Capital Gains & Estate Taxes Giving Uncle Sam less than his “Fair Share”

by Amanda Smith

“I shall never use profanity except in discussing house rent and taxes.”
-Mark Twain

If Mark Twain were a farmer today, he might change that statement to “cash rent and taxes”, but nonetheless, nothing stirs up profanity at the coffee shop like taxation.  When considering taxation relative to succession and estate planning, two key topics need to be addressed, capital gains tax and estate tax.  Both can influence the portion of your net worth that survives your death. In Part 1 of this series we discussed “fair vs. equal” and this article on taxes might be seen as an extension of that.

Selling a farm means giving strong consideration to the potential tax consequences

Although recent changes in the tax law that may influence the propensity with which you reduce income tax through charitable donation, you may choose to benefit charities of choice as an alternative to sharing a larger portion of your estate with Uncle Sam.  We will briefly take a look at implication of capital gains and estate tax.  In Part 2 of this series on Farm Business Structures we’ve outlined several ways to set up the farm for estate planning and these structures may or may not affect capital gains farm taxes. Please remember that this is information only, subject to changes in tax legislation, and should not be a substitute for consulting your estate planning team of professionals.

Capital Gains Tax on Farms

“A person doesn’t know how much he has to be thankful for, until he has to pay taxes on it.”
-Anonymous

Owning property, caring for it well, and leaving it as a legacy for the next generation, might be the greatest source of pride for any farmer, or any American for that matter.  Unfortunately, the greater the appreciated value of property over time, the more you are likely to pay in capital gains tax.  Capital gains is calculated based on the net sale proceeds minus the owner’s basis in a property.  If a property is held beyond a year, capital gains are taxed at a rate of 15% or 20%, in addition to any applicable state taxes.

Reducing capital gains taxes becomes a decision between several options, highlighted below:

Creating a charitable trust provides a lifetime fixed or variable income to the current generation owners. No capital gains are realized when assets like land and equipment are contributed to a charitable “remainder” trust.

At death, a charitable trust to the heirs provides them a lifetime of fixed or variable income. No capital gains are realized, and upon the death of the heirs the assets are distributed to a charitable organization for the purposes desired by the original owners.

In the case of no heirs, where the current owners want to continue to earn income from the operation, and then pass it to a charitable organization at death, property may be deeded to the organization effective upon the owner’s death. This results in a nice income tax deduction for the landowner for the value of the charitable organizations right to own the property, and allows ownership and operation rights for their lifetime.  For the duration of their lifetime they are entitled to all income from the property, and also continue to be responsible for taxes, insurance, maintenance and other operating costs.

In this option, the owner gifts farmland to a charitable organization during their lifetime or at death. No capital or estate taxes would be due with this gift.

If or when the heirs sell the asset, their capital gain realized will be limited to the change in value from the time they inherited the property until the time of sale.

Estate Tax

“A fine is a tax for doing something wrong. A tax is a fine for doing something right.”
-Anonymous

Transferring farm assets from one generation to the next, no matter if it’s during the owner’s lifetime, or upon their death, can be somewhat of a moving target when it comes to tax liability. To better understand how estate tax is defined and calculated, visit this article from Iowa State Extension. (Note: The figures have not been updated to reflect legislative changes in estate tax in 2018) Previous legislation held the limit of transfer without incurring estate tax to $5.49 million, in addition to unlimited transfer to spouses and/or charity.

Current federal legislation, in effect from 2018 through 2025, raised the limits of asset transfer to $11.2 million.  This is in addition to unlimited transfers to spouses and/or charitable organizations.  If you happen to have more than that to be thankful for, or plan to live beyond 2025 or the next Presidential administration change, you will want to pay close attention to legislation changes.

Keeping an accurate balance sheet that reflects current and expected fair market value is key to avoiding estate tax.  Because of the per unit value of not only farmland, but also other farm assets such as equipment, buildings, etc. the value of an estate can approach the $11.2 million per person limit rather quickly.  This is a figure you want to take seriously.  You will want to revisit your estate plan as you acquire assets to make certain you have not reached a threshold which might trigger estate taxes.

“Death and taxes may be inevitable, but they shouldn’t be related.”
-J.C. Watts

In the final article of this series, we will take a look at common mistakes in the estate and succession planning process, and explore a few tools that can be utilized to overcome hurdles when balancing fair and equal regarding heirs.