the owner financing discussion can be found in Chapter three of the farm
transition workbook what would be looking at here are tools that can be
used to facilitate the transfer of assets from the business to one
generation to the next coverage will basically include the
major tax considerations that we have to look at and a few planning pointers that
we should consider also be presented so what tools do we have probably the most
common is installment sales basically an installment sale is you create as a sell
that you receive installments over a period of time that being more than two
years more than one year two years or more basically what it accomplished it
freezes the value of the parents estate now does that work basically we set the
value at the date of the sale any future appreciation in value then accrues to
the buyer or essentially the successor the gain well its payments are made then
we recognize the game that's when the year is tracked is taxable so it's not
full sale only that portion that installment as we receive every year
that we calculate the gain the recognition of future gain is limited to
the transfer or payments for future years the payments that income not
self-employment income also with an installment agreement the seller can
retain a security interest so something happens later default etc we'll talk
about those they certainly tain a security interest they can then be
protected material participation remember what that is material
participation is involvement in the operations day to day business marketing
etc an installment sale to your participation is a lot as the same as
any lease resin a lease depending upon what's going on if there's any type of a
crops rearrangement material participation occurs with an installment
sale any type of participate is not therefore included as mature
participation it's not self-employment income disadvantages once we set up the
sale we lose a step-up in basis remember we froze the value is that that property
at the sale date any future appreciation and value goes to the buyer their basis
in that property is then what they paid for it
not the value that it would go through an estate step-up market value date of
death payments are missed there's two things that can happen one the original
seller has to go through a foreclosure they also have to then resume management
of that business asset may not be the best thing or what they was trying to
occur if payments are fished artificially low it may not provide
sufficient income for the seller remember those payments over time will
go away if we set up a five-year installment agreement after five years
we're done how we set two terms the price well if we set the price too high
the buyers earnings from the property will be less than the payments and I'll
be next to impossible for them to continue that operation if it's too low
bargain purchase then the transaction tree or both income and gift tax
situation they say you're selling the property at a bargain price consequently
IRS will look at that kind of disfavor ibly the interest rate that applies must
be greater than or equal to the IRS approved rate those rates are published
on a monthly basis and you can get an idea of what those are by going to the
IRS website looking for their approved interest rates the duration how long is
this thing going to be going on so the objectives well do we want to minimize a
down payment or term payments is it going to be income for retirement if it
is we won't probably have a duration a little longer do we have a shorter term
with a little more security with a balloon at the end to keep the payments
lower but at the end of five years the Blin
kicks in and we sell it off things to consider payment frequency inform is it
gonna be an annual payment semiannual payment how are we going to get it cost
of the appraisal appraisal and closing costs have to be considered and the big
one is one about default on the buyer so definitely wants to retain a security
interest in that property some of its default occurs then the seller gets it
back we'll have to go through foreclosure procedures to get it
reclaimed repossession that can trigger some tax consequences that will depend
upon the property's value and any gain recognized upon the repossession so
you've really got to look at what's going on cancellation of an installment
debt basically if you cancel that it's considered a donation or gift so gift
tax treatment can occur for the amount of debt that is forgiven or cancelled
death of the seller during the contract think about some options there does the
contract transferred to the estate at large or transfer to a trust or does the
value that contract transfer to the family members there are several tax
considerations that must be also thought about an installment sale does not work
well with the sale of depreciable assets under IRS rules and guidance when we
sell a depreciable asset depreciation is recaptured in the year of sale first
year of sale no matter what so if we're selling a tractor over a three-year plan
depreciation that has been taken is recaptured in the first year the sale
occurs whether or not we've received enough payment for that or not does it
matter missed all much sale works great with
land raised breeding livestock these do not have to preach or depreciation
applied to them consequently it's all capital gain income
there's no adverse tax consequences we simply recognize the gain and the tax in
the year that each payment is received basically what it does it helps reduce
the income tax problems by blushing capital gain in one year for example if
we sell a farm outright in an auction and we get a hundred thousand dollars
for that piece of property the full hundred thousand dollars the gain on
that is taxable in the year of sale if we set up that same piece of property
with sell over an installment contract over five years
we'll only have twenty thousand dollars coming in each year and the gains
calculated on that twenty thousand each and every year consequently we end up
spreading the tax consequences out over a period of time lowering the overall
tax bite also keep in mind payments we've gotten interest we've got return
of original basis and gain of the sale so the interest rate interest then
becomes taxable in year received as ordinary income return of basis is not a
taxable event so if you take a piece of property bought for a hundred thousand
over time you recapture the hundred thousand dollars of basis as just that
non-taxable if the property and increase in value from the hundred thousand we
paid for it to two hundred thousand that extra hundred thousand dollars of gain
is then taxable in each year that we receive in installment payment there's
some other things we've got to watch out for related party issues related parties
are an individual or entity that controls them for example if we've got a
business entity that's an LLC and we're a partner in that entity and we start
