Transferring Your Farm Business to the Next Generation

Bulletin 862

In What Order Do You Transfer Tangible Property?

Tangible assets include things you can touch and feel like livestock, machinery, inventories, and land. Rarely does the next generation take over ownership of all the tangible farm business assets at once. Even when a parent or grandparent dies, the surviving spouse, if any, usually becomes owner of the deceased's assets.

The next generation usually does not have the money required to purchase, or cannot finance the purchase of, all the farm assets at once. They also usually lack the management experience and ability to take over everything at once. It makes sense for them to gradually assume ownership as their experience and commitment to the farm increases.

This raises the question, "What do you transfer first?" Here we look at possible transfers prior to either farming together in a partnership or corporation, or turning the farm completely over to the next generation.

Breeding Livestock First

Farm families with livestock usually start the next generation into an operation with breeding livestock. Farmers without breeding livestock may want to skip to the discussion of inventories of grain, hay and feed.

Here are some reasons farm families frequently transfer livestock first:

1. It is easy. Frequently it begins with the parents giving young children a heifer calf, gilt or foal.

2. No money changes hands and the animals are still in the herd, so it does not seem to cost much at this point.

3. It usually increases the child's interest in caring for the livestock. These animals are often raised at family expense, as part of the herd. The next generation can own several animals fairly quickly. In fact, the next generation's investment may become substantial. Frequently the next generation receives additional breeding animals instead of income from their animals.

   The older generation may use the same process with adults. However, often the older generation isn't financially able to give away large numbers of young animals and raise them for the benefit of the next generation. The next generation may need to purchase them or at least provide labor to help compensate parents for transferring animals.

4. Livestock can be "good investments" for the next generation. During their productive lives livestock usually hold their value well. They don't rust and depreciate. The next generation can usually get most of their money out of them, if necessary.

5. Livestock are mobile. The next generation can take livestock with them or sell them if they decide to leave.

6. If the next generation leaves and takes their livestock with them, their livestock may be identifiable and can be sorted out.

7. The parents can replace the livestock if the next generation leaves, although there is a cost.

8. It may be reasonable to start an equal partnership, with each partner owning the same number of animals and the partnership leasing all other assets from one or more of the partners. A complete discussion is beyond the scope of this publication, but, there are two major advantages of a "livestock only" partnership. First, it makes possible a next generation with limited capital becoming an equal partner. Second, with limited assets involved, it makes it much easier to break up the partnership if it does not work out.

Inventories of Grain, Hay and Feed Second

The next generation frequently does not buy the older generation's inventories if it is a family deal. Children usually don't have the money, and the parents don't want to pay the income tax; therefore, nobody bothers with these inventories. If the parents don't need the income, they may simply ignore the inventories and let the children or new partnership use them up, without compensation.

Sometimes the inventories are simply too large and valuable to ignore. One way to reduce the problem is to start the next generation in the business when inventories are low and before planting next year's crops (March-April). Another way is for the next generation or a partnership that takes over the operation to buy them, perhaps in installments.

Machinery and Equipment Third

The next generation usually starts buying machinery and equipment after they have received a desired percentage of the breeding herd, if any, and before they buy the parents' land. Machinery and equipment are necessary on the farm; but they wear out, rust, break down, become out of date and take a lot of money to keep going. Equipment usually isn't a highly profitable investment. The next generation usually should not start buying machinery until they have a means of paying for it and are fully committed to staying in the operation.

Income taxes are a major consideration when thinking about selling machinery and equipment to the next generation. In the following section we discuss some critical income and gift tax considerations when selling to the next generation. Due primarily to income tax considerations, the next generation usually does not buy much, if any, of the older generation's machinery and equipment.

Commonly, the older generation leases their existing machinery to the next generation or the two-generation partnership. We discuss "Machinery and Equipment Leases" in the next section. The parents usually don't buy additional machinery once they start leasing machinery to the next generation. When the operation purchases new machinery, the people doing the farming (perhaps including parents) buy it. Sometimes parents give their children the old piece of machinery they are replacing to use as a trade-in.

Land and Buildings Fourth

Under current tax laws, extensive farm land often isn't transferred to the next generation until the death of both parents. For most families, an earlier transfer requires a "voluntary contribution" to IRS that many feel is simply too expensive. A transfer also may reduce the older generation's retirement security. The section, "Selling Farm Real Estate to The Next Generation" in Part V of this publication discusses income, gift and estate tax laws that, when considered together, may make other alternatives look better than a transfer. That section also includes discussions of some alternatives and some arguments which could be made for transferring at least part of the real estate while one or both parents are still living. We addressed some income security and retirement concerns in the earlier section, "Some Financial Rules of Thumb."

Some families will decide to make major real estate transfers to the next generation during the parents' lives. Following are some circumstances that suggest making a real estate transfer:

1. The older generation family has a net worth approaching $1,200,000 or more and wants to reduce potential federal estate taxes.

2. Child(ren) live in a home owned by their parents.

3. The families want the next generation to own and control the main base of operation that includes crucial farm buildings and other improvements. However, even in these cases the families should carefully consider the costs and other options.