A Tale of Two Farm Estates

Roland P. Freund
Farm Management Agent
Penn State Cumberland County Cooperative Extension

We hear much about the fact that so many family farms are being lost. It seems difficult for many families to realize their dream of passing the family heritage on to the next generation. Various people like to blame the high property, income and estate taxes; low commodity prices; poor Government programs; pressures from urban development; lack of credit; or all of the above. Unfortunately we seldom hear about what farm families themselves can do to ensure that the next generation will have a reasonable chance to operate a profitable farm. To illustrate what might happen, let's look at two mythical families.

Two family farms

Dan and Deb Dreamer and Paul and Patty Planner had all been active in the same 4-H programs. They were married in the late 1950's, and each bought a farm in 1960 in the rich farmlands in the counties surrounding Harrisburg, Pennsylvania. Each couple had four children - two girls, and two boys. They were good farmers and all the children had a good start in life. They were also able to get their respective farm mortgages paid off in the mid 70s.

When they bought their farms the attorneys titled the farms in joint ownership with rights of survivorship. A short time later the attorney had each couple come in to draft their wills. Each set up a "sweetheart will" leaving all to their surviving spouse, and if the spouse were not to survive them, then everything would be divided equally among the children.

In both families, after getting a good education, the daughters and one son left the farm to pursue professional and business careers. Around 1980 Tim Dreamer and Rick Planner each joined their parents in their respective farm operations. A few years later Tim married Tammy and Rick married Rachael. Each couple had two children who are now in high school.

Expansion

Each operation grew and expanded, cropping more rented acres, and eventually each farm purchased a neighboring farm. Tim and Tammy and Rick and Rachael now live in the renovated houses on these added farms.

As the businesses expanded new facilities were constructed on the new farms to make the operations even more efficient. In 1997 both Deb and Patty each inherited $150,000 from their parents' estates. These funds went into CDs.

2003 Farm Values and Family Equity

(Please note: for those choosing the text only version of this web page the table below will not readily convert to text only. The columns will display below each other instead of reading from left to right. There are 4 columns and the column headings are 1 - Assets, 2 - $ ,000, 3 - Liabilities, 4 - $ ,000)

Taken as a whole, each of these operations has almost identical assets and liabilities:

Apparent Family equity    1,400
Life Insurance                       400

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The Non-farming Children's Equity

Each of the children who left both of these farms were given a college education, and have since been quite successful. They and their respective spouses have purchased homes, made business and other investments, and each has significant retirement accounts. Each of these couples now owns equity of approximately $450,000.

The Business arrangements

On the surface everything appears to be identical on these two farms. However, if we look deeper into the business organization of each we discover some startling differences. Let's examine these in detail and look at the potential outcome of each family farming operation. We will begin with the Dreamers.

Dreamers' business organization

The Dreamers have kept things simple by maintaining joint ownership by Dan and Deb of the entire operation and all the capital assets. They preserved all the tax advantages and depreciation for themselves. They fixed up the new farm house for Tim and Tammy and allowed them to live there - rent free. They provided medical insurance, and gave them free milk and meat, plus a generous wage that was recently raised to $2,000 per month.

They did revise the original will which had been drafted in 1961. They added a clause to give Tim and Tammy the right of first refusal to purchase the farm from the estate.

Tim and Tammy Dreamer's 2003 Equity

Every time Tim asked Dan about getting some ownership share of the business Dan has said "Don't worry about it now - some day this will all be yours". So Tim and Tammy now own no farm assets but their children own a few 4-H and FFA project livestock. They have no retirement accounts, and no real estate. Their assets consist of a mini-van, a pickup truck, life insurance, savings, and household effects totaling $73,000.

Will the Dreamer farm survive to the next generation?

Let's look at the situations if both senior couples were to die sequentially in 2003.

At the first death nothing would happen to transfer assets. There would be nothing to probate and nothing would pass to the next generation. The insurance on Dan's life covers the mortgage and some of the building loan on the Second Farm. The assets now total $2.05 million, all owned by Deb.

Deb Dreamer's Estate

At the second death everything would be included in the estate. In 2003 Federal Estate taxes can be calculated using the Exclusion of $1Million to which everybody is eligible, or it may be calculated for "qualifying small businesses" using an exclusion amount of $1.8 million.

Gross Estate                                              $2,050,K
Liabilities                                      250K
Administration Funeral etc         201K

Dreamer's Heritage

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Where is the banker who will make these loans?

If Tim can't buy the farm and continue the business, the "business exemption" is unavailable because "qualified heirs" must continue to operate the business. So Tim and Tammy and the executor are stuck in a "lose, lose" situation. . The farm must be sold to settle the estate.

So much for:Dad's assurance to Tim: "Son, some day this will all be yours" And so much for "We want to always treat the kids equally"

The Planners Plan

The Planners realized the significance of rising real estate values around Harrisburg. They knew that it was becoming increasingly difficult to retire debt, and so it would be important to get as many assets as possible in the hands of the next generation if that generation is to have any chance to continue the family farm.

Rick and Rachael Planner's 2003 Equity

About 1983 Paul and Rich formed a partnership which now owns the farm business. This business consists of the first three lines of the first balance sheet above which has an equity value of $600,000. Rick's 50% share of this equity is $300,000.

The new farm and house were titled to Rick and Rachael and the partnership's rent has covered the mortgage payments, taxes and repairs. So they have about $100,000 of real estate equity. Their vehicles, life insurance, and household effects add another $63,000 for a total of $463,000.

The Planners Plan

The senior Planners left the original farm and home in joint ownership, but they titled the CDs from her folks' estate in Patty's name. The partnership took out life insurance on Paul so that at his death $150,000 could go to the non-farming heirs and $250,000 could help Rick reduce partnership debt. They drew up new wills.

Paul left his share of the partnership to Rick, and provided that if Patty did not survive him the Old Farm and the family heirlooms would be divided equally among the four children, with Rick having the right of first refusal to buy the Old Farm from the estate.

Patty willed her inheritance CDs to be divided equally among the non-farming heirs. The Old Farm and heirlooms to be handled in the same manner as in Paul's will.

Planners' Estate Settlement

Assuming Paul were to die first, his partnership share of $300,000 would be probated. Even if there had been $200,000 in gifts involved to set up the partnership, there is still no Federal Estate tax here.

Paul Planner

        Paul's partnership share of $300k probated
- Settlement $15K,     PA 4.5%     $13K
- Rick gets $272K
      What happens to the $400K life insurance?
- $250K to Rick - he can use it to reduce debt
- $50K each non-farm heir- $50K (That is $50K more than Dan's heirs got at his death)
Rick benefits by $494,000

With the $250,000 insurance proceeds Rick would probably be able to cover PA Inheritance and administration and still reduce liabilities on partnership assets by $200,000.

Patty Planner's Estate

When Patty dies, her estate also squeaks under the federal limit.

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Planner's Heritage

If we compare the two family estates, recall that the
Dreamer non-farm kids received                       $767K
                                 Difference                              $97K

Rick, Rachael's Farm

Apparent family equity 1,080                       57%

Rick and Rachael will now own $1.9 million of assets with $820,000 of debt and will probably have a reasonable chance of survival. The non-farming heirs have each inherited $219,000 - only$97,000 less than the Dreamer's heirs would each get if all the assets had to be liquidated to settle the estate.

Which farm will survive to the next generation?

Questions:

Who treated their heirs more fairly?

Who treated their heirs more equitably?

Which of the farm families has a chance of passing on the family farming heritage?

Who is responsible for making provisions which will facilitate the preservation of the family farm?

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