Save on taxes when transferring the farm

By Gary Hachfeld, University of Minnesota Extension
(Fourth of four articles)

Most people want to minimize their tax obligations. For families trying to transfer their farm business to the next generation, some basic understanding of these tax issues can help minimize their tax obligation.

One key factor is an understanding of basis. If you purchase an asset, your adjusted basis is what you paid for the asset, plus improvements, minus any depreciation. If you inherit an asset, your basis is generally the fair market value of the asset at the time of death. If the decedent had a basis of $40,000 in a parcel of land and it was worth $250,000 at the decedent’s death, you receive it at the “stepped-up” basis of $250,000 or the fair market value.

If you receive an asset as a gift, the donor’s basis goes with it and becomes your basis. If the donor gives you a tractor worth $25,000 but the donor’s depreciated adjusted basis is $5,000, your basis is $5,000. Keeping records of basis, especially basis in land, is very important because it can affect the amount of tax paid. If you cannot prove the basis, the IRS will assume zero basis and the entire sale amount is subject to tax.

Capital gain tax is payment due on any appreciation in value of an asset. In May 2003, capital gain tax rates were lowered to historical lows of 5 percent and 15 percent. The 5-percent rate applies to people in the 10- and 15-percent federal income tax bracket; the 15-percent rate applies to everyone else. However, another recent tax change has lowered the 5-percent rate to zero percent for folks in the 10- and 15-percent federal tax bracket for 2008, 2009 and 2010.

Estate tax is another tax you can minimize with some planning. Each person has a federal applicable exclusion of $2 million. That means each of us can pass $2 million through our estate without estate tax due. In addition, Minnesota also has an estate tax with an applicable exclusion of $1 million. Planning for the smaller amount can avoid both state and federal estate tax.

Gift tax can enter into the planning as well. Each of us can gift $12,000 to as many people as we want in a given year without a gift tax. Couples gifting jointly-owned assets can gift $24,000 to as many people as they want in a given year. If you exceed that amount, no tax is due until you exceed your $1 million lifetime gift exclusion, but a gift tax form (IRS 709) must be filed. Each of us has a $1 million gift tax exclusion, meaning we can gift away up to $1 million dollars in our lifetime without any gift tax due.

However, upon one’s death, any gifts in excess of the annual or lifetime gift exclusion amounts are added to the value of the estate for estate tax purposes. One exception is that we can gift any amount to our spouse (the marital deduction), and no tax is due.

By working with an attorney and accountant who understand these laws, you can greatly minimize or in some cases eliminate many of these tax obligations.

(Gary Hachfeld is an agriculture business management educator with University of Minnesota Extension.)