selling assets to the LLC that's a related party transaction if it's a
trust in the taxpayer of any trust and the beneficiary it's also a related
party sale an executor of an estate and the beneficiary of such a state since
they are both the same pretty person they are related parties where they have
to watch what's going on related party transaction
from an IRS point of view do not gain the same tax advantages buy-sell
agreements basically what this does is creates in advance the terms of the sale
for corporate or LLC ownership interests so shares of stock or LLC ownership
interest can then be transferred by cell agreement one person wants in somebody
else wants out so advantages of this the owners in a
corporation or an owner of an LLC interest you settle some of the
questions up front who can buy into the LLC who can sell or what price will you
be able to sell for you get some certainty and ownership at the present
time and also in the future in other words looking 10 years down the road who
can become the owners simply family members do the parties that are involved
in the operation have to be Aldi süd determine whether or not a buyer is
acceptable or is there restrictions that will come into play that allow others
not to be able to be or to buy in you make sure that everybody's interests are
on the same page and everybody is aligned with what the original owners
want it also provides an escape hatch if you remember once out I don't want to be
involved in the farm operation anymore it provides in that buy sell agreement
that I can be bought out at some point at some valuation now these bikes the
agreements can't provide certainty for everything it's only as good as your
what if thinking so what if a divorce happens what if death happens what if
somebody wants to get out those are things you've got to think about which
is always those other hidden things that we've probably not thought about that
can occur as well we've got a grandchild that wants to come in and we thought
about that valuation provisions may not be quite the same we're in sync with
economic reality in other words we use market
value but if you look at income Tigra culture we may not see the same
growth in income as we're seeing as inflation on values of the property
itself in other words the business income is not good enough or large
enough to maintain the valuation that would keep up with what other uses of
that property might incur other words urban sprawl items considering your buy
sell agreement what events triggered the agreement and what should happen in the
event of death disability termination marital status change retirement
deadlocks in decision-making these are some of that what-if thinking that
you've got to think about these are some of the main points and then should
purchases be mandatory or optional on a trigger event in other words the buyers
or people involved in the business do they have to buy them out or can it
be an option some other things to look at do you need a cross purchase or
redemption now what's a cross purchase basically that's other owners agree to
purchase what's going on needs to be looked at can an entity so we decide to
redeem it can the entity agree to purchase my ownership shares my
ownership interest so cross purchase other owners buyout meant must me as
another owner where if it's a resumption the entity buys out my ownership what
are the issues that impact the design of the agreement do we have simply family
members are there other things going on that we want to consider so we need to
be looking at the agreement what things go into it and the benefits that have to
be coordinated for example deferred compensation as the
outgoing member do I want to be paid a salary or do I want to after so many
years be bought out do I want retirement income do I need other
sources of the income or do I not even care so benefits have to be coordinated
with the buy seller agreement what things need to occur when where and how
one other point that we've got to look at is the business valuation one method
of value of the business's book value what is its value as an operation on the
accounting books for the business very high on science if you go talk to the
accounting professors they say yes it's not hard to come up with there's a
science to it not much in the way of art basically if you look at it value equals
shareholder equity now that may or may not be true valuation it may undervalue
the investment assets there's certain going concerned with values and there's
some other accounting baggage that goes along with that so when you start
looking at this thing sit down with the accountant do some calculations kind of
figure out what the value of the business is from a book value standpoint
and then compare that work with that on a market value
now market values low on science with high on art in other words if we can go
out and see what the properties are selling for but there's more to it more
underlying pieces than just saying well property around me is selling for X
amount of dollars we've got to remember depending a willing buyer and willing
seller who's going to be buying into the business do they want to buy in a lot of
times in small closely held family businesses nobody on the outside wants
to buy in so limited capital from the outside that's what we've got to deal
with is capital is generated on the inside what about capitalized value of
earnings what are the earnings of the business what kind of a period are we
looking at 30 40 years down the road if we are looking at a long term you gotta
look at a discount rate in other words what's the future values brought back to
a current market your current price that is the discount
rate do we have to use to come up with a future value of earnings over a period
of time brought back to a current value today so we review basically those these
are some tools that can be used to keep the business operating get the assets
transferred to those that we want to have them those will operate the
business those are involved in the family day-to-day operations also the
business entity discussion you've got to really review to better evaluate the
options that are available read closely the material in them in the manual be
sure to contact or acquire good sound business entity advice legal counsel
talking to your accountant make sure your accountant understands business
entity accounting those are key ingredients to making good sound
decisions on setting up the business entity also making sure that the
transition transition goes the way we want it to so proper legal advise proper
taxes ice make sure that our goals for the business as well as personal goals
and objectives are met both now and in the future again for more information
website to the farm transitions material read this and other items that are
included in the chapter to get a better handle of what's going on thank you