Don Hofstrand

1. Don Hofstrand • Agricultural Economist www.extension.iastate.edu/agdm • Co-Director, Ag Marketing Resource Center www.AgMRC.org • dhof@iastate.edu • 641-423-0844

2. Critical Success Factors(can you answer YES to these questions?) • 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?

3. Transfer Plan Transfer Stages Testing Commitment Established Withdrawal TransferOwnership Sale, Gift, Inheritance TransferMgmt. General Manager, Equal Voice DivideIncome Wage, Contributions, 50-50 Division, Lease

4. Business Arrangements Transfer Stages Testing Commitment Established Withdrawal Multi-Person Spin-Off

5. Transfer Period older party younger party Short Transfer Period time

6. older party younger party time Transfer Period Long Transfer Period

7. Multi-Person Arrangement Spin-Off Arrangement Two Basic Choices

8. Business Business Business Multi-Person Approach P C P & C P C

9. P Business Business Business Business Spin-Off Approach P C P C C

10. Tax Implications of Asset Transfers Transfers Sale Gift Inheritance Transfer Taxes Sales Taxes Gift Taxes 1 Death Taxes 2 Income Tax 3 • Federal gift tax, no Iowa gift tax • Federal estate tax, Iowa inheritance tax • Federal & state income taxes

11. Income Tax Implications Machinery Example $50,000 fair market value $30,000 income tax basis

12. 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

13. Income Tax Implications • Gift – tax postponed Donor $50,000 gift value (gift tax) 0 taxable gain Donee $30,000 basis

14. Income Tax Implications Farmland Example $100,000 fair market value 60,000 income tax basis

15. Income Tax Implications • Sale – tax paid Seller $100,000 sale value 60,000 basis $ 40,000 taxable gain Buyer $100,000 basis

16. Income Tax Implications • Gift – tax postponed Donor$100,000 value (gift tax) 0 taxable gain Donee $ 60,000 basis

17. Income Tax Implications • Inheritance– tax eliminated Decedent $100,000 value (death taxes) 0 taxable gain Recipient $100,000 basis

18. General Considerations • Valuation • Appraiser • Dealer • Auctioneer • Disposal of machinery not wanted by successor

19. Transferring Ownership(personal property) • Sale • Leasing • Gifting • Combinations

20. Outright Sale • Simple • Tax consequences of seller • Depreciation recapture • Capital gains • Cash flow needs of buyer (third party financing) • New income tax basis for buyer

21. Installment Sale • Payments spread over period of years • Spreads buyers cash-flow commitment • Tax consequences of seller • Depreciation recapture • Capital gains • Seller financed • New income tax basis for buyer

22. Piecemeal Sale • Spread tax consequences of seller • Depreciation recapture • Capital 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

23. Gift • 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

24. Combination • 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 • Lease/Sale

25. Order of Asset Transfer Younger Party Older Party Asset Operations & Feeder Livestock 1 1 Breeding Livestock 2 2 Machinery 3 3 Buildings & Facilities 4 4 Land 5 5

26. Decision Making Authority • General Manager • On-going decisions • Both parties • Major decisions • Final authority

27. Decision Making Authority • Equal Voice • Both parties • Final authority • One party • Vote • Arbitration

28. 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

29. Tranferring Management • Division of Responsibility • Enterprise division • Functional division • Management Styles • Analytical vs. interpersonal • Competitor vs. peacemaker • Withdrawing from Management

30. Income Sharing Arrangements • Contributions approach – share income based on contributions • 50/50 approach – pay a return to resources and share residual

31. Contributions Approach Child Parent Resources (Annual value=$100) Resources (Annual value=$50) Joint Operation 67% contributed by parent 33% contributed by child

32. 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 $200 Parent = $133 Child = $67

33. 50/50 Approach Gross Income $300 Direct Expenses $100 Net Return $200 Parent’s Resources (an. value) $100 Child’s Resources (an. value) $ 50 Net $ 50 ParentChild $ 25 $ 25 $100$ 50 $125 $ 75

34. 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.

35. What is the annual value (cost) of a resource used in a business venture? Income Sharing Arrangement

36. Contributions Approach 109,000 156,000 Parent’s Share = 70% 47,000156,000 Child’s Share = 30%

37. Contributions Approach(allocating income) Parent’s Child’s Gross Income $186,200 $79,800 Prod. Expenses -65,800-28,200 Return $120,400 $51,600

38. Contributions Approach(cash flow) Parent’s Child’s Return $120,400 $51,600 Land Taxes -8,000 0 Land Debt -35,000 0 Machinery Debt -4,000 -3,000 Net Cash Flow $73,400 $48,600

39. 50/50 Approach Gross Receipts $266,000 Production Expenses -94,000 Net Return $172,000 Parent’s Land -52,000 Parent’s Machinery -24,000 Child’s Machinery -6,000 Parent’s Labor & Mgmt. -33,000 Child’s Labor & Mgmt. -41,000 Profit $ 16,000

40. 50/50 Approach(allocating income) ParentChild Land $52,000 $ 0 Machinery 24,000 6,000 Labor 23,000 33,000 Management 10,000 8,000 Profit 8,000 8,000 Total Return $117,000 $55,000

41. 50/50 Approach(cash flow) Parent Child Total Return $117,000 $55,000 Land Taxes -8,000 0 Land Debt -35,000 0 Machinery Debt -4,000-3,000 Net Cash Flow $70,000 $52,000

42. Parent’s Perspective Transfer their dreams Inspection tour Advice on raising children Social life Daughter-in-law Son-in-law Problem Areas

43. Problem Areas Adult Child’s Perspective • Accept parent’s lifestyle • Marriage spats • Confidant • Baby sitting • Carrying stories

44. Keys to Success • 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

45. 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

46. For More Information Ag Decision Maker www.extension.iastate.edu/agdm