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Compiled by Lynn Snyder

Passing on a business is a complex endeavor. Not only are there business decisions to be made, but there are emotional issues that come into play. Ohio State University Extension has written a very thorough bulletin on this topic, "Transferring Your Farm Business to the Next Generation."

The authors said in their experience assisting families, they have noticed the same five questions:

• Do we have an economically viable business to transfer?

• Are there enough income and assets to provide for the older generation's retirement needs?

• How can we happily work together to help make the transfer a success?

• What should be transferred to the next generation and when should it be transferred?

• How do we avoid paying unnecessary income, gift and estate tax?

Farm Bureau at both the state and national levels has worked for many years to ease the estate tax burden on farm families so when they are ready to pass on the farm the tax burden isn’t so great. This year, the federal estate tax exemption rises to $1.5 million and under current law, estate taxes will be phased out in 2010. The Ohio estate tax rate is $338,000.

Here is an excerpt from OSU Extension’s bulletin, regarding tax implications involved in transferring the farm:

Income Taxes
Paying income taxes discourages farm families from selling the family farm. There is nothing in the law that specifically prohibits a sale. It is just that several key income tax, gift tax and estate tax provisions, when considered together, may make other alternatives look better than a sale.

The largest and most immediate problem faced by most farm families considering a sale is income taxes. Many farm owners must pay $20,000 to $50,000 or more in income taxes if they sell the farm. However, if they leave it to their children after both parents' deaths, there frequently is no federal estate tax and little or no income tax.

Gains Are Fully Taxed Now
As a rule, when you sell a farm, the difference between the selling price and the property's "income tax basis" is fully taxable. The tax problem stems from farm owners having an income tax basis well below what the farm is worth.

For example, if the owners paid $20,000 for an unimproved farm when they bought it, their initial income tax basis was $20,000. If they've never made any improvements or taken any depreciation on improvements their income tax basis is still $20,000. If they sell the land for its $100,000 fair market value they have an $80,000 taxable gain (sales price minus basis equals gain). It is capital gain, but it is taxable.

Tax Basis Rules
"Income tax basis" is a crucial tax concept. It is important when considering income, gift or estate taxes. Usually, your income tax basis in an asset is what you paid for it. In the example above, it was the $20,000 originally paid for the unimproved farm.

"Income tax basis" increases when you make capital improvements and decreases when you depreciate. If our hypothetical farm family made capital improvements on the farm costing $10,000, its income tax basis would increase from $20,000 to $30,000. Its income tax basis would decrease each year, by the amount of any depreciation on the capital improvements.

If someone gives you property, you get their basis, too. For example, assume that due to inflation, the farm with the $20,000 basis has a current fair market value of $100,000. If someone gives it to you, the gift is valued at $100,000, but you receive their $20,000 income tax basis. Thus, if you later sold it for $100,000 you would have an $80,000 gain, the same gain the person who gave it to you would have had if they sold it for $100,000.

"Stepped-Up" Basis at Death
Property going through an estate gets a "stepped-up income tax basis" equal to its appraised value in the estate. In our example, if the farm owner(s) let it go through their estates and it is appraised in the estates at $100,000, the $100,000 appraised value becomes the heir's income tax basis.

Therefore, if the parents in our example leave the farm to their children they avoid the income tax on a sale, the children receive a "stepped-up" basis equal to the property's appraised value in the estate, and the parents get the benefits of ownership until death. This provides a significant disincentive to selling the farm.

Parents can avoid the income tax on a sale by giving it to the children. But they must lose the benefits of ownership, and the children receive the parent's $20,000 income tax basis. The low basis means the children must pay tax on $80,000 of gain if they sell it for $100,000.

When It Pays Not to Sell
From the tax standpoint, under current law, it is frequently preferable for children to receive property through the parents' estates rather than by gift or sale from the parents. This is primarily so when one or more of the following is true: the property has a low income tax basis relative to its fair market value; it is likely to be sold later by the person(s) who receive it; it may appreciate significantly in value before the death of the current owners; the parents have a short life expectancy; and the parents have a combined net worth less than $2 million.

Alternative Strategies
If you decide to postpone a sale, it may still be important to develop a strategy that will protect the parents and those children wanting to farm. Gifts, leases and purchase options are possible means of meeting family goals. OSU’s bulletin has in-depth information on these options.

You may obtain the full bulletin from the Ohioline Web site, ohioline.osu.edu or from your county extension office. It is Bulletin 862.