Two Generation Farming

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Don Hofstrand: 

Don Hofstrand Extension Field Specialist Founder, Ag Decision Maker www.extension.iastate.edu/agdm Co-Director, Ag Marketing Resource Center www.AgMRC.org dhof@iastate.edu 641-423-0844

Critical Success Factors (can you answer YES to these questions?): 

Critical Success Factors (can you answer YES to these questions?) Are the parents ready for a partner? Is the child committed to farming? Is the business large enough? Do you have a Common Vision of your future together? Can you live and work together? Are the non-farming children supportive?

Transfer Plan: 

Transfer Plan Testing Commitment Established Withdrawal Sale, Gift, Inheritance General Manager, Equal Voice Transfer Ownership Transfer Mgmt. Divide Income Transfer Stages Wage, Contributions, 50-50 Division, Lease

Business Arrangements: 

Business Arrangements Transfer Stages Testing Commitment Established Withdrawal Multi-Person Spin-Off

Transfer Period: 

Transfer Period older party younger party time Short Transfer Period

Transfer Period: 

Transfer Period Long Transfer Period

Two Basic Choices: 

Two Basic Choices Multi-Person Arrangement Spin-Off Arrangement

Multi-Person Approach: 

Multi-Person Approach P C P & C P C

Spin-Off Approach: 

Spin-Off Approach C C C P P

Tax Implications of Asset Transfers: 

Tax Implications of Asset Transfers Federal gift tax, no Iowa gift tax Federal estate tax, Iowa inheritance tax Federal & state income taxes Income Tax 3 Sales Taxes Gift Taxes 1 Death Taxes 2 Transfer Taxes Transfers Sale Gift Inheritance

Income Tax Implications: 

Income Tax Implications Machinery Example $50,000 fair market value $30,000 income tax basis

Income Tax Implications: 

Income Tax Implications Sale – tax paid Seller $50,000 sale value 30,000 basis $20,000 taxable gain* Buyer $50,000 basis *depreciation recapture & capital gains

Income Tax Implications: 

Income Tax Implications Gift – tax postponed Donor $50,000 gift value (gift tax) 0 taxable gain Donee $30,000 basis

Income Tax Implications: 

Income Tax Implications Farmland Example $100,000 fair market value 60,000 income tax basis

Income Tax Implications: 

Income Tax Implications Sale – tax paid Seller $100,000 sale value 60,000 basis $ 40,000 taxable gain Buyer $100,000 basis

Income Tax Implications: 

Income Tax Implications Gift – tax postponed Donor $100,000 value (gift tax) 0 taxable gain Donee $ 60,000 basis

Income Tax Implications: 

Income Tax Implications Inheritance – tax eliminated Decedent $100,000 value (death taxes) 0 taxable gain Recipient $100,000 basis

General Considerations: 

General Considerations Valuation Appraiser Dealer Auctioneer Disposal of machinery not wanted by successor

Transferring Ownership (personal property): 

Transferring Ownership (personal property) Sale Leasing Gifting Combinations

Outright Sale: 

Outright Sale Simple Tax consequences of seller Depreciation recapture Capital gains Cash flow needs of buyer (third party financing) New income tax basis for buyer

Installment Sale: 

Installment Sale Payments spread over period of years Spreads buyers cash-flow commitment Tax consequences of seller Depreciation recapture Capital gains Seller financed New income tax basis for buyer

Piecemeal Sale: 

Piecemeal Sale Spread tax consequences of seller Depreciation recapture Capital gains New income tax basis for buyer Spreads buyers cash-flow commitment Flexible—can vary sale amount from year to year May use with a lease If retired and not leasing out unsold machinery, cannot claim depreciation

Gift: 

Gift No compensation received by donor (giver) No cash-flow commitment by donee (receiver) Financial needs of donor Equity issue with non-farm heirs Gift tax consequences $10,000 annual exclusion No income tax consequences of donor Donor’s income tax basis carries over to donee

Combination: 

Combination Sale/Gift Buyer cannot afford to pay full value for assets Seller cannot afford to give away asset Better utilization of annual gift tax exclusion Minimize sellers tax liability Lease/Sale

Order of Asset Transfer: 

