Can Gifting Part of the Farm to Our Heirs Reduce Tax Burdens?

Farm succession planning is an important process for many families who want to keep their farm in the family for generations. One of the key questions that often comes up is whether gifting part of the farm to heirs can help reduce tax burdens. The answer is yes, but it’s a little more complex than simply handing over a piece of land. Gifting part of a farm can be an effective way to manage estate and gift taxes, but there are rules, limits, and strategies to consider.

Why Gifting is a Common Strategy in Succession Planning

When passing down a farm, taxes can be a major concern. Federal estate taxes, which are taxes imposed on the value of the estate after someone passes away, can take a significant portion of the farm’s value if not properly planned for. Gifting allows you to pass ownership of parts of the farm during your lifetime, helping to reduce the size of the estate and, in turn, the amount of estate taxes owed when the farm eventually passes to your heirs.

Gifting can also help with the long-term transition of management responsibilities. By gradually gifting portions of the farm to your heirs, they can start taking on more responsibility over time, ensuring a smoother transition. It also ensures that your heirs have a stake in the farm’s success while you are still alive to guide them.

The Annual Gift Tax Exclusion

One of the most important tools in gifting is the annual gift tax exclusion. As of 2024, you can give up to $17,000 per person, per year, without triggering the federal gift tax. This means that if you have two children, you can gift each of them $17,000 worth of the farm’s value every year, or a combined total of $34,000. If you and your spouse gift together, you could double that amount, making it $68,000 annually. Over time, this can significantly reduce the size of your estate and the potential estate taxes that would be due later.

It’s worth noting that this amount is adjusted for inflation, so it may increase slightly in future years.

Lifetime Gift Tax Exemption

In addition to the annual gift tax exclusion, there’s also a lifetime gift tax exemption. This is the total amount you can give away over your lifetime without being subject to gift taxes. As of 2024, the exemption is set at $12.92 million per person. So, if the total value of your farm is below this threshold, you may be able to gift a large portion of the farm without incurring taxes.

However, any amount you gift that exceeds the annual exclusion counts against your lifetime exemption. For example, if you gift $100,000 to your child in a single year, $83,000 of that would reduce your lifetime exemption (since $17,000 is covered by the annual exclusion). If you gift more than your lifetime exemption, you’ll owe gift taxes, which can be as high as 40%.

Valuation of the Gift

When gifting part of your farm, it’s important to establish a proper valuation. The IRS requires that gifts be valued at fair market value, which is what the farm or its portion would sell for on the open market. This can be tricky for farms, where the value may not just come from the land but also from equipment, crops, or livestock.

You’ll likely need to hire an appraiser with experience in farm valuations to determine the correct value of the portion you plan to gift. This ensures you comply with IRS regulations and don’t accidentally undervalue or overvalue the gift, which could result in penalties or additional taxes.

Potential Tax Benefits of Gifting the Farm

Gifting part of the farm can come with some tax benefits:

1. Reducing estate taxes: By gifting portions of the farm over time, you reduce the overall value of your estate, which can help lower or eliminate estate taxes when you pass away. This is especially important for families who want to keep their farm intact for future generations, as high estate taxes can sometimes force heirs to sell part of the farm just to pay the tax bill.
2. Capital gains tax considerations: One potential downside to gifting is the impact on capital gains taxes. When you gift part of the farm to your heirs, they receive your original cost basis. This means that if they sell the farm in the future, they could owe capital gains taxes on the increase in value from when you originally acquired the farm to when they sell it. By contrast, if they inherit the farm upon your death, they would receive a stepped-up basis, which adjusts the cost basis to the value of the farm at the time of your death. This can significantly reduce the capital gains taxes owed.
3. Retaining some control: Gifting doesn’t necessarily mean giving up control of the farm. Many farm owners choose to structure the gifts in such a way that they retain some control over the operation of the farm until a certain point, such as through life estates or trusts.

Using Trusts to Gift the Farm

Another strategy to consider is placing part of the farm into a trust. Trusts can provide a number of benefits when gifting farm assets, such as offering more control over how the farm is managed and ensuring that the farm is used in a way that aligns with your long-term goals. Trusts can also offer protection from creditors or legal challenges, which may be especially important if you want to ensure the farm remains in the family for generations.

By placing the farm in a trust, you can specify terms under which your heirs will receive ownership, such as when they reach a certain age or achieve certain milestones (e.g., taking over management responsibilities). Trusts can also offer tax advantages by helping to reduce the overall value of the estate and qualifying for special tax treatment in some cases.

Consult with Trusted Advisors

While gifting part of the farm can be an effective way to reduce tax burdens, it’s essential to work with qualified advisors, such as an estate planning attorney, a CPA, and a farm succession specialist, to ensure you’re following the rules and maximizing the benefits. Each farm is unique, and what works for one family may not be the best strategy for another.

Working with advisors can also help ensure that you’re considering all aspects of the gifting process, from tax implications to family dynamics. For example, you’ll want to make sure that the heirs who receive portions of the farm are prepared to handle the responsibilities that come with ownership.

Final Thoughts

Gifting part of the farm to your heirs is a popular strategy in farm succession planning, as it can help reduce estate taxes and make the transition smoother. However, it’s not without its complexities. By understanding the gift tax exclusions, valuing the farm correctly, and considering trusts, you can make an informed decision that benefits both you and your heirs. Always consult with trusted advisors to ensure you’re making the best choice for your family’s future and the farm’s legacy.

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.