Written by Scott Wagendorf based on an interview with Alex Vasichek, Financial Planner
Before you consider “how to,” transfer equipment to the next generation of family farmers, you may want to reflect on the “what,” “who,” and “when.” What are your goals? Who’s involved? When do you hope to complete the transfer? “There are a lot of ways to do it and every client is different,” advises Alex Vasichek, an Agriculture Focused Financial Planner at Elevate Financial in Fargo, N.D. “But you’ll need a strategy and a plan; and be able to execute on it.”
1. Sell Outright / Auction Sale
This is a simple, direct and total sale, where the former owner no longer has any financial interest in the item or items being sold. Chances are, the current owner still needs income from their equipment; especially during the transition phase. This strategy buys some of the equity off prior generations.
Pros:
- Immediate income for owner
- Allows next generation to use equipment
- Owner no longer responsible for maintenance
Cons:
- Depreciation must be recaptured
- Owner loses access to equipment
- Increased tax burden
2. Sell on Installment / Contract
A pre-arranged official agreement to finance equipment over a specified length of time. It works out because it spreads the payments out but taxes are due the year equipment is sold. “We set up the strategy and work with our client’s accountant to finalize the agreement,” according to Vasichek. “In this scenario a younger farmer can stretch the purchase out for 10 years; or even structure it piece-by-piece.”
Pros:
- Steady income flow for owner
- Reduces buyer’s cash outflow
- Buyer gains ownership of equipment
Cons:
- Depreciation recapture still due in year of sale
- Seller not entitled to depreciation
“50% of equipment value could be gifted and the other 50% financed on installment…”
3. Lease-to-Own
A lease-to-own agreement seems similar to an installment sale in that the seller receives income from the arrangement over time and the buyer is able to use the equipment immediately; however he or she doesn’t own it outright until the last payment has been satisfied. The primary differences are the tax implications 1) The lease payments are treated as ordinary income by the IRS in the year received, and; 2) The purchase occurs at the end of the lease so owner pays depreciation recapture taxes when the value of the machinery has significantly declined.
Pros:
- Lease payments deductible for buyer
- Owner pays depreciation recapture at the end
Cons:
- Buyer does not own equipment until lease is paid off
4.Gifting
Giving a piece or pieces of equipment to a family member or friend without expecting payment in return. It may be combined with any other method discussed here depending on the nature of the familial relationship and needs of the partners. “Just as an example, 50% of equipment value could be gifted and the other 50% financed on installment, based on your unique situation and needs,” says Vasichek.
Pros:
- No capital gains tax due
Cons:
- Possible tax burden above federal gift allowance
- No stepped-up basis for recipient
5. LImited Liability Company (LLC)
The seller and buyer set up an operating partnership that provides for ownership shares equivalent to each partner’s contribution to the business. Vasichek believes this is the method clients prefer most often. “In this situation it’s likely both the senior and junior partners already farm together and each owns a percentage of the equipment and thus shares. The younger partner can buy additional shares from the older one over a prescribed period of time or at will.
Pros:
- Liability protection for owner
- Spreads out payments and tax burden
Cons:
- Set-up and administration costs of LLC
- Causes owner to become a business partner
- Subject to capital gains tax
6. Do Nothing Inherit
If the owner does not need the income from the equipment it may be transferred at death, according to a will. Vasichek is not a fan of this method: “This isn’t much of a strategy unless the owner plans to farm until an indefinite date in the future.”
Pros:
- Stepped-up tax basis for inheritor
Cons:
- No immediate access for next generation
- Requires impartial third-party executor
Final Advice
Any of these strategies can be effective depending on the needs of the seller and buyer, according to Vasichek. “But don’t go it alone.
We recommend consulting with an Agricultural Focused Financial Planner and tax professional to understand the cash flow and tax implications of each strategy. Think of equipment transfer as one part of a wholistic approach to financial planning” concludes Vasichek.
