Ranchers, farmers cover assets for future generations
YAVAPAI COUNTY - Ranchers and farmers hardly ever intend to be in the land business, but many who have been around a while find themselves in that position. And when Andy Groseta talks about keeping a family business in the family, he is talking about estate taxes, a subject many folks who work the land don't look into until their personal suns are moving toward the horizon.
According to Groseta, the average Arizona rancher today is 60 years old.
"We wonder why ranches are selling out and farmers are selling out," Groseta said. "It's the estate taxes. What happens is the kids have to sell the farm, sell the ranch, because they can't come up with the money to pay them. It takes all the fun out of it."
But there are ways to get around those potentially devastating taxes, according to Prescott attorney Chris Kottke, who specializes in ranch law. It just takes some serious planning.
"They don't focus on "What happens when I die?'" Kottke said. "But now you're 70 and sitting on this land and you go to the estate planner and ask what to do."
But in large part, ranching families stay in ranching, passing the business down through the generations. It is only in the past few decades that maintaining this progression has become a challenge, largely because the value of land has increased so dramatically.
Without proper planning, Uncle Sam will demand 35 percent of the value of mom and pop's estate when they pass away. That value includes the appraised value of the land they acquired along the way. In Northern Arizona it takes a lot of land, about 70 acres, to raise a cow for commercial purposes. So if mom and pop and the generations before them had pieced together a ranch that could raise 400 head - about 50 sections - that ranch, workable and unprotected, would be worth about $15 million.
Say pop passes away without a will. About half of his half of the community property goes to mom, leaving her with a net worth of about $11 million, but with no actual money, just a lot of land. The children at this point would take advantage of 80 percent of the current $5 million exclusion to estate taxes.
But when mom dies, again without legal protection, the kids would owe estate taxes on $10 million, or $3.5 million.
Needless to say, the family ranch is gone.
"This actually happens," Kottke said, "and it's sad."
In this case, the simple matter of a marital trust would double the estate tax exemption, leaving the kids with half as much tax liability. According to Kottke, though, there's a better way.
"If it's raw land and you really want to ranch it," he said, "we really have to get creative."
One way is through a conservation easement, and several examples of this option exist in the county. The land goes into a conservation trust, meaning it can never be developed but can still be used for agricultural purposes by the entrusting family. This greatly reduces the value of the land, by something on the order of 90 percent, thereby greatly reducing the tax liability.
"Then they can do their cow/calf thing forever," Kottke said, adding that the land becomes publicly owned, but with no access to the public as long as the original family keeps it in use. The value to the public at large, then, is that the land is perpetual open space.
But if there is a thought that the family might want to sell the property somewhere down the road, the best option could be in the formation of a limited partnership. Mom and pop convey their holdings to the private partnership, all but a small amount which goes into a general partnership that mom and pop still own. The value of the general partnership, though, is less than the estate tax exclusion amount and so eliminates that burden. Everybody involved then becomes employed by the limited partnership and, over time, mom and pop gift the general partnership to the kids in small amounts.
This works in most cases, as long as everyone is willing to work for a paycheck and not use the partnership as if it was their personal piggy bank, as too many draws for personal expenses will void the arrangement.
"You need to manage it like a business," Kottke said. "If you don't, it's not worth a penny."
The IRS doesn't especially care for this arrangement, he added because "we're taking people who are easy pickings and educating them. But all these arrangements are honest, ethical and legal under Arizona law."
The planning may become even more difficult, Kottke said, unless Congress extends the estate tax exemption, which is due to revert back to $1 million from $5 million at the end of 2012.
Either way, he said, getting a plan in order is an essential first step.
"Doing nothing," Kottke said, "is the worst possible thing."