ALBANY — As a kid, Alex Balsam loved to ride tractors. East Hampton was home to many potato farms at that time, and each summer Alex looked forward to hanging around the farmers and farm machinery. The experience led him to attend Cornell University for a degree in agriculture and start a farm in 2003. He leased land from a longtime local farmer who knew Alex as a kid and trusted him to maintain the land for farming.
Heading toward his 90s, the farmer set up a 20-year lease with Alex and his Balsam Farms business partner, Ian Calder-Piedmonte, to keep the land undeveloped and farmable. The farmer was concerned about selling the land outright to Balsam Farms due to potential taxation issues. However, by working with a local CPA knowledgeable in agricultural land deals, the farmer was able to negotiate a sale that wouldn’t trigger a huge capital gains tax impact. It was designed to benefit his heirs after the farmer’s death, and also allow Balsam Farms to maintain 60 acres for agricultural purposes as long as they own it.
“Access to land was one of our biggest challenges, of course, being on an island,” says Alex Balsam. Balsam Farms now employs dozens of people. It supplies fresh, seasonal produce and some year-round processed produce such as jams and pickles for residents, farmer’s markets and local restaurants.
This story has a happy ending, but for many farmers with large tracts of land, they often have the burden of huge capital gains taxes when transferring ownership. By the same token, the high price tag of limited land makes it very difficult for aspiring farmers to afford it.
Through the estate planning process, farmers can strategize on ways to transfer ownership that reduce their tax burden. Depending on the location of land, some counties and towns also offer ways to reduce the tax impact on current farmers while sustaining agricultural land for the next generation. Here are a few options for transitioning agricultural land if you are a current farmer, aspiring farmer or a community leader concerned about preserving the farmable land in your region — and its charm.
Selling Development Rights
Within regions with high real estate values such as the East End of Long Island, some counties like Suffolk County have created a way for farmers to sell their development rights to the county or town, which restricts the land for development as a residential or commercial property. This allows the farmer to pull some cash out of the property and still continue to farm the land. In addition, due to the resulting reduced property value from this transaction, farmers should be able to sell or gift the land to a family member or next-generation farmer at more reasonable pricing.
The county finances purchases of development rights through a tax on real estate transactions within the county. The tax monies go into a fund for purchase of development rights, which ultimately preserves the green spaces and charm of the county.
Selling Enhanced Development Rights
Since this option came about, some real estate investors have taken advantage of the land development restriction. They have purchased farmland adjacent to homes and used it to extend their front lawns, to create a polo or horse-riding field or build a nursery. The original intent of maintaining farmland was lost. Just as importantly, the value of the land started to climb again as the demand for this land began to increase.
As an alternative, counties are now offering farmers the option of selling “enhanced” development rights. The town or county will pay farmers an additional fee to further restrict land uses, with the caveat that the property must be farmed for food production specifically.
Using the same tax on real estate transactions, towns and counties effectively purchase the enhanced development rights to reduce the value of land for existing or new farmers.
Gifting or Selling Partial Interests in Land
Another way that farmers can reduce the land value and potential estate taxation is by gifting a portion of it. Fractional interest in land will be worth less than its whole for obvious reasons. By utilizing discounts such as lack of marketability and lack of control discounts, a land owner can significantly reduce the value of remaining land values. Farmers can do this by gifting land to children or grandchildren or other family members. Keep in mind, there are limits to how much can be gifted per year.
Farmers may also structure a deal by having the land transferred into and owned by a limited liability company or partnership. They can then give away partial interests in the entity. In this way, an owner won’t have full control of the land and the interest will be less marketable, which reduces its value.
These partial ownership interests in land or entities can help to reduce the values for transfers or help in reducing an owner’s estate and potential estate taxes.
Trusts
Often, when large tracts of land have been in a family for generations but future preservation of the land is a concern, the owner may put the land in trust. The trust legally owns the land and a trustee manages it, but children or other family members are often allowed to live on and/or farm it. Trusts protect land from liabilities if family members are sued, divorced or have difficulties managing money. The land is preserved for future generations.
Like-Kind Exchanges
In order to preserve the value of their asset but limit taxation, land owners may consider a like-kind exchange (IRC Sec 1031), which allows them to “exchange” farmland for another type of real estate asset. For example, some farmers may exchange farmland for an income-generating rental property. The proceeds from a sale of farmland are exchanged to purchase investment property. Generally, any cash invested into new property would not be subject to capital gains tax.
This and the previous options to transfer farmland to the next generation are just an introduction to careful transitional and estate planning for agribusiness owners. Because every situation is different, farmers should consult a CPA experienced with agricultural real estate deals and transactions to create an estate planning and tax strategy that works best for them. Whether you are 25 or 85, it’s never too late to protect your land and family assets.
John Larkin, CPA, ABV, is a partner with Markowitz, Fenelon & Bank, LLP, and has spent his entire career in the Hamptons working with many local businesses and families, including farming, landscaping and nursery businesses. He has extensive experience in income tax planning for individuals and closely held businesses, and provides tax consulting services in the areas of estate and gift tax preparation and business valuations. He is certified as an Accredited Business Valuation expert through the American Institute of Certified Public Accountants. Contact him at jlarkin@mfbcpa.com or 631-537-2300.
–John Larkin, CPA, ABV