Property Ownership and Transferring Are Important Features of Your Farm Succession Plan
Many people think an estate plan is just a will, but it is much more than that. Your estate plan will typically include documents and tools to distribute your property according to your wishes at your death. When it comes to transitioning your farm or any family business to the next generation, how property is owned and transferring property prior to your death can be important features of your succession or estate plan. Titling property in a joint tenancy with rights of survivorship can allow you to pick who inherits upon your death and allows the property to transfer outside the will. Transferring property, such as through gifting, allows property to go to the next generation prior to your death and provides control over who gets your property.
Real Vs. Personal Property
In the law, title has a specific definition and means the legal evidence of a person’s ownership rights in property (Black’s Law Dictionary). You can own two forms of property:
Real property is land and anything growing on, attached to, or erected on it. For example, your farmland, crops growing on the farmland, and any barns on the farmland is considered real property.
Personal property is a movable or intangible object subject to ownership and not classified as real property. Personal property includes, for example, farm equipment, tools, or company stock.
How Do Own Your Property?
Individual Ownership: Typically, individual ownership is the common way property is owned, although co-ownership forms exist and are useful in the estate planning process. Individual ownership is often referred to as fee simple ownership, which gives the owner complete control over the property, and the ability to dispose of (sell, gift, or leave in a will) the property at any time. Fee simple ownership can be limited by the government through taxation, police power, eminent domain, and reverting ownership to the state with no heirs (also called escheat).
Life Estate: A life estate is possessive right in property and not technically a true form of property ownership. In a life estate, an interest in property is transferred to another person (life tenant) for the duration of the tenant’s life. Upon tenant’s death, the property goes to a remainderman, the person who takes ownership of the property at death. The life tenant’s interest in the property passes to the remainderman outside of the probate process.
Forms of Co-Ownership: Co-ownership is where more than one person owns a piece of property. Not all forms of co-ownership are equal, and each will impact your estate plans. Both co-owners will have access the property and may not exclude each other. Co-owners can demand an accounting of profits from the property, such as demand an accounting from other co-tenants for improvements made to the property, rents paid to a co-tenant, or profits received by a co-tenant. Co-owners must also contribute to the costs of owning the property (such as pay taxes and other costs). The forms of co-ownership we will discuss are 1) tenancy in common, 2) joint tenancy, and 3) tenancy by the entirety.
Tenancy in Common: A tenancy in common requires two or more owners called tenants in common. Each tenant in common holds an undivided interest (meaning they own a part of the total value of the property) in the co-owned property. Although each tenant in common hold an undivided interests, that interest may be unequal. For example, Stacy and Sarah are tenants in common to Blackacre, and each holds an undivided interest, but Stacy could potentially own a 60-percent interest in the property while Sarah owns a 40-percent interest.
Tenants in common have the ability to sell, give away, or transfer their interest to any person (including another co-tenant). Tenants in common hold no right of survivorship; when one co-tenant dies, his/her interest passes to his/her heirs, either by will or by intestate succession.
A tenancy in common is typically created through language such as “to A and B.” The language creating the interest is important. A tenancy in common can be ended by seeking a partition of the property through a court. Under such a partition the property is divided up among the co-owners based on their ownership interests. From our previous example, Stacy would end up with 60 percent of Blackacre and Sarah would end up with 40 percent. If a partition of the property is not possible, then a forced sale may be required.
Joint Tenancy: A joint tenancy is a form of co-ownership where the co-owners (called joint tenants) have an undivided interest in the property and a right of survivorship. Unlike in a tenancy in common, each joint tenant owns an equal share of the property. A joint tenancy can be broken by one of the co-owners transferring their interest to a third party. For example, A, B, and C own a farm in joint tenancy. C needs money and sells his interest to P. A and B would still be joint tenants in the property and P would be a tenant in common with A and B.
This property interest will pass to the surviving co-owners outside the probate process or even what a will says. Let’s say, for example, a father and son own a farm in joint tenancy. Son unexpectedly dies first and leaves his entire estate to his wife in his will. The farm owned in joint tenancy would pass to the father regardless of what the son’s will says because of the right of survivorship. The father would now own the farm in fee simple ownership and would indicate in his will who inherits the farm upon his death.
This form of co-ownership is common with property owned by husband and wives or a parent and child. To form a joint tenancy, the language needs to be clear, such as “to A and B as joint tenants with a right of survivorship and not as tenants in common.”
As with a tenancy in common, a joint tenancy can be ended by seeking a partition of the property through a court. If the partition is not possible, then the court could potentially require the owners to sell the property.
Tenancy by the Entirety: A tenancy by the entirety is similar to a joint tenancy but can only be created by a husband and wife. Husband and wife would each own an undivided interest in the property and have the right of survivorship. Creditors of an individual spouse cannot force a sale of the surviving spouse’s interest. If the parties divorce, a tenancy by the entirety would terminate.
