In 2008, my wife agreed to run the New York City Marathon with me. She had finished 10 marathons, so I listened carefully to her. She expressed two things that impacted my preparation:
1. The first 20 miles and the last 6 miles of a marathon are two separate but psychologically equal races.
2. If I trained properly, I would make it 20 miles. If I could get through 20 miles, I could “gut out” the final 6 miles.
Three separate times I had run 20 miles in training. I was confident that I could make it 20 miles and “gut” the last 6 to the finish.
The start of the run went well. However, I didn’t anticipate the energy required to stay warm on a chilly November morning (we were dropped on Staten Island by bus more than 3 hours before the race even started).
I hit the wall at mile 14 and had to use up my 6 mile “gut” just to get to mile 20. Not knowing what to do, I focused only on putting one foot in front of the other.
With 3 miles to go I had slowed considerably. My wife could run backwards and kept pace with me.
With 1 mile left, I recognized that I didn’t need much in the tank because I didn’t have very far to go. We made it together.
I am forever grateful to her for sticking with me through the marathon process (and in life). Winners get to the top and turn to see who they have defeated, while leaders get to the top and turn to see who they can help get to the top with them.
Transition is like a marathon
Transition planning for a farm can be like running a marathon. We start out not knowing what to expect but knowing that it will not be easy. As much as we try to plan, there will be unexpected adversity that will change the course of even a well thought- out plan.
There will be sacrifice and pain along the route. Leadership will help you stay on track so when the finish is in sight, you can get there even though you may not have much left in the tank.
The parallel of the marathon and farm transition planning came up this morning while discussing options with an uncle and his nephew.
The uncle owns 320 acres of land and a building site. He is not married and has two children who are not involved in farming. His nephew, however, is involved in farming.
We discussed his main goals:
1. Transfer his building site to his nephew immediately.
2. Create a plan to transfer his 320 acres to his nephew that would provide an adequate inheritance for his children but would also cash flow for his nephew.
3. Maintain income that the uncle could not outlive.
4. Transition the estate to his children without estate tax and with minimal administration costs.
They discussed selling the building site to his nephew on a 10-year contract for $225,000, retaining a right to occupy the residence for as long as the uncle wished. This would reduce his property tax while getting the building site to his nephew to maintain and grow the farm operation.
The portion of this purchase price considered the sale of a qualifying residence would be tax-free to the uncle and non-depreciable for the nephew. The portion considered sale of previously depreciated buildings would be taxable to the uncle and depreciable for the nephew.
They mutually agreed to sell the residence for a $25,000 reduction from the original price (exchanging tax savings for the uncle for a lower price and loss of depreciation for the nephew).
Since he wasn’t yet to the 20-mile mark of his marathon, the uncle decided to hold off on selling the rest of his land on contract but rather add future option terms in his trust.
Cash-flow land value
The uncle’s attorney had already drafted a revocable trust to distribute his estate. The purpose of the revocable trust is to avoid the administration process of probate (cost, time delay and publicity).
He decided to add an option for the nephew to buy the land on contract and would make payments to his children as their inheritance.
We started the land valuation discussion with the highest value that the market would bear based on comparable sales. We assumed the land would appraise for around $8,500/acre.
The uncle knew the appraisal method to price land would not be favorable for his nephew to cash flow, but he struggled with how to identify a better price strategy and how to communicate this process to his children.
Anyone who has borrowed money for farmland knows that to buy land above $5,000/acre requires subsidization. This subsidization may come in the form of an off-farm job, an inheritance or borrowing against cash flow from other land holdings.
Our industry has lost sight of a farm purchase being able to cash flow on its own merit.
Land acquisition for $6,000, $8,000, $10,000 or even $12,000 per acre sounds irrational for those who pencil a cash flow without subsidization to justify a land purchase.
Once the sale price for land rolls past a cash-flow price, the only thing that will stop it is the subsidization capacity of the respective bidder.
The uncle decided to use special-use valuation set up under section 2032A of the internal revenue code to value his land for its “farm use” value or its “cash flow” value rather than to offer an arbitrary 25 percent discount off the appraised value.
Special-use value is a formula of five-year average cash rent for comparable land, less five-year average property tax, divided by an interest rate set by the government for the calculation.
If the average five-year cash rent was $260/acre and the property taxes were $30/acre, the net rent of $230 divided by 4.46% would equal a “cash flow” price of $5,156/acre.
If he passed today, the contract terms would provide an annual payment to each of his two children for an inheritance of $46,000 ($5,156/acre at 2.89% AFR interest over 25 years).
The uncle recognized that his children could work their entire life for a social security check of $24,000 per year and receive an inheritance of contract payments that would provide them each with nearly twice as much ($46,000 per year).
With the quantity of farm land that is going to transfer in the near future due to the age of current land owners, the viability of our rural communities is at stake.
My hope is that as you near the finish of your marathon, you will consider strategies to transfer your land to the next generation in a manner that is fair to your non-farm heirs while giving opportunity for the next generation of producers to cash flow the transfer.
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.