Fair is not always equal and equal is not always fair

In most estates, dividing the assets equally is both fair and workable. In a farm estate it is frequently one or the other, and the arithmetic that makes it so is not complicated. The difficulty is that the land is simultaneously the family's largest asset and the means by which one member of the family earns a living.

Split it evenly and the person who farms may be left unable to farm. Give it to the person who farms and the others receive comparatively little. Neither outcome is what the parents intended, and both are common.

Why the usual answer does not typically work

Consider an operation where the land represents the great majority of the estate's value, with the remainder in machinery, stored crop, and a modest amount off the farm. One of three children has farmed alongside the parents for years. The other two live elsewhere and have careers of their own.

An equal division gives each child a third of everything, including a third of the land. The farming child now rents two-thirds of the land from siblings, buys it from them, or watches it be sold. Renting works only while relations hold, and buying likely requires debt the operation may not be able to service.

The parents did nothing wrong. They applied a principle that works in nearly every other setting to the one setting where it typically does not.

Separating the two questions

Progress usually begins by splitting a single question into two. How do we protect the land so the farming operation can continue, and how can we also provide for our non-farming heirs? The following are some common planning tools used to address these questions.

Life insurance

Oftentimes overlooked, a life insurance policy payable to the non-farming heirs creates off-farm value that does not have to come out of the land. It can also be used to help the farming heir purchase the land from the non-farming heirs. This tool is sensitive to timing, since it depends on the insurability of the parents.

A long-term lease attached to the inheritance

The land passes to all three heirs, but the farming heir holds a written lease at a defined rate (with or without escalators) for a defined term (sometimes with a renewal option). Typically this lease is negotiated between the parents and the farming heir during the parents' lifetime.

A right of first refusal or purchase option

Modest, and often the difference between an orderly transition and a forced sale. As part of the parents' estate and succession plan, they can grant the farming heir a right of first refusal or purchase option for the land with defined terms regarding price and payment terms. This provides the farming heir an opportunity to purchase the land in the event the non-farming heirs desire to sell (right of first refusal) or in the event the farming heir desires to purchase (purchase option).

A partnership or land trust

A combined approach where a single legal entity (typically a partnership or a land trust) owns the land with all three heirs as the owners or beneficiaries. The partnership or land trust may give operating control to the farming heir and income distributions to the non-farming heirs.

Oftentimes, the partnership or the land trust will include provisions regarding preferred lease terms for the farming heir and/or purchase rights for the farming heir. These structures allow all three heirs to own and benefit from the land, while also building in rent and purchase protections for the farming heir.

The valuation questions underneath

Every tool requires a number, and the number is typically where most plans come apart. Three points deserve attention early.

Fair market value and use value are different figures. Land valued at its highest and best use may be worth considerably more than land valued at what it produces as a farm. If your land could be used for development or non-agriculture use, this distinction may greatly impact the valuation of the land.

An interest in an entity is not the same as an interest in the land. Where land is held in a separate legal entity, such as a partnership, rather than owned directly, a minority ownership interest can carry very little control and may be subject to transfer restrictions, sometimes permitting a lower value than a proportionate share of the underlying land. Valuation discounts of this kind must be supported by a qualified appraisal and a structure that properly incorporates these restrictions.

Sweat equity is real and rarely documented. Where a farming heir has worked at below-market compensation for years, the parents often intend that to be recognized. Sometimes this can take the form of a gift of part or all of the farming operation (not including the land), and other times it can be reflected in how they distribute land and the restrictions they may put on the land to benefit the farming heir.

The conversation is part of the work

Regardless of the tools used in your farm succession plan, it is often very beneficial for the family to openly discuss their farm succession plans. This gives everyone the opportunity to be heard and discuss the reasoning behind some of the decisions incorporated into the farm succession plan. Oftentimes this is done separate from in-laws.