurance and transaction costs.
Summary
Landowners and tenants should not rely on verbal promises for the purchase of the farm at landowner’s death. Using either a will/trust or ROFR can ensure that a tenant will have a legally enforceable right to purchase the farm. When drafting the will/trust or ROFR, include specific purchase terms to avoid conflict between the tenant and the landowner’s heirs. The parties should seek legal counsel to assist in drafting the documents to be sure that all legal requirements are met.
By Robert Moore, Attorney and Research Specialist, OSU Agricultural & Resource Law Program
Establishing a new entity in Ohio is relatively easy. The first step is to submit an application to the Ohio Secretary of State along with a $99 fee. This application can be done online with the fee being paid with a credit card. For an LLC, the application only needs to include the name of the entity and the name and address of a contact person. Applications for corporations and other entities may require a bit more information but nothing overly burdensome. The Secretary of State reviews the application and either approves the application or rejects and provides information as to what needs corrected.
Upon approving the application, the Secretary of State will issue an Articles of Organization certificate, or similar document, for each new entity. This certificate is confirmation that the state of Ohio recognizes the entity, and it is permitted to conduct business in Ohio. Upon the entity being registered, business documents such as operating agreements and ownership certificates should be completed.
Usually, a few weeks after registering a new entity, credit card applications will begin to show up. As mentioned previously, each new entity must provide the name and address of a contact person for the entity. The name and address are publicly available on the Secretary of State’s website. Credit card companies retrieve this information and send applications hoping the new entity needs a credit card to conduct business. Credit card companies are not the only solicitors to use the contact information.
The credit card applications are easily identifiable, obvious in their intent and can be easily discarded if not needed. However, a more nefarious letter is likely to show up as well. It is common for new entities to receive an envelope that looks like it is from an official government entity. Upon opening the letter, a form that also looks official will request $67.50, $90 or some other amount for a copy of the certificate of organization or certificate of good standing. Upon first glance, the letter and enclosed form looks like something you would receive from a government agency.
The certificate of organization will be provided to the new entity upon registration. At any time, a copy of the certificate of organization can be obtained from the Ohio Secretary of State web site for no cost. A certificate of good standing, sometimes requested by lenders, can be obtained from the Secretary of State for $5. The certificate of good standing merely states the entity is still registered with Secretary of State. The point being, there is likely no reason to pay a company for the articles of organization or a certificate of good standing.
There is nothing illegal about the letters requesting money for a certificate of organization. If you look closely at the form, somewhere it will say it is not from a government agency. If someone wants to pay $90 for a certificate that is provided for free by the Secretary of State they are within their rights to do so.
The intent of this article is to make new business entity owners aware that they do not need to spend extra money on certificates after their entity is registered with the state. Paying for the requested certificates is probably just a waste of money. Unfortunately, people who are registering entities for the first time are often not aware of what is required by the state and just assume they are required to pay the extra fees. If in doubt, contact your attorney.
Below is an example form letter requesting $67.50 for a certificate of good standing. You will need to look closely to find the disclaimer that it is not from a government agency.
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
Machinery $278,809,055,000
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.
Tags: legal groundwork, long-term care, Estate Planning, farm transition planning
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By Robert Moore, Attorney and Research Specialist, OSU Agricultural & Resource Law Program
There is no doubt that Long-Term Care (LTC) costs are a financial threat to many farms. Some farmers go to great lengths to protect their farm assets from potential LTC costs. Protection strategies include gifting assets to family members, transferring farm assets to irrevocable trusts and buying LTC insurance. But what do the statistics say about the actual risk to farms for LTC costs?
According to the Administration for Community Living, someone turning age 65 today has an almost 70% chance of needing some type of long-term care services in their remaining years. Due to women having longer life expectancies, predictions are that women will need an average of 3.7 years of care and men will need 2.2 years. While one-third of today's 65-year-olds may never need long-term care support, 20% will need it for longer than 5 years. The following data from the ACL provides more details as to the type and length of care needed:
This table shows that of the three years of LTC needed on average, two of those years are expected to be provided at home and one year in a facility. It is noteworthy that a majority of LTC services are typically provided at home because most people do not want to leave home for a facility, some at-home care isn’t paid for, and home care is less expensive than facility care. Many people may think all LTC will be provided in a facility, but as the data shows, this is not usually the case.
The next important statistic is cost. The following are costs of various LTC services from the 2021 Cost of Care Survey provided by Genworth Financial, Inc.
Nursing home costs are significantly higher than in-home services. People may think of LTC costs in terms of nursing homes, but as discussed in the previous paragraph, the majority of LTC services are the less expensive, in-home type. So, while all LTC costs are significant, they might not be as high as commonly thought.
Let’s use this data to come up with some possible numbers for an Ohio farmer. Assume the following:
- A 65year-old farmer has a 67% chance of needing LTC
- The length of that care will be around 3 years
- 1 year of care will be unpaid inhome services
- 1 year of care will be paid, inhome services at around $60,000/year
- 1 year of care will be in a nursing home at around $90,000/year
Based on the above assumptions, a 65-year-old Ohioan, on average, can expect about $100,000 in LTC care costs ($60,000 + $90,000 x 67%). Keep in mind that these costs are per person and a married couple will have double these potential costs. The next question is, can the average farmer absorb LTC costs without jeopardizing the farm? That's a question we'll examine in a future post in the Legal Groundwork Series.
Tags: legal groundwork, long-term health care, Estate Planning, transition planning
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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.
Tags: farm transition planning, Estate Planning, legal groundwork, charitable remainder trust
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