What Tax Advantages Are Available for Transferring a Farm to the Next Generation?

Transferring a family farm to the next generation is a big decision that often comes with important questions about taxes, succession planning, and how to make the process as smooth as possible. Many families worry about the financial impact of passing on their farm, particularly when it comes to taxes. Fortunately, there are several tax advantages available that can make transferring a farm to the next generation much more affordable and manageable. Understanding these options can help you preserve family wealth, keep your farm business strong, and give your heirs the best possible chance for success.

Here’s a look at some of the top tax advantages available for farm transfers and how each of them can benefit your family.

1. Estate Tax Exemption

One of the most valuable tax benefits when transferring a farm is the estate tax exemption. In 2024, the federal government allows estates valued up to $12.92 million per individual (or $25.84 million per couple) to be passed on without any federal estate taxes. This means if your farm’s total value is within this exemption limit, your heirs won’t have to pay estate taxes on the property when it’s transferred.

It’s worth noting that the estate tax exemption can change over time due to inflation adjustments or new legislation. If your farm exceeds this threshold, other tax-saving strategies can reduce the amount owed.

2. Stepped-Up Basis

Another important tax advantage for farm transfers is the stepped-up basis. This rule allows the value of your farm to be reset (or “stepped up”) to its fair market value at the time of the owner’s death. This adjustment in basis reduces or even eliminates capital gains taxes for the inheritors if they decide to sell the farm later.

Here’s an example: let’s say you bought the farm 30 years ago for $100,000, but it’s now worth $1 million. If the basis steps up to $1 million, your heirs only pay capital gains tax on any amount above $1 million if they decide to sell. Without this stepped-up basis, they’d be taxed on the difference between $1 million and the original $100,000, leading to a much higher tax bill.

3. Agricultural Exemption and Use Valuation

Some states offer a specific tax relief known as agricultural use valuation (or current use valuation), which can reduce estate and property taxes. Instead of valuing the farm based on its potential development value, it’s assessed based on its actual use for agriculture. This often means a much lower tax rate because farmland has a lower tax valuation than commercial or residential property.

To qualify, your heirs will need to continue using the land for agricultural purposes, and there may be specific state requirements for them to keep the tax benefit. This exemption can make a significant difference in the total tax burden for the new generation of farm owners.

4. Conservation Easements

A conservation easement is a tool that offers twofold benefits: preserving your farm’s natural resources and offering tax advantages. When you place a conservation easement on your property, you essentially agree to keep it in its natural state or continue farming, protecting it from future development.

By setting up a conservation easement, you may qualify for income tax deductions, as well as reductions in estate and property taxes. The easement’s value depends on the difference between your farm’s fair market value and its restricted value due to the easement. This approach can be especially attractive for families committed to conservation or preserving farmland for future generations.

5. Gifting the Farm Over Time

Rather than transferring the farm all at once, you can use gifting strategies to pass on portions of the farm gradually, taking advantage of annual gift tax exemptions. In 2024, you can give up to $17,000 per person per year without incurring gift taxes. For example, if you’re married, you and your spouse can each give $17,000 to your children, totaling $34,000 per child each year.

Gifting gradually allows you to reduce your taxable estate while giving your heirs partial ownership over time. If done strategically, this method can save your family significant amounts in estate taxes by the time the full farm transfer occurs.

6. Family Limited Partnership (FLP)

Setting up a Family Limited Partnership (FLP) is another effective tax-saving strategy for transferring a farm. In an FLP, you can gift partnership shares of the farm to family members, usually at a discounted rate. This structure allows you to maintain control over the property while gradually transferring ownership to the next generation.

FLPs also offer the benefit of valuation discounts—since limited partners lack control, their share’s value may be discounted, reducing the total taxable estate value. Additionally, FLPs protect the farm from creditors and provide a clear succession path, which can be beneficial for family-owned businesses.

7. Installment Sales

An installment sale allows you to transfer the farm to your heirs while receiving payments over a period of time, which spreads out any capital gains taxes. This can help keep your tax rate lower than if the farm were sold all at once, making it easier for your heirs to afford the farm purchase without an overwhelming tax burden.

Installment sales also provide steady income during your retirement, making them an attractive choice if you still want financial security while passing on the farm. However, it’s essential to consult a tax advisor when using this approach, as specific requirements and considerations exist to maintain tax benefits.

8. Section 2032A Special Use Valuation

The IRS offers a special provision known as Section 2032A that can benefit family farms. If certain conditions are met, this provision allows the farm to be valued based on its agricultural use instead of its fair market value. This can lead to a significant reduction in estate taxes, as agricultural land is typically valued much lower than land for potential commercial or residential development.

To qualify for Section 2032A, the farm must continue to be used for agriculture for at least 10 years after the transfer. If your heirs decide to sell or develop the land during this period, they may have to repay some of the tax benefits, so it’s important to plan carefully.

Planning for a Smooth Transition

While these tax advantages can help make farm succession more affordable, it’s essential to plan carefully to maximize these benefits. Working with a tax professional or estate planner who specializes in agricultural transfers can ensure you’re using the best strategies for your family’s unique situation. Many families find that combining several of these methods—such as using gifting, FLPs, and conservation easements—provides the most comprehensive tax relief and ensures the farm’s continuity.

Final Thoughts

Transferring a farm to the next generation isn’t just about paperwork; it’s about preserving a legacy. With careful planning and a clear understanding of available tax advantages, you can make this transition smooth and financially sustainable. By using tools like estate tax exemptions, conservation easements, gifting, and special use valuations, you can reduce the financial strain and create a stable foundation for your heirs to continue your family’s agricultural tradition.

Make sure to check out more articles in our News & Views section. Feel free to reach out any time to see how Kindred can help you and your trusted advisors manage the complex succession plan process with simple software – cutting time & cost of the current process by 50% or more.