Long-Term Leases in Succession Planning
We often think of farm leases in terms of an unrelated landowner leasing to an unrelated tenant. However, leases can play an important role among related parties. It is common practice to incorporate long-term leases into an estate plan to help protect the farming heir and help keep the land in the family. In this article, we will discuss how and when to incorporate long-term leases into an estate plan.
Parents may find themselves in a situation where they would like an off-farm heir to inherit a farm but they also want to keep the land base together for the farming heir. The parents realize that the off-farm heir, upon inheriting the farm, could sell the farm or lease the farm to another farmer. A long-term lease is one solution to this dilemna.
Consider the following example: Mom and Dad operate a dairy farm and own 500 acres. They would like Andy, their son, to inherit Greenacre, a 100-acre parcel that sits next to the dairy operation. Bill, their other son, will continue to operate the dairy operation after Mom and Dad’s death. Bill must be able to farm Greenacre because it is critical to the dairy operation for corn silage production and for manure application.
This is a common example where the parents want an off-farm heir to inherit a farm but also realize that the farm is critical to the viability of the farm operation’s future. If Andy inherits Greenacre without any conditions, he could simply sell or lease the farm to a neighbor, possibly causing Bill’s dairy operation to faulter. Essentially, the ability for Bill to continue farming is contingent upon what Andy does with Greenacre.
A long-term lease may solve Mom and Dad’s dilemma. Mom and Dad could have Andy inherit Greenacre but require him to lease it back to Andy for a term of years. This allows Andy to inherit the farm but protects Bill’s land base for his dairy operation.
Using the same example as above: Mom and Dad establish a trust. The trust gives Greenacre to Andy but as a condition of him receiving Greenacre he must lease it to Bill for 20 years. The trust also provides other lease terms including how the lease rate is determined and occasionally updated.
Mom and Dad have now met both goals: Andy received Greenacre and Bill can continue to use Greenacre for his dairy operation. Bill will pay rent to Andy for the use of Greenacre for the term of the lease.
When using long-term leases, a common question is: how long should the lease be? Generally, the lease should be long enough to protect the farming heir’s farming career. This may cause the lease to be 10 years long or perhaps the lease will be 50 years long.
When using long-term leases, we need to consider the effect on the off-farm heir. The off-farm heir, in reality, has little control over the land because the lease essentially makes the land unmarketable. Few people will want to buy a farm that has a 20-year lease on it. Therefore, the off-farm heir receiving the farm may be disappointed that the only benefit they receive from the land during the term of the lease is a lease payment. Using the example above, if Andy thought he could immediately sell Greenacre and build his dream house in Florida he is going to be disappointed.
Using long-term leases to keep the land base together for the farming heir significantly impedes the off-farm heir’s ability to control the land they receive. However, for many farm families, allowing for a viable farming operation for future generations is of prime importance and limiting the off-farm heir’s ability to control their own farm may be a necessary outcome. It also may be beneficial for Mom and Dad to inform the off-farm heir that their land will be subject to a lease to avoid disappointment and surprises.
Like all estate planning strategies, long-term leases are another tool in the estate planning toolbox. For some plans, long-term leases should be kept in the toolbox. For other plans, long-term leases may be a critical part of the estate plan. The impact on both the farming heir and the non-farming heir is an important factor when considering using long-term leases in a succession plan. Be sure to consult with an attorney to determine if a long-term lease may be right for you.