Don Hofstrand
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Extension Field Specialist
Founder, Ag Decision Maker
www.extension.iastate.edu/agdm
Co-Director, Ag Marketing Resource Center
www.AgMRC.org
dhof@iastate.edu
641-423-0844
Critical Success Factors
(can you answer YES to these questions?)
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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?
Transfer Plan
Transfer Stages
Testing
Transfer
Ownership
Commitment
Established
Withdrawal
Sale, Gift, Inheritance
Transfer
Mgmt.
General Manager, Equal Voice
Divide
Income
Wage, Contributions, 50-50 Division, Lease
Business Arrangements
Transfer Stages
Testing
Wage
Wage &
Incentive
Commitment
Established
Multi-Person
Farm or
Enterprise
Operating
Agreement
Partnership
Corporation
Spin-Off
Wage & Income
Sharing
Labor &
Machinery
Sharing
Labor &
Machinery
Sharing
Separate
Operations
Withdrawal
Lease
Corporation
Transfer Period
Short Transfer Period
older party
younger party
time
Transfer Period
Long Transfer Period
older party
younger party
time
Two Basic Choices
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Multi-Person Arrangement
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Spin-Off Arrangement
Multi-Person Approach
P
Business
P&C
Business
P
C
Business
C
Spin-Off Approach
P
C
Business
P
P
C
Business
Business
C
Business
Tax Implications of Asset
Transfers Transfers
Sale
Gift
Inheritance
Transfer Taxes
Sales Taxes
Gift Taxes 1
Death Taxes 2
Income
Tax 3
1.
2.
3.
Federal gift tax, no Iowa gift tax
Federal estate tax, Iowa inheritance tax
Federal & state income taxes
Income Tax Implications
Machinery Example
$50,000 fair market value
$30,000 income tax basis
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
Income Tax Implications
 Gift
– tax postponed
Donor $50,000 gift value (gift tax)
0 taxable gain
Donee $30,000 basis
Income Tax Implications
Farmland Example
$100,000 fair market value
60,000 income tax basis
Income Tax Implications
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Sale – tax paid
Seller $100,000 sale value
60,000 basis
$ 40,000 taxable gain
Buyer $100,000 basis
Income Tax Implications
 Gift
– tax postponed
Donor $100,000 value (gift tax)
0 taxable gain
Donee $ 60,000 basis
Income Tax Implications
 Inheritance
– tax eliminated
Decedent
$100,000 value (death taxes)
0 taxable gain
Recipient
$100,000 basis
General Considerations
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Valuation
 Appraiser
 Dealer
 Auctioneer
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Disposal of machinery not wanted
by successor
Transferring Ownership
(personal property)
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Sale
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Leasing
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Gifting
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Combinations
Outright Sale
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Simple
Tax consequences of seller
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Depreciation recapture
 Capital gains
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Cash flow needs of buyer (third party
financing)
New income tax basis for buyer
Installment Sale
Payments spread over period of years
 Spreads buyers cash-flow
commitment
 Tax consequences of seller
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Depreciation recapture
 Capital gains
Seller financed
 New income tax basis for buyer
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Piecemeal Sale
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Spread tax consequences of seller
 Depreciation
 Capital
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recapture
gains
New income tax basis for buyer
Spreads buyers cash-flow commitment
Flexible—can vary sale amount from year to
year
May use with a lease
If retired and not leasing out unsold
machinery, cannot claim depreciation
Gift
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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
Donor’s income tax basis carries over to
donee
Combination
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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
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Lease/Sale
Order of Asset Transfer
Younger
Party
Older
Party
1
1
Breeding Livestock
2
2
Machinery
3
3
Buildings & Facilities
4
4
Land
5
5
Asset
Operations & Feeder
Livestock
Decision Making Authority
A.
General Manager
1.
On-going decisions
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2.
Both parties
Major decisions
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Final authority
Decision Making Authority
B.
Equal Voice
1.
2.
Both parties
Final authority
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One party
Vote
Arbitration
Transferring Management
Child’s goal = Develop management
 Parent’s 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
1.
Division of Responsibility
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2.
Management Styles
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3.
Enterprise division
Functional division
Analytical vs. interpersonal
Competitor vs. peacemaker
Withdrawing from Management
Income Sharing
Arrangements
1.
Contributions approach – share
income based on contributions
2.
50/50 approach – pay a return to
resources and share residual
Contributions Approach
Parent
Child
Resources
Resources
(Annual value=$100)
(Annual value=$50)
Joint Operation
67% contributed
by parent
33% contributed
by child
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
Parent = $133
Child = $67
$200
50/50 Approach
Gross Income
Direct Expenses
Net Return
$300
$100
$200
Parent’s Resources (an. value)
Child’s Resources (an. value)
Net
$100
$ 50
$ 50
Parent
$ 25
$100
$125
Child
$ 25
$ 50
$ 75
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.
Income Sharing Arrangement
What is the annual value (cost) of a resource used
in a business venture?
Land
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Machinery &
Livestock
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Operating
Capital
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Comparable cash rent
Return on investment
 Depreciation, etc.
Return on investment
Contributions Approach
Parent
Land
Child
$52,000
Total
$52,000
Machinery
24,000
6,000
30,000
Labor
23,000
33,000
56,000
Management
Total
10,000
$109,000
8,000
18,000
$47,000 $156,000
Parent’s Share
109,000
156,000 = 70%
Child’s Share
47,000
156,000 = 30%
Contributions Approach
(allocating income)
Gross Income
Prod. Expenses
Return
Parent’s
$186,200
-65,800
$120,400
Child’s
$79,800
-28,200
$51,600
Contributions Approach
(cash flow)
Return
Land Taxes
Land Debt
Machinery Debt
Net Cash Flow
Parent’s
$120,400
-8,000
-35,000
-4,000
$73,400
Child’s
$51,600
0
0
-3,000
$48,600
50/50 Approach
Gross Receipts
Production Expenses
Net Return
$266,000
-94,000
$172,000
Parent’s Land
Parent’s Machinery
Child’s Machinery
Parent’s Labor & Mgmt.
Child’s Labor & Mgmt.
Profit
-52,000
-24,000
-6,000
-33,000
-41,000
$ 16,000
50/50 Approach
(allocating income)
Land
Machinery
Labor
Management
Profit
Total Return
Parent
$52,000
24,000
23,000
10,000
8,000
$117,000
Child
$
0
6,000
33,000
8,000
8,000
$55,000
50/50 Approach
(cash flow)
Total Return
Land Taxes
Land Debt
Machinery Debt
Net Cash Flow
Parent
$117,000
-8,000
-35,000
-4,000
$70,000
Child
$55,000
0
0
-3,000
$52,000
Problem Areas
Parent’s Perspective
 Transfer their dreams
 Inspection tour
 Advice on raising children
 Social life
 Daughter-in-law
 Son-in-law
Problem Areas
Adult Child’s Perspective
 Accept parent’s lifestyle
 Marriage spats
 Confidant
 Baby sitting
 Carrying stories
Keys to Success
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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
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