In Maryland, all property held by a married couple is presumed to be held in a tenancy by the entirety. This presumption can be overcome by including language to create a joint tenancy or tenancy in common. Husbands and wives may consider doing this for estate planning reasons.
Transferring Property Commonly Done Through Gifts and Sales
Another strategy in succession planning and estate planning is transferring assets, frequently through gifts and sales. In developing your farm succession plan and estate plan, discuss with your tax professionals to pick the method which will work for your situation.
Gifts Can Reduce Size and Costs of Your Estate
Gifting property is one way to transfer property prior to your death. A lifetime gift, made during your lifetime, allows you to reduce the size of your estate, reduce administrative costs in your estate plan, and can potentially reduce estate and inheritance taxes upon your death.
A gift is a voluntary transfer of property (personal or real) from the donor or grantor to another party, called a donee or grantee, without anything in return. For example, you decide to give $100 to each of your children. You do this for no reason other than to be nice and expect nothing back in return. The $100 would be an example of a gift.
Gifts come in two kinds, 1) lifetime gift and 2) deathbed gift. A lifetime gift is one made during the grantor or the donor’s lifetime. For example, giving your children $100 during your lifetime would be a lifetime gift. A lifetime gift can also be for a future interest in property, such as promising your daughter shares in the family farm business upon her 30th birthday. The promise of shares upon reaching her 30th birthday would be an example of a future interest.
A deathbed gift is a gift of a future interest given in anticipation of the donor’s imminent death. For example, Parent A is suffering from a terrible disease and in anticipation of death gives to his children his entire estate. In order for this to be a deathbed gift, then Parent A would have to die from the terrible disease. If Parent A does not die, it would not be considered a deathbed gift.
Every person is allowed to gift to any individual tax-free up to $14,000 a year in 2016; check with the IRS to determine the tax exemption in future years. A couple can give up to $28,000 a year in 2016. Any amount in gifts exceeding $14,000 a year to any particular individual is taxed at the federal rate of 40%.
Individuals can use part of their Unified Credit to cover taxes due on gifts exceeding $14,000, or $28,000 per couple. The Unified Credit is a tax credit given to every U.S. citizen and resident to use against wealth transfer taxes, either taxable gifts or estate bequests. In 2016, the Unified Credit exempts a total of $5,450,000 in cumulative lifetime gift and estate transfers; it is adjusted each year based on inflation. For a married couple, the Unified Credit would exempt a total of $10, 900,000 in lifetime gifts and estate transfers. If one uses this tax today to avoid taxation on their gifts, it decreases the amount available at the time of death. How best to utilize the Unified Credit to transfer property is something to discuss with your tax professionals.
Sales Are the Simplest Way to Transfer Property
Another option is to sell the property to the person you want to have it. This is probably the simplest way to directly transfer property to a loved one. You will lose control of the property but potentially gain capital for retirement or other advantages.
You can sell the property for cash or on credit. If you sell the property on credit, you will receive cash payments over several years. If the buyer falls behind in payments, you have the option to foreclose on the buyer, or take possession of the property again. You can also condition the sale with a contract for deed. In this case, the seller retains possession of the deed till certain conditions are met. For example, you could condition the sale of farmland to a child on your receiving two-thirds of the sales price before the child gets the deed. Once the child has paid two-thirds of the sales price, you would deliver title to the property.
Before selling any property, talk to your tax professional. Sales of property can have income tax implications and your tax professional can help structure the sale in a way to lessen your tax burden.
Transitioning your property and the farm to the next generation is not a simple process. How property is owned impacts how it can be transferred upon your death. It’s important to check deeds and titles to see how co-owned property is held. This will help your farm transition and estate planning professionals as they work with you to develop a plan to transition the farm to the next generation.
Transferring your property to another party through gifts or sales will also facilitate the transition to the next generation. Each strategy can have tax implications and could be used by your team of professionals in the transition plan or estate plan. Work with your professionals to make sure you pick the gifting or sales strategy best for your situation.
Finally, remember that just because your neighbors are utilizing one strategy to pass on the family farm, it may not be the best for your situation. Listen to the advice of farm transition and estate planning professionals to make sure you have a plan that works for you and your family.
Lynch, Lori, Paul Goeringer, and Wes Musser. Estate Planning for Farm Families. University of Maryland, College Park, MD. Department of Agricultural and Resource Economics, Fact Sheet No. 972 (2014).
Tengel, Patricia. Estate Planning — Owning and Transferring Property. University of Maryland, College Park, MD: Extension Fact Sheet No. 410 (1997).
Source: Paul Goeringer, Medium.com