Land-rich and cash-poor has aptly described generations of farmers and ranchers, and today the description is becoming more accurate every day.
The value of farm and ranch land has climbed steadily since the early 1990s, but over the past two years, prices have escalated at an unprecedented rate. According to a University of Nebraska report, agricultural land values in Nebraska, during 2007 alone, increased 23 percent from an average of $1,155 to $1,425 per acre. Data from the University of Missouri shows land prices since 1990 in key cow-calf states such as Missouri increasing 225 percent, Kansas 142 percent, and Oklahoma 119 percent. On average for the lower-48 states, land values increased 216 percent since 1990 and 87 percent since 2001, according to the report.
Demand from investors, developers and recreation drove the trend through the 1990s and the first part of this decade. Today, a new trend has taken over, causing rural land prices to skyrocket even as the economy stalls and residential property loses value.
That new force is biofuels. Global energy demand and government policy have converted agriculture from the traditional production of food, feed and fiber to production of fuel. The prospect of $5 corn, $9 wheat and $13 soybeans makes even marginal farmland an attractive investment. Even ranch land not suited for row-crop production holds the potential for growing biomass crops such as switchgrass for production of cellulosic ethanol.
The dramatic run-up in land values has numerous implications for farmers and ranchers, but one that could bring some unwelcome surprises is their change in tax liability when the operation passes to the next generation.
Producers, whose assets just a few years ago might have been valued below the threshold for inheritance taxes, could now find themselves in a different situation.
Jason Jordan, manager of legislative affairs for NCBA, explains that federal tax reform from 2001 initiated a temporary 10-year phase out of the “death tax” that places such a huge burden on family-owned businesses. Under current law, a full repeal takes effect in 2010. But unless the government makes the repeal permanent, or otherwise revises the law, the death tax will return with a vengeance in 2011, with the exemption level dropping to $1 million with a tax rate of 55 percent, as it stood in 2001. (See table).
“The death tax is right at the top of issues for our members,” Jordan says, adding that repeal or reform of the tax is a top priority for NCBA. “Since the tax reform measures instituted in 2001 and 2003, measures to permanently repeal the tax have fallen slightly short in Congress,” he says.
The U.S. House of Representatives has shown little interest in addressing the issue, at least until after the November elections. On the Senate side, Jordan says, there has been some continued interest in the issue, particularly from Sen. Max Baucus (D-Mont.), who chairs the Senate Finance Committee, and Sen. Charles Grassley (R-Iowa), who serves as ranking member on the committee.
The Finance Committee held hearings on the issue in November 2007, March 2008 and again on April 1 with a hearing titled “Outside the Box on Estate Tax Reform: Reviewing Ideas to Simplify Planning.”
Jordan says the hearings have been constructive, but he doubts the Senate will introduce legislation this year. And if the Senate does, there is almost no chance it would reach the president. “In an election year, tax issues are particularly contentious and polarizing for both parties.”
He adds there is a general consensus in the Capitol that Congress needs to take action on this issue and that something has to happen before the temporary repeal expires. It is unclear, however, what Congress will do.
Plan, but be flexible
The uncertainty makes it difficult for NCBA to advise members about what they should be doing in terms of their business planning. “All we can tell them now is to monitor the situation, and if it looks like they could be affected, to work with an attorney to maintain a flexible estate plan that can account for year-to-year changes in the tax law,” Jordan says.
NCBA also encourages pro-ducers to communicate with their Congressional representatives. Put a human face on the issue, Jordan says. Make them realize there are real voters whose family businesses could be ruined by this tax.
Rodney Jones, a farm management economist at Kansas State University, agrees that farmers and ranchers need to keep up with their succession planning. Even if an owner has an estate plan in place, the recent increase in asset values warrants revisiting the plan with an expert. “Tax laws are in a state of flux,” he says. “Maybe some of these issues will be settled after the November election, but for now, property owners just need to watch the issue and remain flexible.”
Jones encourages family farmers and ranchers to have a succession plan in mind, even if the primary owner is not nearing re-tirement. An early start to the planning can prevent problems later.
Jones notes that only about 30 percent of family-owned businesses successfullytransfer to the second generation. Only about 15 percent make it to the third generation and about 5 percent to the fourth generation. Sometimes the younger generation might have no interest in the business, but Jones says that in many cases, the failure relates more to a lack of understanding of the underlying issues, a failure to communicate and a lack of planning
The first and perhaps most important step in succession planning is to open lines of communication with all the stakeholders, Jones says. Engage in a process to build mutual understanding of what everyone wants from the transition. This should take place before bringing in attorneys or other experts to develop the legal and technical details of an estate plan or other succession issues.
In cases where several heirs stand to inherit shares of the farm or ranch, the family needs to determine, as early as possible, each person’s goals and preferences. If, for example, one sibling wants to remain on the ranch and pursue a career in agriculture and the others do not, early planning can allow equitable distribution of assets without a need to sell part of the property. Jones says there are tools and strategies available that can enable one sibling to buy out the others’ shares in the operation over time or to build non-farm assets for later distribution, but the process needs to begin early.
Jones adds that planning becomes even more important as the scale of the business and its monetary value become larger, as has happened with most farms and ranches. “It’s never too early,” he says, “to start communicating and planning how to finance the transition.”
In early April, Arizona cattle producer and NCBA President Andy Groseta wrote to Sens. Baucus and Grassley outlining NCBA’s stance and suggestions for reforming the inheritance tax.
In the letter, Groseta explains that urban expansion and high commodity prices driven by unprecedented demand for food, feed and fuel have contributed to sharp increases in agricultural land values. Compounding the situation, economies of scale have driven families that are wholly dependent upon farming and ranching income to expand the scope of their operations.
NCBA encourages producers to voice their concerns over this issue with their Congressional representatives and lists several additional points outlining the impacts of inheritance taxes on agriculture.
Ninety-seven percent of American farms and ranches are owned and operated by families, and death taxes are one of the leading causes of the breakup of multi-generation family beef enterprises.
In an asset-rich and cash-poor business like ranching, the appraised value of rural land is extremely inflated when compared with its agricultural value.
The cash-rich can afford accountants and estate planners to help them evade the tax. But for family businesses in which the assets are equipment and land, the tax can be a death warrant.
The temporary nature of the death tax repeal creates uncertainty for family farms, ranches and businesses, requiring business owners to continue with estate-planning strategies that are costly, cumbersome and time consuming.
If Congress were to permanently repeal the death tax, owners could invest more back into their businesses, creating new job opportunities and boosting local economies.
Surveys show that 78 percent of all Americans believe the death tax is an unfair tax. Among cattlemen surveyed, 88 percent say that fear of death taxes has changed the way they invest in their own businesses.