Order of Asset Transfer Operations & Feeder Livestock 1 1 Breeding Livestock 2 2 Machinery 3 3 Buildings & Facilities 4 4 Land 5 5 Asset Younger Party Older Party

Decision Making Authority: 

Decision Making Authority General Manager On-going decisions Both parties Major decisions Final authority

Decision Making Authority: 

Decision Making Authority Equal Voice Both parties Final authority One party Vote Arbitration

Transferring Management: 

Transferring Management Child’s goal = Develop management Parent’s goal = Protect financial interest and desire for control Traditional parent-child roles “Taking Things Easier” Training ground Written arrangement Consistency of goals

Tranferring Management: 

Tranferring Management Division of Responsibility Enterprise division Functional division Management Styles Analytical vs. interpersonal Competitor vs. peacemaker Withdrawing from Management

Income Sharing Arrangements: 

Income Sharing Arrangements Contributions approach – share income based on contributions 50/50 approach – pay a return to resources and share residual

Contributions Approach: 

Contributions Approach Parent Child Resources (Annual value=$100) Resources (Annual value=$50) Joint Operation 67% contributed by parent 33% contributed by child

Contributions Approach: 

Contributions Approach Gross Income $300 67% to parent = $200 33% to child = $100 Direct Expenses $100 67% to parent = $67 33% to child = $33 Net $200 Parent = $133 Child = $67

50/50 Approach: 

50/50 Approach Gross Income $300 Direct Expenses $100 Net Return $200 Parent’s Resources (an. value) $100 Child’s Resources (an. value) $ 50 Net $ 50 Parent Child $ 25 $ 25 $100 $ 50 $125 $ 75

Business Concept : 

Business Concept Opportunity Cost Assume I can use a resource in both Enterprise A and B. If I invest in A, the opportunity cost is the income I forgo by not investing in B. If I invest in B, the opportunity cost is the income I forgo by not investing in A.

Income Sharing Arrangement : 

Income Sharing Arrangement What is the annual value (cost) of a resource used in a business venture?

Contributions Approach: 

Contributions Approach Parent’s Share 109,000 156,000 = 70% Child’s Share 47,000 156,000 = 30%

Contributions Approach (allocating income): 

Contributions Approach (allocating income) Parent’s Child’s Gross Income $186,200 $79,800 Prod. Expenses -65,800 -28,200 Return $120,400 $51,600

Contributions Approach (cash flow): 

Contributions Approach (cash flow) Parent’s Child’s Return $120,400 $51,600 Land Taxes -8,000 0 Land Debt -35,000 0 Machinery Debt -4,000 -3,000 Net Cash Flow $73,400 $48,600

50/50 Approach: 

50/50 Approach Gross Receipts $266,000 Production Expenses -94,000 Net Return $172,000 Parent’s Land -52,000 Parent’s Machinery -24,000 Child’s Machinery -6,000 Parent’s Labor & Mgmt. -33,000 Child’s Labor & Mgmt. -41,000 Profit $ 16,000

50/50 Approach (allocating income): 

50/50 Approach (allocating income) Parent Child Land $52,000 $ 0 Machinery 24,000 6,000 Labor 23,000 33,000 Management 10,000 8,000 Profit 8,000 8,000 Total Return $117,000 $55,000

50/50 Approach (cash flow): 

50/50 Approach (cash flow) Parent Child Total Return $117,000 $55,000 Land Taxes -8,000 0 Land Debt -35,000 0 Machinery Debt -4,000 -3,000 Net Cash Flow $70,000 $52,000

Problem Areas: 

Problem Areas Parent’s Perspective Transfer their dreams Inspection tour Advice on raising children Social life Daughter-in-law Son-in-law

Problem Areas: 

Problem Areas Adult Child’s Perspective Accept parent’s lifestyle Marriage spats Confidant Baby sitting Carrying stories

Keys to Success: 

Keys to Success Strengthen Family Relationships Improve Communication Skills Recognize Individual Differences Allow for Management Participation Practice Family Decision Making Encourage Diversionary Activities Separate Housing is Required Fit the Agreement to the Situation

Keys to Success (continued): 

Keys to Success (continued) Develop a Written Agreement Update the Business Arrangement More than One Child Concerns of Off-Farm Heirs Parents Without an Interested Child

For More Information: 

For More Information Ag Decision Maker www.extension.iastate.edu/agdm