Land Price Bump Strains Family Buyouts

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by Marcia Zarley Taylor

ELMER, N.J. (DTN) — Runaway farmland values are making it harder for young farmers to buy into the business. Just ask Mike Brooks, 29, an eighth-generation farmer who has purchased 300 acres from his parents in a state with the priciest land in the country.

One thing Brooks knows from experience: “There’s no way $15,000 or $20,000 per acre land cash-flows.”

Around Brooks’ home in Salem County, N.J. — about 45 minutes south of Philadelphia — bulldozers are running, and raw land still sprouts housing developments with $300,000 houses. Unable to compete with urbanites, Brooks needed his parents, Bill and Diane, to sell development rights to a state agency before transferring real estate titles to him. Typically, that knocks pure farmland values down to about $4,000 to $6,000 per acre.

Even with the discount, Brooks had to rely on an understanding lender and high-value crops such as processing tomatoes, potatoes and double-crop spinach to help service his Mount Everest-sized debts. On the 300 acres remaining in Bill and Diane’s estate, “I’ve told my parents, if I can rent land from my sisters, it’s cheaper than me owning it,” Brooks said.

LAND MAY NOT CASH-FLOW

Hyper-inflation hasn’t just priced farmland out of reach in the East. Farmland now commands $11,500 per acre in some parts of central Illinois with no peak in sight. Since last fall, Farm Credit Services of Illinois offices have plugged increases of 4{dfeadfe70caf58f453a47791a362966239aaa64624c42b982d70b175f7e3dda2} per month into their appraisals.

Corn and soybean operators can generate about $400 an acre to service principal and interest payments on land, said Gary Streit, an estate tax attorney with Shuttleworth & Ingersoll in Cedar Rapids, Iowa.

“The problem is $400 doesn’t go very far when cropland is selling for $8,000 to $10,000 an acre, as it is in east-central Iowa today. There’s a lot of tension in family discussions when trying to match the younger generation’s desires to purchase their parents’ land, and parents are trying to be fair to their other children,” Streit said.

Even with a 20-year installment sale at 3{dfeadfe70caf58f453a47791a362966239aaa64624c42b982d70b175f7e3dda2} interest, operators would need $538 per acre to buy out partners at the moment. Payments on a 10-year note would run $670. “It’s hard to structure a reasonable cash flow that an operator can handle when farm income is so unpredictable,” Streit said. As Congress threatens to revamp farm programs, and with commodity prices prone to booms and busts, this only complicates matters as parents attempt to design fair transitions.

Kevin Mills, a CPA with Kennedy and Coe in Garden City, Kan., agreed.

“If you don’t plan well, and heirs have to buy ground at today’s escalated prices, the cash-flow just doesn’t work. There’s a good chance the land will end up getting sold or the farm just ends up as a smaller operation,” Mills said.

“In an ideal world, operators would own all the farm assets, and off-farm heirs would receive an equivalent in non-farm property, such as stocks or the family home.

“But many times, land values have appreciated so fast that ag assets are worth far more than personal property. With some of the bigger farms we work with, the personal assets might be worth $1 million and farm assets $10 million. It’s just not possible to buy enough life insurance on a 60- or 70-year-old to equalize the estate.”

PLAY FAIR


In those situations, farm estate planners recommend splitting the business into two entities — one as the farm’s landlord, where all heirs share ownership — and one operating unit, where only those involved in business operations share ownership. “That way, an operator doesn’t have to call his sister in New York and explain why it’s time to spend $200,000 to trade combines,” Mills said.

If on-farm heirs end up with siblings or cousins as landlords, parents might want to consider establishing some ground rules. “The best time to agree to buy-sell terms is before you need them,” said DTN Family Business Adviser Lance Woodbury of Garden City, Kan. “You’ll be more judicious when you don’t know if you’ll be the buyer or the seller.” Among practices recommended by professionals:

1 – Pay fair rent. Some families steeply discount cash rents as a way to keep operators in the black, but that can fray family relations. Mills recommended arbitrating fairness by using the Farm Service Agency’s county average cash rent as a minimum payment. It’s at least a year or more out of date, but it adjusts to market conditions over time.

It’s common for heirs who are multigenerations removed from a family business to feel that the dividends they get from cash rents seem miserly next to the value of their land. To avoid underpaying landowners, some families require mandatory cash distributions over time, so off-farm heirs receive some benefits to their inheritance. But “leave your heirs flexibility,” Mills stressed.

2 – Agree to exit terms in advance. If someone wants to sell his or her shares in the farm real estate, ease the heirs’ cash-flow crunch. Many families set a 15- to 20-year buyout, with interest rates set at the applicable federal rate for related parties. Some also restrict exits, so that one stockholder must be paid in full before another demands payment.

If it’s the senior partners’ wish to keep the farm intact for multiple generations, they may set a discount price on any sales, so the operators aren’t forced to pay fair market value, Mills added. “In other words, if you’re getting out, you won’t get $1 cash for $1 of property.” How much to discount is a family decision, but the “tax” for exiting the business has run 10{dfeadfe70caf58f453a47791a362966239aaa64624c42b982d70b175f7e3dda2} to 30{dfeadfe70caf58f453a47791a362966239aaa64624c42b982d70b175f7e3dda2} in some of the estates he has handled, he said.

3 – Consider pros and cons of private annuities. When a western Minnesota farmer died unexpectedly, his brother, nephew and son couldn’t afford to pay the 62-year-old widow outright. So they’ve scheduled a lifetime annuity worth 4{dfeadfe70caf58f453a47791a362966239aaa64624c42b982d70b175f7e3dda2} of her farm shares. Their intent is to provide her with a comfortable retirement but still keep the farm intact for her son and nephew’s generation.

“I always thought private annuities were a fair approach. They provide some certainty to the on-farm operators and cap future value of the estate by transferring the deed to the kids during the parents’ lifetime,” Streit said. Like an installment sale, parents get the income and capital gains from the property, and the child can deduct a portion of the interest.

Unlike an installment sale, there’s no end to the land payments, however. So if a parent does beat the actuarial tables and lives past 88, a child would pay more for the farm than an outright sale, Streit added. On the other hand, if they die prematurely, the debt is forgiven.

4 – Give an early inheritance. Lifetime gifts can make buying land more affordable and also freeze the estate’s value. The $13,000 per person limit on tax-free gifts doesn’t go far given today’s land values, so Streit sees more farm clients using the $5 million estate tax exemption ($10 million per couple) while they’re alive.

The biggest challenge to intergenerational farm transfer for now remains the cost of land, however. “Buyouts are extremely difficult at the moment, because you just can’t make the numbers work,” Streit said. “So my advice is go slow. There seems to be a certain amount of irrationality in this trajectory.” Maybe would-be heirs should save their money to buy when the next farmland bubble bursts.

Marcia Taylor can be reached at marcia.taylor@telventdtn.com

(ES/TT)

 

© Copyright 2011 DTN/The Progressive Farmer, A Telvent Brand. All rights reserved.

Posted with DTN Permission by Haylie Shipp

 

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