Often, families I work with are challenged with the determination of “fair and equitable” distribution of their assets at death, primarily because most of their assets are “farm-related”, and thus necessary for the farming heir(s) to have control to continue the farming legacy. At the same time, they do not want to leave their non-farming children “out” of their estate plan. This is a very common problem; and thankfully there are some good options to help alleviate it.
One common solution is known as a “first right of refusal.” A “first right of refusal” is a provision built in as a part of your will or revocable living trust (estate planning vehicle), that provides assurances that the land stay in the family, and be available to the farming heir(s), even if ownership is not immediately involved.
The concept involves leaving specific parcels of land to each of your children through your will / trust (estate planning vehicle.) However, along with this distribution, the document would stipulate that before the intended owner of the land – the child you are leaving the parcel to – rents or sells the land to an “outsider”, they would first have to offer it to their farming sibling(s), or other related parties, depending on the circumstances – “keeping it in the family.”
There are two parts to this: rent, and a sale. When determining rent, the big question is how fair market rental value is determined at that time. This is a “moving target” and will continue to be. Because of this, determining what “fair market value” for rent is can be difficult for the parties to determine. If it is not specified in the legal document, then an argument could arise. Providing a specified “method” for determining fair market value is crucial, so that both parties feel they are being treated fair in the process.
Sometimes people will use “county averages” to determine fair market value in these situations. However, I advise against that usually; as counties can be very different regarding land qualities and use. One option I like is to have the farming heir produce “proof” of fair market value by producing lease agreements they have with “outsiders” - other non-related landlords. The rental amounts paid in these agreements would be averaged, and used as the “fair market value” for the rental agreement between the farming child and non-farming child. Another option is to name an individual (or panel of individuals) that is unbiased and would be in charge of determining what fair market value is. This person or panel of individuals should be selected so that both your farming child and your non farming child trust the decision, and trust that it is unbiased. Other times, people will decide to use a combination of both. The choice is up to you – the important this is to have a clear method to determine what fair market value is for rental.
The first right to purchase is the next part of the “first right of refusal” component in your estate planning. This involves the non-farming heir that owns land wanting to sell the land. Notice, no “forced” sale occurs; instead, it is up to the non-farming child as to whether they want to keep it and rent it for income, or sell it. If the decision to sell is made, the same consideration needs to be taken in determining the valuation of the land. Sometimes people will state that the land will be sold at fair market value. How is that determined? If it is not specified in the legal document, then an argument could arise. The seller could view “fair market value” as being able to hold bids on the land, and then giving the farming child the right to match the highest bidder. Today’s markets are a perfect example of how that could be a bad situation for the farming heir.
Often, fair market value is determined using the following steps. First, a certified appraisal will be done on the land. This appraisal provides the independent valuation where both parties can trust is fair. Often, parents will stop here, and have the appraised value be the “purchase price.” However, there are times when parents will provide a discount to the appraised value, in the hopes of preventing an inability for the farming child to purchase the land. Appraised values reflect current market values, and if those are high at the time of sale, the farming child may not be able to obtain adequate financing to make the purchase, regardless of their desire to purchase the land. So, discounts may be applied, to help with this. I have often had people choose a discount of 25% to 30% of the fair market value in these situations, in order to help assure that the farming heir is able to purchase the land.
Another method I have used to help families have assurances that the farming child has the ability to purchase the land is to incorporate a contract for deed into the option. In this instance, instead of the farming child paying the purchase price all at once (and likely financing the purchase), they would have the ability to enter into a contract for deed with their selling sibling. Often these contracts for deed are set initially to be very “farm cash flow friendly.”
The terms of the sale could be very specific to your goals, and depending on the cash flow abilities of the farming heir(s). The sale of the land could be specified by terms in the will:
- Manageable down payment
- A term of 20 years (or more or less, depending on what you want), with a balloon payment due earlier than that (say 7-10 years)
- Minimal interest rate, based on the Applicable Federal Rate
The goal here would be to make sure any farming child (or non-farming, should they want the land) the financial ability to purchase it. They may have the strong desire to purchase it, but not the ability, financially. This will hopefully alleviate that potential problem.
First rights of refusal are very good tools. They are very important to take a close look at in planning, should you desire to incorporate them into your estate planning. I suggest you talk with your qualified estate planning professional more on these, if they are something you are interested in.
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