The earth is unique; we don’t do it anymore. It is for this reason that families will cling to farms, ranches and coastal properties for continued income, appreciation and, of course, sentimental value.
Estate planning professionals typically see real estate going through multiple generations – grandfather, father, children, grandchildren, and even their own descendants – with little interest in selling or transferring assets outside of extended families. . Demographic changes that began in the middle of the last century showed branches of these families moving away from ancestral farms to populate cities and find occupations outside of agriculture. Other families have fond memories of annual family vacations at the beach or in the mountains and want their children and grandchildren to enjoy it with their family.
As real estate planners, we may be responsible for finding strategies that allow extended families to continue to appreciate the value of real estate, to use the property cooperatively, or to share a pro rata share of mineral production and crop income while dividing taxes fairly. and other expenses.
Families often have a common goal of preserving equal ownership through each generation. As ownership passes from generation to generation, what might have been fractional ownership of one-third of the land held by a father and his two siblings can evolve into a one-ninth interest for each of the father’s three children. If each of these three children has three children of their own, each grandchild can become a 1/27 owner. In the absence of additional planning, deeds would have to be prepared for each generation as the property divides. Further planning is also required to share income and expenses as ownership passes through each generation.
SARL family and partnerships
Forming a family limited liability company or partnership is a practical solution to intergenerational ownership and management of family assets.
Limited Liability Companies (LLCs) originated decades ago to organize small businesses. In the early 20th century, a business owner was personally liable for a business’s debts and receivables unless he formed a corporation. Corporation taxes were often inconvenient for most small businesses, so later subchapter S corporations were created under the tax code to simplify taxes while limiting personal liability. Beginning in the late 1970s, many states created statutes allowing the formation of limited liability companies. LLCs began to gain popularity in the 1990s and today many small businesses are organized as LLCs.
An LLC operating agreement sets up the person(s) responsible for the day-to-day running of the business or for collecting rent, paying expenses, and distributing income. The operating agreement also divides ownership into units, with each member holding units in proportion to their ownership percentage.
Maintain the family farm
Maybe your grandfather was a farmer or rancher. His land was his vocation. He might not consider himself an agribusiness entrepreneur, but he was. His family farm or ranch was a business and should always be treated as such. Many of his generation relied on a farm or ranch to support their family. Their work has given generations the resources and flexibility to move away from rural life to find other pursuits, in part because improved technology and work practices have changed farming so that it no longer requires the same amount of work as before.
An LLC or family partnership may not have been in your grandfather’s toolbox. However, it is in yours and should be considered to meet your current interfamily goals.
Typically, families want to continue to hold their entire farm or ranch as a single unit rather than subdividing it with each generation. A family LLC or family limited partnership is an effective way to do this. Ownership of the entire farm may be held in the LLC, with each family member holding a pro-rated share of the LLC’s membership units based on that person’s individual ownership percentage.
There are a number of advantages for future generations owning the farm within an LLC rather than directly:
- If an heir or family member knows about the farm, they can continue to operate the farm or enter into a contract with an operator under a cash rent or crop sharing agreement. Each family member or partial owner can vote their shares to select the family member or third party LLC manager to operate the farm or contract with the operator.
- The LLC manager has a fiduciary duty to account to all members for receipt of income or payment of expenses.
- Net rental income can be distributed to owners or retained in the LLC to enhance the property or to allow the value of the LLC to increase as an inheritance for future generations.
- Each owner is not personally liable for farm debts, injuries or other liabilities.
- LLC units can be easily sold within the extended family if a family member wishes to liquidate their interest in the farm.
- The operating agreement or partnership agreement may restrict sale or transfer outside the family unit or give other family members a right of first refusal if the units are sold.
- LLC units can be passed down to each generation as part of a previous generation’s estate planning. This planning may include appraisal discounts offering estate tax savings.
- Ownership changes are reflected in the LLC’s records and not in public land records.
- Family LLCs and family partnerships are not limited to family farms or ranches. Vacation homes on the beach or lodges in the mountains where generations of your family hope to continue hunting, fishing, or hiking can also be placed in an LLC and managed in the same way as a family farm or estate. ranch. Additionally, services such as Airbnb and Vrbo can be used by the family to generate income and support ownership when not just for the enjoyment of family members.
- Often, families do not want to continue owning undeveloped land, but want to take advantage of the revenue stream generated by mineral-rich properties in the lower Midwest and South. In this situation, the surface of the land can be sold to raise equity, which can be distributed to the owners or invested by the LLC. The mineral rights are then retained by the LLC, and offers to drill can be considered, rental premiums received, and income distributed among family members. Centralized management, accounting, ease of transfer and potential estate tax advantages benefit owners in the same way as operating a farm or ranch.
Holding family property in a trust
Trusts are generally an efficient way to hold and manage the assets of beneficiaries. There are some practical disadvantages to actively managing a farm, ranch, or vacation property within a trust, assuming the goal is to maintain centralized management of farm property for the benefit of your descendants for many generations.
- Tax on undistributed income. There is no doubt that a trustee has the legal power to enter into agreements to manage trust assets and distribute income among beneficiaries. The trustee can easily pay taxes and expenses from the body of the trust and distribute the income pro rata to the beneficiaries. However, keeping income in the trust can cause the trust to pay income tax at a higher rate than most individuals.
- A manager or a trustee? Since the operation of the property is governed by the trust agreement and not an LLC operating agreement, care should be taken to give beneficiaries the ability to select or remove a trustee.
- Probate Considerations. If state law permits, the transfer of a beneficiary’s interest in a trust can be accomplished by using a power of appointment over their interest. However, without careful planning, it may be necessary to admit the beneficiary’s probate will to give effect to any testamentary power of appointment.
- Perpetual ownership. Finally, most states do not allow a trust to continue in perpetuity, as this is contrary to the common law rule against perpetuities. If your goal is to hold the property for both your current heirs and future unborn descendants, it may be necessary to locate a trustee in one of the few states that have completely abolished the rule against perpetuities or a way that meets your planning objectives.
Family farms and ranches have traditionally been a source of pride and have provided the income necessary to create wealth for several generations of American families. The struggle and good fortune of our ancestors has enabled current generations to acquire recreational property and enjoy endless opportunities far from our roots.
LLCs and partnerships are often used to shape businesses large and small, allowing these businesses to continue for as long as their owners wish. Using this solution for the ownership and management of farms, ranches, and recreational properties can preserve the intrinsic and extrinsic value of properties, honor the efforts of family ancestors, and allow properties to be a source of revenue. and enjoyment for generations to come.
Vice President/Counsel, Argent Trust Company
Jim Ferraro is vice president and trustee in the office of Argent Trust Company in Shreveport, Louisiana. Ferraro is a 2003 graduate of the University of Missouri at the Kansas City School of Law, past chairman of the family and law section of the Kansas City Metropolitan Bar Association, and is a member of the Shreveport Tax and Estate Planning Council.