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Using partnerships and corporations to transfer farm assets

Quick facts

  • Establishing a business entity, such as a partnership or corporation, can help with the process of transferring a farm business to the next generation.
  • In Minnesota, there are two major categories of partnerships: partnerships and limited partnerships. 
  • The two corporation entities available to farm businesses are S corporation and C corporation.
  • Developing any business entity is a complicated process. Seek assistance from a qualified legal expert and accounting assistance if you plan to explore developing a business entity.

Transferring the farm business to the next generation can be a daunting task. However, there are strategies and methods that can help simplify the process.

When operating as a sole proprietorship, it can be challenging to establish a transition plan. There are many individual assets that need to be accounted for such as machinery, equipment, livestock and land. It is difficult and time consuming to transfer separate, individual assets.

One possible solution is to establish a business entity such as a partnership or a corporation to accomplish the business transition. As members and owners of the entity, the parents are issued ownership shares or shares of stock in the entity. These shares can be sold, gifted or passed through an estate to the entering generation, over time, as a method of transferring the business. This does away with the need to transfer separate, individual assets. This also spreads out the parent’s income and thus tax obligations. It allows the entering generation the ability to acquire assets over time thus minimizing their need for large amounts of capital. 

Learn about partnerships and corporations


Self-employment tax on land, buildings and facility rent regarding entities

The US Eight Circuit Court of Appeals has ruled that if you are a member of any business entity (such as a partnership or corporation explained above); own land, buildings, or facilities that are outside that entity; and rent those items to the entity; the rental income is exempt for self-employment tax IF the rent is fair and reasonable.

This applies only to those states in the eighth circuit which include Arkansas, Iowa, Minnesota, Missouri, Nebraska, North Dakota and South Dakota. With any of these laws, they are subject to change so seek legal advice on this matter.

Discounting business entity assets

An additional strategy that may be useful is the discounting of assets being placed into a business entity, such as any of the partnerships or corporations described earlier.

When you place business assets such as machinery or livestock into the business entity, you can elect to discount those assets. The main reason for discounting assets being placed into the business entity is to reduce the size of an estate in order to get below the federal and perhaps even the state estate applicable exclusion amounts. Doing so will reduce or eliminate any estate tax.

Justification for the discount is based upon lack of marketability of the assets due to a fractional ownership interest.

One disadvantage of discounting is that you have artificially lowered the basis of the assets in the entity. This can be a problem if the entity is discontinued and the assets are sold as a result. This could result in a tax obligation. If the assets are replaced due to use, this is not an issue.

Assets being discounted and placed into an entity should be appraised. If, at a future date, the entity is audited by the IRS, you can document the value of the assets placed into the entity. For machinery and equipment, simply take the depreciation schedule to the local implement or equipment dealer and ask them to put a value on all machinery. Have them put the values in writing on their dealership letterhead along with a signature and date. For livestock you can take a list to a livestock auction facility or someone who deals in livestock and would have a grasp of the values. The values should be put in writing and listed on their letterhead with a signature and date. For land, seek the help of a realtor who deals with ag land. Simply have them do an estimate or appraisal of the land, put it in writing on their letterhead, with a signature and date.

Note: In late 2016, the Internal Revenue Service and the US Treasury Department enacted 2704 rules which drastically changed discounting rules and during which situations they may apply. If assets are transferred and then sold, discounting will definitely not apply. If you are contemplating discounting any assets seek legal and accounting assistance to make sure you are in compliance with 2704 rules.

Business entities and maintaining homestead classification

When using a business entity for ag land ownership, caution must be used in order to maintain eligibility for the Minnesota Qualified Small Business Property Qualified Farm Business Property estate exclusion. In addition, utilizing limited liability companies (LLCs) as a business entity have new rules to comply with due to passage of the Minnesota Revised Uniform Limited Liability Company Act of 2015. The law states the land-owning LLC and its members must be the ones farming the land on behalf of the owner LLC. If the owner LLC rents the land to someone else, even another member of the LLC who then farms it personally, homestead classification is lost and therefore the qualified farm property estate exclusion is also lost. New LLCs must have complied with the new law as of August 1, 2015. Existing LLCs must have complied with the new law by January 1, 2018.

Ag land held in any trust, except a revocable living trust, as well as land in limited partnerships, limited liability limited partnerships, S and C corporations and LLCs must file documentation with the Minnesota Department of Agriculture under the Minnesota Corporate Farm Law in order to be eligible for the qualified farm property exclusion. The application must be done annually and there is a filing fee of $15 per application.

For more details on the Minnesota Homestead Classification requirements see maintaining farm land homestead classification and qualification. This is a complex area and there is a lot at stake regarding the qualified farm property estate exclusion so seek legal advice specific to your situation when establishing any entity that owns ag land.

Farm Service Agency (FSA) payments and business entities

Under the current farm bill, there are some restrictions regarding commodity program payments made to individuals versus entities. Entities that limit member’s liability exposure (all entities except the general partnership) are limited to one maximum payment limit regarding FSA commodity program payments.

This is a complicated issue. If you have any questions or concerns related to your situation, check with your FSA office for details of the program.

Caution: This publication is offered as educational information. It does not offer legal advice. If you have questions on this information, contact an attorney.

Gary Hachfeld, former Extension educator; David Bau, Extension educator and C. Robert Holcomb, Extension educator

Reviewed in 2017

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