Estate Planning for Farms, Ranches, and Oil & Gas: Tax and Succession Strategies (Pt. 1 of 2)

“Estate Planning for Farms, Ranches, and Oil & Gas: Tax and Succession Strategies (Pt. 1 of 2),” that is the subject of today’s ACTEC Trust and Estate Talk.

This is ACTEC Fellow John Challis of St. Louis, MO.

When family wealth is tied to farms, ranches, or oil and gas interests, estate planning presents unique challenges. This is part one of a two-part series. Today, we’ll focus on identifying and understanding these unique assets. In part two, we’ll focus on how to administer and address these assets.

ACTEC Fellows Kelly Henry of Louisville, KY, Matt Hochstetler of Naples, FL, and Gene Wolf of El Paso, Texas join us to share their expertise and help navigate these complex planning considerations. Welcome to all of you and today we’ll start with Matt.

Estate Planning Challenges for Farms, Ranches, and Oil & Gas Interests

Matthew (Matt) R. Hochstetler: Thanks, John. This is an important topic for a lot of estate planning lawyers because farms are really important to the US and the US economy. There are about 2 million farms operated in the United States, and about 98% of those are operated by families. And that can include individual ownership, family partnerships, or family corporations. But they produce the bulk of the food that we consume. There are some strong headwinds that are really obstacles for transitioning these farms to the next generation.

One is just there’s a dwindling pool of potential farmers, the fertility rates lower, it’s below replacement value now in the United States and an increasing number of people are living in urban centers rather than rural areas. In 1900 we saw about 40% of the US population working on a farm and now we’re down to 1.3% in 2021. There’s a lot of headwinds to transitioning farms to the next generation and ensuring we have a strong food supply in the United States and strong family businesses for children and grandchildren.

But it’s difficult for lawyers who are used to business planning and business succession planning to handle this because farms are unique in a variety of ways.

• First, the assets are unfamiliar. They can be hard to identify, may have inconsistent ownership.
• The cash flow is unfamiliar; whereas businesses can often have steady predictable cash flow, farm cash flow is lumpy and seasonally dependent and can be affected by a variety of external factors.
• And family dynamics are particularly risky because farming families have a real visceral connection to the land and to the business that isn’t really present in most other companies.

Livelihood Farms vs. Lifestyle Farms: Understanding the Differences

In thinking about planning for a farm, there are two types of family farms that we want to highlight. And the approach is very different between the two. The first is the “livelihood farm.” This is the farm that I grew up on in rural Ohio. And this is the farm where the owners have dirt under their fingernails, might be missing some fingers, maybe have a lost family member from a farm related death. And these families rely on farm operation for their family income. They’re relatively asset rich, but cash poor, and usually don’t have a lot of other non-farm assets. This can make estate planning really hard. If they have a good year, they buy trucks and tractors, but are not that interested in buying legal services. These are the folks that have farmed the same land for generations and generations just feel a real strong connection to the land.

The other type of farm is the “lifestyle farm.” This is not my family, but it seems like every client of ours who has at least a couple hundred million dollars wants to play Yellowstone buys one of these farms. The owners typically have a lot of money elsewhere. Now, these farms can do well, but sometimes the farms actually cost them money instead of generating money, sometimes to the tune of tens of millions of dollars.

These farms are really more valuable, not from a family support perspective, but more from an investment perspective, because they ain’t making any more land. For hunting and fishing and writing ATVs, hosting guests, even playing cowboy. Since there’s a lot of non-farm assets, transition can usually be easier from one generation to the next.

But the difference is, the farm here isn’t central to the family mission or family dynamics. It’s often just another asset, or at least one that doesn’t trigger the same emotional connection that a livelihood farm does. If you’re not sure which type of client you’re working with, the easy test is: Do you have assets like significant non-farm assets? Or is the farm the bulk of the assets and you have to worry about how to split that up to make things equal or at least fair for the next generation? Kelly, take it on.

Identifying Farm Assets and Establishing Ownership

Kelly Henry:  Yes, as Matt said, for those who actually live on a farm — the livelihood farm —  it’s important to identify the assets because there’s a lot of emotion attached to the land. And families sometimes don’t necessarily separate the farm, the land from the farming operations and the assets involved in those operations.

