In the first half of the 20th century, Willie Sutton became notorious for a prolific criminal career which lasted for 40 years.
He is credited with robbing $2 million from over 100 banks. His expertise at carrying out robberies in disguise earned him the nickname “Slick Willie.”
In spite of being a notorious criminal, Willie was non-violent. He always carried a gun on his robberies, but later admitted that it was not loaded.
Willie Sutton was often arrested for his crimes and spent half of his adult life in prisons. He was also infamous for breaking out of prison on three separate occasions.
Perhaps “Slick Willie” is most famous for his reply to reporter Mitch Ohnstad inquiring as to why Sutton robbed banks. According to Ohnstad, Sutton replied, “Because that's where the money is.”
The quote evolved into Sutton’s Law, which medical students often use as a figure of speech for emphasizing the most likely and obvious diagnosis, rather than wasting time and money investigating every conceivable possibility.
The well-known response also produced the Willie Sutton Rule which is used in managerial accounting to prioritize budgeting where the greatest costs occur because that’s where the greatest savings can be found.
Where’s your money?
When speaking this past week to a producer group about farm transition and the perfect storm we are currently facing in agriculture, I took an opportunity to shock my audience with the statement, “I’m getting up the courage to write a column on why basis step-up can be bad for a farm family.”
A discussion about death and taxes always turns lively when a comment like that is made. One man reacted, “Basis step-up will get me out of my tax problem. All I have to do is farm until I die.”
This gentleman didn’t realize the depth of his simple statement. It was the ultimate admittance of a major problem that we are facing in transition in our industry.
If conventional wisdom says to hold onto appreciated assets (like land) or depreciated assets (like operating assets) until death to get the basis “step-up,” we are running the risk as an industry that a generation of potential farm owners may never get the chance to own their family farm operation.
Another man probed, “Why doesn’t anyone offer ideas other than waiting to die to get a basis step-up?”
A third participant jumped in, “Because that’s where the money is!” Willie Sutton would have been proud.
We do not need added encouragement to defer transition planning. The natural tendency is to continue to farm even if it’s past time to pass it on.
This tendency is facilitated by a number of factors: a history of ownership and control, independence, love of the growing cycle, lack of transition ideas, stubbornness and a resistance to quit. Deferral is the easiest course.
With values outside the range of profitability and the age of the landowner at an all-time high, consciously waiting to transition your family farm until death opens your family and your farm up to unnecessary risk.
If the average age of death for a farm owner was 65, the next generation would be in their early 40s.
However, people are living into their mid- to late-80s and the next generation are in their mid- to late-60s. It is concerning for someone to take on major obligations of a capital and labor intensive farm operation at this age.
Over a lifetime, a farm family accumulates a lot of depreciable items. It can be tempting to wait until death to transfer these assets through an estate with a basis adjustment that resets the value of these items to be re-depreciated.
The basis adjustment (step-up) on an asset because it was included in the decedent’s estate inventory allows the next owner to sell without tax or to re-depreciate the asset.
Certainly, an adjusted basis at death for equipment, livestock and grain can be advantageous for a farm family.
If basis step-up becomes the main (or possibly only) factor in deciding to defer asset transition until after death, the concept of adjusted basis may be disadvantageous for a farm family — especially if the byproduct is lost ownership opportunity for the next generation.
Mom and dad could effectively “trade positions” with the next generation by selling, leasing to own, gifting or a combination of all three to transition operating assets.
An operation can experience a major shock if the next generation isn’t making management decisions before the death of their parents.
Living to see the operating assets transition and allowing the next generation an opportunity to establish their own identity becomes appealing as long as we can find a way to neutralize any income tax bubble.
Basis adjustment for re-depreciation also holds true for other depreciable items such as grain bins, livestock buildings, machine sheds, fence, tile and fertility of real estate. This can be a good situation for those heirs who choose to keep inherited farmland.
Unfortunately, too often a basis step-up at death has inadvertently encouraged the sale of farmland. For the sake of argument, think through two hypothetical scenarios for your family.
What is the probability of your heirs keeping the land for the next 20 years if you transfer it to them before your death? They would have your basis (carry-over) in this scenario. If we assume this basis is $1,000/acre and the appraised value of the land is $8,000/acre, the likelihood of them keeping it increases due to the deferred tax liability to sell it.
What is the probability of your heirs keeping the land for the next 20 years if they receive a basis step-up and there is no tax to sell it?
In which of those two scenarios would your heirs be better off?
My sincere hope is that you will be able to sort through the transition of your family farm assets to alleviate possible issues that could arise in an estate proceeding (taxation, administration, valuation and family discord). Unfortunately, that is where the real money is.
For 26 years, Steve Bohr has been a partner in the farm continuation firm of Farm Financial Strategies, Inc. For additional information on farm continuation issues or if you have a question please contact Steve via email at Bohr@FarmEstate.com or by phone at 1-800-375-4180.