Don Hofstrand

1
Don Hofstrand

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

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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?

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Transfer Plan
Transfer Stages
Testing
Commitment
Established
Withdrawal



Transfer Ownership
Sale, Gift, Inheritance
Transfer Mgmt.
General Manager, Equal Voice
Divide Income
Wage, Contributions, 50-50 Division, Lease
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Business Arrangements
Transfer Stages
Testing
Commitment
Established
Withdrawal
Wage Lease
Wage Incentive Farm or Enterprise Operating Agreement Partnership Corporation Corporation
Wage Income Sharing Labor Machinery Sharing Labor Machinery Sharing
Separate Operations
Multi-Person
Spin-Off
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Transfer Period

• Short Transfer Period

• older party
• younger party

time
6
Transfer Period
Long Transfer Period
7
Two Basic Choices

• Multi-Person Arrangement

• Spin-Off Arrangement

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Multi-Person Approach
P
C
P C
P
C
9
Spin-Off Approach
C
P
C
P
C
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Tax Implications of Asset Transfers
Transfers
Sale
Gift
Inheritance
Transfer Taxes
Sales Taxes
Gift Taxes 1
Death Taxes 2

Income Tax 3

1. Federal gift tax, no Iowa gift tax
2. Federal estate tax, Iowa inheritance tax
3. Federal state income taxes

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Income Tax Implications

• Machinery Example
• 50,000 fair market value
• 30,000 income tax basis

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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

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Income Tax Implications

• Gift tax postponed
• Donor 50,000 gift value (gift tax)
• 0 taxable gain
• Donee 30,000 basis

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

• Sale tax paid
• Seller 100,000 sale value
• 60,000 basis
• 40,000 taxable gain
• Buyer 100,000 basis

16
Income Tax Implications

• Gift tax postponed
• Donor 100,000 value (gift tax)
• 0 taxable gain
• Donee 60,000 basis

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Income Tax Implications

• Inheritance tax eliminated
• Decedent 100,000 value (death taxes)
• 0 taxable gain
• Recipient 100,000 basis

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General Considerations

• Valuation
• Appraiser
• Dealer
• Auctioneer
• Disposal of machinery not wanted by successor

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Transferring Ownership(personal property)

• Sale
• Leasing
• Gifting
• Combinations

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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

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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

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Piecemeal Sale

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

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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
• Donors income tax basis carries over to donee

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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

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Order of Asset Transfer
Younger Party
Older Party
Asset

• Operations Feeder Livestock 1 1
• Breeding Livestock 2 2
• Machinery 3 3
• Buildings Facilities 4 4
• Land 5 5

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Decision Making Authority

• General Manager
• On-going decisions
• Both parties
• Major decisions
• Final authority

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Decision Making Authority

• Equal Voice
• Both parties
• Final authority
• One party
• Vote
• Arbitration

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Transferring Management

• Childs goal Develop management
• Parents goal Protect financial interest and
  desire for control
• Traditional parent-child roles
• Taking Things Easier
• Training ground
• Written arrangement
• Consistency of goals

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Tranferring Management

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

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Income Sharing Arrangements

• Contributions approach share income based on
  contributions
• 50/50 approach pay a return to resources and
  share residual

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Contributions Approach

• Parent

Child
Resources (Annual value100)
Resources (Annual value50)
Joint Operation
67 contributed by parent
33 contributed by child
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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

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50/50 Approach

• Gross Income 300
• Direct Expenses 100
• Net Return 200
• Parents Resources (an. value) 100
• Childs Resources (an. value) 50
• Net 50
• Parent Child
• 25 25
• 100 50
• 125 75

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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.

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Income Sharing Arrangement

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

Land Comparable cash rent
Machinery Livestock Return on investment Depreciation, etc.
Operating Capital Return on investment
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Contributions Approach
Parent Child Total
Land 52,000 52,000
Machinery 24,000 6,000 30,000
Labor 23,000 33,000 56,000
Management 10,000 109,000 8,000 47,000 18,000 156,000
Total 10,000 109,000 8,000 47,000 18,000 156,000
109,000 156,000
Parents Share
70
47,000 156,000
Childs Share
30
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Contributions Approach(allocating income)
Parents Childs Gross Income
186,200 79,800 Prod. Expenses -65,800
-28,200 Return 120,400 51,600
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Contributions Approach(cash flow)
Parents Childs Return 120,400 51,60
0 Land Taxes -8,000 0 Land Debt
-35,000 0 Machinery Debt
-4,000 -3,000 Net Cash Flow 73,400 48,600
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50/50 Approach
Gross Receipts 266,000 Production Expenses
-94,000 Net Return 172,000 Parents Land
-52,000 Parents Machinery
-24,000 Childs Machinery -6,000 Parents
Labor Mgmt. -33,000 Childs Labor Mgmt.
-41,000 Profit 16,000
40
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
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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
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Problem Areas

• Parents Perspective
• Transfer their dreams
• Inspection tour
• Advice on raising children
• Social life
• Daughter-in-law
• Son-in-law

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Problem Areas

• Adult Childs Perspective
• Accept parents lifestyle
• Marriage spats
• Confidant
• Baby sitting
• Carrying stories

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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

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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

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For More Information

• Ag Decision Maker
• www.extension.iastate.edu/agdm