Farm owners should carefully consider what would happen to their farmland in the event one of the owners passes away. Many issues come to mind, including whether the farm, as a business, would be able to survive. Questions have increasingly been centered on step-ups. Have you recently asked yourself how much of a step-up in cost basis farmland gets when someone passes away? A fundamental factor to keep in mind for determining the step-up is who owns the farmland. Is it owned by the person who passed away, or is it owned by an entity that is then owned by the person who passes away? We’ve outlined a few examples to help explain possible scenarios:
- Farmer John owns 300 acres of good farmland worth $3 million. He passes away in 2016 and leaves it to his wife. His wife’s cost basis in this farmland will now be $3 million.
- Farmer John and his wife jointly own 300 acres of land worth $3 million. They paid $300,000 for it 40 years ago. Farmer John passes away in 2016. His half worth is $1.5 million. This plus his wife’s basis of $150,000 (1/2 of $300,000) or $1,650,000 is now her new cost basis.
- Farmer John and his wife put the land into a C corporation many years ago. When he passes away, his half of the stock in the C corporation is stepped-up to fair market value, which is likely less than $1.5 million that was shown in the previous example. The C corporation stock is discounted for lack of marketability and minority of interest. None of the farmland value inside the corporation gets a step-up. If the corporation sells the farmland for $3 million, it will then owe federal and state tax on a full $2.7 million gain.
- Same situation, but the land is in an S corporation. The result is the same in that there is no step-up in basis for the farmland and the farmer is taxed on the full gain when the land is sold. If the farmland is the only asset held by the S corporation, then there will likely be a loss on liquidation to offset the farmland gain, if the S corporation is liquidated. This is true only if capital assets like farmland are inside the corporation.
- Farmer John and his wife have decided to put the farmland into a limited liability company (LLC). When he passes away, the LLC can make an election to step-up the basis of farmland to reflect the fair market value of $1.5 million.
Based off these examples, a C corporation is least desirable for ownership of farmland when you pass away and your heirs plan to sell it. Following a C corporation, an S corporation would be the next least desirable. An LLC is favorable, but you may have to discount the land for lack of marketability and minority discounts.
Assuming you owe no estate taxes, the best option is to own the property outright. If you live in a community property state, both halves of the asset typically get a step-up.
As always, feel free to contact one our agribusiness specialists if you have any questions or would like to learn more.