Tax considerations when transferring farms
Farm succession planning has become a very popular topic lately. Transferring the farm to the next generation can be a challenge. Figuring out a plan that will work for both parties is not easy, but with careful planning, the goals of both the older and younger generation can be met.
Phil Harris, farm law specialist with the University of Wisconsin-Extension, has helped many farm families accomplish their goals. He said succession planning can never start too soon but often starts too late.
The older farmers generally need to have cash flow for their retirement while minimizing taxes. The younger farmer often has trouble securing the funds to buy the business.
During a recent workshop in Watertown, Harris pointed out that most farm owners have several options that will work for transferring their farm so they need to determine the tax and other consequences of each option and then decide which is best for them.
The most common methods are by sale, by gift, by transfer at death, by trade or by transferring to a business entity. The income, gift and estate taxes differ among the alternatives.
If a farm is transferred by sale at the fair market value of the asset6s, there are no gift or death tax consequences. The seller must report the sale for state and federal income tax purposes, and the income of some of the assets is also subject to self-employment tax.
The sale of farm assets requires the seller to recognize gain or loss, the difference between the selling price and the seller's basis – generally the amount the seller paid for the asset.
Some of the gain or loss is taxed as ordinary income, which means it is taxed at the marginal income tax rate of the seller. The federal income rates for individuals currently range from 10 to 39.6 percent. The state income tax rates range from 4 to 7.65 percent.
Some of the gain or loss is taxes as long-term capital gains, which means it receives favorable income-tax treatment. Some is taxed as ordinary income and is also subject to the self-employment tax. Therefore, the tax liability for the sale of livestock or grain, for the sale of depreciated items such as machinery and for land will be determined differently.
Farm owners can sell assets under a contract that calls for part of or the entire sale price to be paid in one or more years after the year of sale. Unless the sellers elect to report all of the gain in the year of the sale, they must report the gain as the principal payments are received.
Transfer by gift
If farm assets are transferred by gift, there may be gift tax consequences. The transfer will also have an effect on the donee's income taxes because he or she will have a carryover basis in the property.
A donor can give $14,000 to each individual each year without tax consequences.
However, gifting assets can have a significant effect on the donee's income taxes because the donor's income tax basis in the assets carries over to the donee.
Transfer at death
If the farm assets are transferred at the time of death, there may be estate tax consequences. The transfer will also have an effect on the donee's income taxes because he or she will have a date-of-death value basis in the property.