Shane came to me with the following problem. “I came back to the farm about six years ago. My mother had died unexpectedly and my dad had developed some health issues that didn’t allow for him to do as much labor anymore. Now that I have been there for six years, what started as an emergency situation is now feeling like the right career choice for me.
He continued “My dad acquired both land and machinery debt close to a million dollars over the past few years. As such, I haven’t acquired any land or machinery as Dad needs the income to pay the debts. With his failing health, I finally asked him what happens if he dies. He said the land would be split up between me and my sister (who doesn’t farm) and we would work things out. What should I do?”
I told Shane “If your dad won’t change the will, and won’t allow you to purchase some of the assets today, you should find another line of work.”
“Why? Here is the deal. If you inherit half of the assets and all of the farm debt, you are getting a worse deal than your sister. When it comes time to settle the estate, the banks are going to come calling for the outstanding loans. Don’t expect your sister to show up and offer a part of her inheritance to pay off the loans. She can simply sit back and wait until you make the decision to farm or not farm. If you decide to farm, she’ll say that’s okay – as long as you take on the debt. If you don’t farm, then you’ll both share in the debt.”
Shane said “Well, my dad has some life insurance of about a quarter of a million dollars. Dad wanted that to be used to pay the debt.”
I said “In most cases, the spouse was named as the primary beneficiary but now that your mother is dead, then the normal contingent beneficiaries are you and your sister. If she gets a check from the insurance company for half the death benefits – as is her right as beneficiary – again, I wouldn’t expect her to give it back to the estate to pay debts with it. As far as she’s concerned, that is her money! Unless you change the beneficiary, it’s not going to be there to pay for debts and again, you sister will have half of the assets but none of the debt”.
Here is what should be done. If you have significant debt on the farm operation, the farming child is going to need at least a two to one asset to debt ratio before s/he will even be able to function.
Why? Because bankers use the old forty-five to fifty-five percent ratio of debt to determine whether or not they will continue lending money to you – even for such things as operating.
If you walk in the bank with a debt ratio – inherited or not – of higher than this amount, you’re going to get a cup of coffee and a cookie but not a loan and you’re out of business.
If dad is serious about keeping this family farm together, he has to recognize this basic principle. If he gives you double the debt value in assets and then splits the rest between you and your sister, then we might have an equitable situation. We still have to control what the sister might do with her undivided share.
On that note, for the assets she receives, you need to have a rental rate based on a profit margin for your farm operation, or a purchase option that will work for you based on what your particular farm or ranch is capable of producing.
For her protection, Dad can put a clause in the will or the deed that says if you get the bargain rate on purchase or got more in inheritance than your sister to make the cash flows work, if you sell the property within, say, ten years after you inherit it and/or buy it from your sister, and you have a profit, you and/or your heirs, spouse, etc. have to pay back the difference to the sister of what she received versus what you got on the sale. If neither of you is farming, then it should be equal shares.
So, this estate plan needs to be balanced two ways – one for you farming – and one if you don’t continue to farm. That’s a bit of trick in wills, but it can be done once you understand simple ground rules like these.
“Keeping the Family Farm in the Family”
Great Plains Diversified Services, Inc.
1424 W. Century Ave., Suite 208
Bismarck, ND 58503-0917
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