Earlier we looked at sales, gifts, and leases of farm property from parents to children. We saw that when a sale or gift from the parents to the children does not seem appropriate, it may make sense for the parents to consider leasing the property to the children on a multi-year lease. This provides some additional security for the children.
Buy/sell agreements are a type of purchase option frequently included in a farm partnership or farm corporation to provide for purchasing a partner's or shareholder's stock when he leaves the business. Books have been written about buy/sell agreements for partnerships and corporations, but we are not discussing them here.
This discussion focuses on using purchase options with "intermediate term" farm leases from parents to children. There are several types of purchase options. The one discussed here gives the children the right to buy the property covered, if the parents decide to sell. Unlike some purchase options, the children do not have the right to purchase at any time. The parents initiate the process, not the children. The children should pay the parents, at least a nominal sum, for a purchase option. The payment of "consideration" strengthens the legality of the option.
Creating a legal purchase option does not mean that the parents have to sell or that the children have to buy the option property. It simply means that if the parents offer it for sale, the children with the purchase option will have the first opportunity to purchase it. The parents cannot sell it to someone else without first offering to sell it to the children with the option. Such an option can represent important security to on-farm children.
A purchase option is a legal document that should be drafted by an attorney.
An option provides different assurance than a will that states that certain children will receive certain property. A person can change his or her will without the benefactors knowing about it. A purchase option is a legal document that limits the seller's sales options. It may be useful to provide certain persons with purchase options in a will. They are legal and binding.
Sometimes a will provides an opportunity for certain children to purchase particular assets. Sometimes the purchase provisions are favorable to the children purchasing the property. There is nothing wrong with that. One problem with children relying on a parent's will is that wills are easily changed without the children knowing until after the parent's death.
One frustrating thing about this option is that there is no assurance that the property will be offered for sale. It may never be offered for sale during the current operator's lifetime. The option simply provides that if the owner(s) want to sell the property the person(s) with the option can buy it.
Sometimes a worse frustration occurs when the property is offered for sale, but the children with the option are unable to buy it. The children may have become financially unable or have simply reached an age when they no longer want to take the financial risk associated with purchasing it.
Sometimes conditions change so the parents no longer want to sell to the children holding the option. There may have been a disagreement or a change in circumstance such as a death, disability, or divorce that makes a sale less desirable. Sometimes the parents can buy back the option. Other times they may simply refuse to sell, or they may have to sell to children other than those to whom they would prefer to sell.
There are many ways to set the selling price to the person holding an option. Sometimes the price is determined by the price offered by some bona fide third party purchaser.
The option itself could specify a set purchase price. If the price is near fair market value when set, and the buyer pays reasonable consideration for the option, it probably will be acceptable to the IRS. However, any attempt to set the price artificially low, freeze prices, or avoid estate or gift taxes is likely to come under the scrutiny of the IRS.
You could put a method for determining price in the agreement. The method could require an appraisal, valuation by formula, capitalization of earnings, or another reasonable method.