Keeping Property in the Family with LLCs and Partnerships
By James J. Ferraro, JD,2022-04-29
Land is unique; there is no more of it being made. It’s for this reason families will hold tight to farms, ranches and coastal property for continued lifetime income, appreciation and, of course, sentimental value.
Estate planning professionals commonly see real estate pass through many generations — grandfather, father, children, grandchildren and even their own descendants — with little interest in selling or transferring property outside of extended families. Demographic changes that began in the middle of the last century have shown branches of these families moving away from ancestral homesteads to populate cities and to find professions apart from agriculture. Other families hold fond memories of annual family vacations at the beach or the mountains and want their children and grandchildren to enjoy the same with their families.
As estate planners, we may be charged with finding strategies that allow extended families to continue enjoying appreciation in the real estate’s value, to cooperatively use the property, or to share in a pro-rata share of mineral production and crop revenue while equitably dividing taxes and other expenses.
Families often have a common goal of preserving equality of ownership across each generation. As ownership passes from generation to generation, what might have once been a one-third fractional ownership in the land held by a father and his two siblings can evolve to a one-ninth interest for each of the father’s three children. If each of those three children has three children of their own, then each grandchild may become a 1/27 owner. With no further planning, deeds would need to be prepared at each generation as ownership divides. Further planning is also needed to share revenue and expenses as the property passes to each generation.
Family LLCs and partnerships
Formation of a family limited liability company or partnership is a practical solution to the intergenerational ownership and management of family property.
Limited liability companies (LLCs) came into being decades ago to organize small businesses. In the early 20th century, a business owner would be personally liable for a company’s debts and claims unless he or she formed a corporation. Corporate taxes were often impractical for most small businesses, so later, subchapter S corporations originated under the tax code to simplify taxes while also limiting personal liability. Beginning in the late 1970s, many states created statutes allowing for the formation of limited liability companies. LLCs started to gain popularity in the 1990s, and today, many small businesses are organized as LLCs.
An LLC operating agreement puts in place the person or persons who are responsible for the daily operation of the business or collection of rents, payment of expenses and division of revenue. The operating agreement also divides ownership into units, with each member owning units in proportion to his or her ownership percentage.
Keeping the family farm
Perhaps your grandfather was a farmer or rancher. His land was his vocation. He may not have thought of himself as an agribusiness entrepreneur, but he was. His family farm or ranch was a business and should still be treated as such. Many in his generation relied on a farm or ranch to support their families. Their work allowed the resources and flexibility for generations to move away from rural life to find other pursuits, in part because technology and improved work practices have changed agriculture so it doesn’t require the same amount of labor as it once did.
An LLC or family partnership may not have been in your grandfather’s toolbox. However, it is in yours and should be considered to meet your current interfamily goals.
Typically, families wish to continue holding their entire farm or ranch as a single unit rather than sub-dividing it at each generation. A family LLC or a family limited partnership is an effective way to do so. Ownership of the entire farm can be held in the LLC, with each family member owning a pro-rata share of the LLC’s membership units based on that person’s individual ownership percentage.
There are a number of benefits for future generations owning the farm within an LLC rather than directly:
- If an heir or family member is familiar with the farming operation, he or she can continue to operate the farm or can contract with an operator in a cash rent or crop sharing arrangement. Each family member or partial owner can vote his or her shares to select the family member or third-party LLC manager to operate the farm or contract with the operator.
- The LLC manager has a fiduciary duty to account to all the members for receipt of income or payment of expenses.
- Net rental revenue can be distributed to the owners or retained in the LLC to improve the property or to allow the value of the LLC to increase as a legacy for future generations.
- Each owner is not personally liable for farming debts, injuries or other liabilities.
- The LLC units can be easily sold within the extended family if a family member wants to liquidate his or her interest in the farm.
- The operating agreement or partnership agreement can restrict the sale or transfer outside of the family unit or give other family members a right of first refusal if units are sold.
- The LLC units can be passed to each generation as part of a preceding generation’s estate planning. This planning may include valuation discounts providing estate tax savings.
- Changes in ownership are reflected in the LLC records and not the public land records.
- Family LLCs and family partnerships are not limited to family farms or ranches. Vacation homes on the beach or lodges in the mountains where generations of your family hope to continue to hunt, fish or hike may also be placed in an LLC and managed in the same way as a family farm or ranch. Additionally, services such as Airbnb and Vrbo may be used by the family to generate income and support the property when not reserved for family members’ enjoyment.
- Families often don’t wish to continue owning undeveloped land, but want to enjoy the income stream generated from mineral-rich property in the lower Midwest and South. In this situation, the land surface can be sold to harvest equity, which can be distributed to the owners or invested by the LLC. Mineral rights are then retained by the LLC, and drilling offers can be considered, lease bonuses received and revenue divided among family members. Central management, accounting, ease of transfer and potential estate tax advantages benefit the owners in the same way as operating a farm or ranch.
Holding family property in a trust
Trusts are generally an effective way to hold and manage property for beneficiaries. There are some practical disadvantages when actively managing a farm, ranch or vacation property inside a trust, assuming that one’s goal is to maintain centralized management of farm property for the benefit of your descendants for many generations.
- Tax on retained income. There is no question that a trustee has the legal authority to enter into agreements to manage trust property and divide the income among the beneficiaries. The trustee can easily pay taxes and expenses from the trust corpus and distribute income pro-rata to the beneficiaries. However, retaining income in the trust may cause the trust to pay income tax at a rate higher than most individuals.
- A manager or a trustee? Since the operation of the property is governed by the trust agreement and not an LLC operating agreement, care must be taken in giving the beneficiaries the ability to select or remove a trustee.
- Probate considerations. If permitted by state law, transferring a beneficiary’s interest in a trust can be achieved by using a power of appointment over his or her interest. However, without careful planning it may be necessary to admit the beneficiary’s will to probate to give effect to any testamentary power of appointment.
- Perpetual ownership. Lastly, most states won’t allow a trust to continue perpetually since this is contrary to the common law Rule Against Perpetuities. If your goal is to hold the property for both your present heirs and future unborn descendants, it may be necessary to locate a trustee in one of the few states that have completely abolished the Rule Against Perpetuities or in a way that meets your planning objectives.
Family farms and ranches have traditionally been a source of pride and provided the income to build wealth for multiple generations of American families. Our ancestors’ struggle and good fortune have made it possible for current generations to acquire recreational property and appreciate endless opportunities away from our roots.
Limited liability companies and partnerships are often used to shape both large and small firms, allowing those firms to continue for as long as their owners wish. Using this solution for the ownership and management of farms, ranches and recreational property can preserve the properties’ intrinsic and extrinsic worth, honor the efforts of family ancestors and allow the properties to be a source of income and pleasure for generations to come.
This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.
About the Author
Vice President/Legal Counsel, Argent Trust Company
Jim Ferraro is a vice president and trust counsel in the Shreveport, La., office of Argent Trust Company. Ferraro is a 2003 graduate of the University of Missouri at Kansas City School of Law, past president of the family and the law section of the Kansas City Metropolitan Bar Association, and is a member of the Tax and Estate Planning Council of Shreveport.
© 2023 Particle Media.
Comments / 0