When it comes to the land, it’s important to identify who owns the land versus who lives on the land. Because oftentimes with large families, there may be one tract of land and there are several houses. Someone may have built the house on the land, but they don’t actually own the parcel the house sits on. When people die, it’s important to actually probate a will because that’s how you establish a chain of title to the land.

Probate, Land Titles, and Inherited Oil and Gas Interests

This is particularly important when it comes to oil and gas interests. There are just a few companies in the country that administer and pay the royalties from oil and gas interests. But without probating the will, they can’t show who the ancestor was that transferred the ownership. And oftentimes, you end up a couple generations down the line having to go back and probate grandpa’s will in maybe Louisiana, even though it’s been 34 years after Grandpa died just so you can track the ownership for those interests. And so that’s a big problem when it comes to intestacy.

The value of the land, a lot of times the fair market value may be more than agricultural assessment. When it comes to recording deeds when there’s a transfer, even though you have to list the actual fair market value, which may be its highest best use for commercial development, residential development, God forbid an AI Data Center, the agricultural assessment could be much lower.

Estate Planning for Farm Equipment, Livestock, and Crops

The same applies to tangible personal property because oftentimes you may leave in your will all of my tangible personal property to my spouse, to my children, but that could inadvertently include your farm equipment because the farm equipment may be titled in mom or dad’s name and the farm may be going one place. You don’t mind that the furniture inside the house, go to another, but whoever’s receiving the farm needs the equipment to actually manage the farm. So how are the tractors, the bush hogs, those types of things, how are they registered? They could still be registered in mom or dad’s name and not necessarily an entity name because they use the tractor to mow the, or to shovel the driveway when it snows in the winter.

The same applies to animals, which include livestock, which includes horses. When it comes to horses, if the horses are pets may not be anything that you necessarily need to do, but with horses in particular, if you’re engaged in any type of horse activities: racing, breeding, training, jumping, then the rules become a little bit more complicated. We won’t get into those here, but when it comes to particular horses, if it’s a thoroughbred, you need to start with a jockey club to transfer ownership. Quarter of horses, you have the American Quarter Horse Association; same for saddlebred, appaloosa, standard breads. Arabians, you need to re-register, retitle those into the name of the new owner because oftentimes it’s one individual owner who can make all decisions relating to the horse, including registering them for races, for breeding, things of that nature.

When it comes to livestock, cattle, you need to distinguish between whether the cattle is an asset that you use over and over, which makes it an asset used in a trade or business, which receives separate tax treatment under Section 1231. Or is it something that you just raise and deliver to market and then it becomes more inventory, which has different tax treatments?

When it comes to crops, if they’re growing and unharvested, who gets the crops? Because a lot of times there’s upfront expenses that are paid, and then the profits may be recognized by different owner when they’re sold. Who bears the risk associated with those crops? Who bears the expenses when mom or dad dies, when the estate divided?

Family Farm Succession and Informal Land-Use Agreements

Oftentimes, getting back to the land. Even though you know who record title is, there may be some unrecorded easements and unrecorded access that are granted. So when your older generation is living, one of the things that you should do is maybe walk the farm, walk the land with mom or dad. They can point out, oh, well, we always let, for example, Matt have access to our stream on our property so he can water the cattle. You know, in exchange, he lets us use this parcel over here to grow extra crops. It’s not adverse possession it’s a promise that’s made between neighbors, neighbors helping neighbors because oftentimes when it comes to farming and raising of things of that nature, agreements are by handshake. There’s not a written contract not a recorded easement. And so, when mom or dad has died, it’s up to the next generation. Do they want to honor those agreements? Which, when a lawyer tells them, well, it’s not recorded, you don’t have to honor it, gets back to Matt’s earlier point, that’s why farmers don’t necessarily trust lawyers.

John Challis: Thank you, Matt and Kelly, for a great discussion of these unique assets. Please look forward to part two for a continuation of this discussion with Gene Worf and thank you for listening to the ACTEC trust and estate podcast.

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