As you know, buying or selling a farm is a complex process that entails risk and reward for both parties. Exposure to tax is one of these risks, but it can be mitigated when the buyer and seller plan for and pursue the most advantageous structure for the sale. This is especially important when considering a corporate transaction.
According to the most recent USDA figures, about 3.1% of family farms are held in corporations, totaling about 15% of total agricultural production. The overwhelming majority—92% of farms and 66% of production—are owned by sole proprietorships. Still, that leaves 63,147 family farms in corporations. Often, these corporations were formed for beneficial tax purposes, but at some point they are likely to be sold, which can create a less-than-ideal situation for both the buyer and the seller.
When considering buying or selling a corporation, you essentially have two choices:
1. Buy the stock for as low a price as possible.
2. Avoid a corporate transaction altogether.
On a straight stock sale, the seller receives capital gains treatment on the proceeds, but the buyer has nothing to depreciate going forward. One way around this is to sell the stock for a low price and allocate the remainder of the purchase price to intangible assets such as going concern, goodwill, client relationship or corporate name. In this case, the seller still gets capital gains treatment, but now the buyer has an asset they can amortize, and thereby deduct, over 15 years.
Another consideration in a corporate sale is the buyer is taking on potential environmental, vendor and liability issues. Because you’re buying stock, not just assets, you might be liable for past problems of the corporation. There are ways to deal with these issues through indemnifications, but it’s much more complicated than simply buying assets. Also, the buyer is subject to double taxation going forward.
The ideal transaction involves a partnership-taxed structure (partnership, sole proprietorship or single-member LLC) to hold the assets for sale, giving the buyer a step-up in basis when the entity is sold. This also allows the buyer to receive assets available for expensing, deducting and amortizing, while allowing the seller to receive installment-sale reporting associated with their taxes. This means the seller can report their taxes over several years instead of at once, allowing them to stay in a lower tax bracket. If you’re in a C corporation, consider restructuring.
This structure can also permit installment-sale reporting without the seller having to finance the buyer’s purchase. If you sell an asset and want to recognize the gains over time without financing the sale, you must use a partnership-taxed structure.
This strategy eliminates liability or financial risk that can be reasonably avoided, offering both the buyer and seller the best possible outcome. If you’re considering selling, remember: There is so much intrinsic value to the operation that escapes the balance sheet. Your operation is more than your assets.
Deal with professional advisers who can help you identify value and protect you. Another caveat is certain assets can’t be sold on installment, so consult with your tax adviser to plan around those limitations. There are strategies to avoid triggering all the gain at once.
There are opportunities to get the best tax results for both the buyer and seller in farm transitions. This partnership strategy works better in agricultural production than any other industry—with the ability to use installment-sale reporting. It’s good for an exit strategy. It’s good for a succession planning strategy. And it’s good for those who are caught in a deferred-tax environment.
This column is not a substitute for financial advice.