A growing number of farm clients come to my office to discuss succession planning. In many cases, there is a single farming child that has stayed behind to help run the operation, and this child will be the successor. Often, there are other children in the family who have left the farm and have blazed their own paths in life.
Inevitably, the parents wrestle with how to pass the farming assets (land, buildings, machinery, etc.) to the farming child without alienating the other children and damaging the family dynamics.
In many cases, parents seek to equalize their estates among all of their children. Sometimes this is attempted through a life insurance policy to benefit the off-farm children or by the parents gifting certain parcels of land in their will.
Farm family example
Consider the example of a family of five, with one farming child and two non-farming children. The parents own twelve parcels of farmland and decide to bequeath each child four parcels of land and gift the buildings and machinery to the farming child as payment for their years of sweat equity. Their estate-planning problem should be solved, right? Well,…maybe.
Simply giving the two non-farming children legal right to four parcels of land imposes no obligation on them to allow the farming child to rent those parcels and continue farming in the same way as the parents did. Even if there were a right of first refusal agreement granting the farming child the opportunity to purchase the parcels, there is no guarantee the farming child would be in a financial position to do so.
As land is usually the most valuable and saleable asset of any farm, an off-farm child often sees their share of the land as a means to fund their own financial obligations.
If each of the non-farming children were to sell their parcels to third parties, the farming child would be left with one-third of the acres previously owned by the family. Presumably, the farming child would then have buildings and machinery that could not be fully utilized. If the machinery and buildings were financed and payment depended on those lost acres, the farming child would be further burdened.
The farmland partnership solution
At times, we have recommended and implemented farmland partnerships as a solution to this problem.
While the parents remain the principal farmers, we have them separate the land from the rest of their farm by forming a partnership and transferring some (or all) of their farmland to the partnership. The transfer can occur without tax consequences if the transferors file an election under Section 97 of the Income Tax Act (ITA).
The result is a family farm partnership that will rent its land back to the farm.
The next step is to solidify the partnership’s objectives by executing a partnership agreement. In addition to other terms, the agreement should set out the following:
- The objective of the partnership is to rent land to the family farm operation.
- The rent charge is to be determined in a consistent, objective and easily calculated manner to ensure there is no misunderstanding between the renter and the partnership (i.e., annual rent to be a set percentage of the previous year’s municipal assessment).
- The sale of any parcel of land may be undertaken only with the unanimous written consent of all partners.
Such an arrangement represents one of the few opportunities for parents to “rule from the grave.” The partnership agreement will bind the current partners (the parents) and all future partners (the children). If the future partners wish to re-write the agreement, they must agree unanimously.
Once the partnership agreement is signed, the existing partners (the parents) can transfer a portion of their partnership interest to the farming child. This is done without tax consequences through ITA Section 73.
Continuing with our example, the parents could transfer 34 per cent of their partnership interest to the farming child, and retain 66 per cent until their passing. At that time, each of the non-farming children would inherit a 33 per cent interest.
The result
Once the partnership interests are fully transferred to the next generation, there are several key outcomes:
- All children have an equal share in the value of the land owned by the partnership.
- All children share equally in the annual profits generated by the partnership.
- The farming child is guaranteed access to the land at a set annual rental rate.
- The non-farming children have recourse if the farming child does not pay rent.
In the event future partners decide to sell a parcel of land, the capital gain on that sale will be allocated from the partnership to the individual partners, who will (most likely) qualify to use their capital gains deduction against it.
This example is just one of many strategies that can be used to facilitate an effective farm succession plan. This particular plan will work well in certain situations, but not all. Each farm is different and each solution will be different. The succession process often takes a few years to plan and execute. To begin the conversation, contact your Baker Tilly advisor.
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