What’s the right ownership entity for farm land?
One of the most popular questions my firm gets is “how should I own my farm ground?” Many people inherit farm ground from their family and start to wonder if it would be better to put it in a corporation, an LLC or some sort of a trust. The answer, like all good answers from an attorney, is “it depends.” Typically the following discussion is specifically driven by the owner’s concerns and future desires for the ground. In the rest of this column, I will explain two very common examples I believe that most readers can relate to.
The nonfarming landlord. The landlord who is not farming on a day-to-day basis has different concerns than the person who is actually farming. Many people think their number one concern should be liability protection. While liability protection is important, it is more often taken care of by a properly drafted lease that puts liability on the tenant farmer. Ultimately, the nonfarming landlord entity selection is made based on what they plan to do with the property. If an individual desires or believes they will sell the property during their lifetime or that their kids will sell it at their death, then there is no real necessity to put an entity together.
However if they desire to keep the ground in the family for future generations, then a limited liability company (LLC) is the preferred method. The reason for this is that the LLC can adopt buy/sell agreements, management can be consolidated at the manager level, and multiple members can operate as a single, unified body. As an example: the first generation of parents own farm ground. They have three children, and each of those three children have three children. In that situation you could end up with nine different owners of land. With nine different owners, you could, in theory, have nine different opinions on the ground. If an LLC is put in place by the parents at the first generation, then there are rules and bylaws that must be followed by all. In my practice, a commonly contested issue is buyouts of members. A carefully drafted LLC agreement will provide a price, terms and who has the chance to buy out who. Does a sibling have the right to buy out a sibling before a cousin can? It is important to try to anticipate future issues when setting up the LLC, so that hopefully, the future generations will avoid those issues with each other.
The farming landlord. The landlord who is also an operator has a completely different set of circumstances to worry about, but like the previous example, it tends to come down to the next generation. If the landlord has multiple children, and they are not all coming back to the farm, you can get into some complex issues. In that situation, the above LLC analysis could cause the following: The farmer has two children, one who is back on the farm operating, and one who is not, and the neighboring land comes up for sale. What incentive does the off-farm heir have to make the purchase? This is what my office is seeing more and more. With the increased cost in farm ground, most of the time, the current owned ground is required for collateral for a bank loan. So, you now have an LLC with two members (the on-farm and off-farm heirs). The LLC has provided x income to both members for x years, and now the on-farm heir wants the LLC to take out a substantial loan to buy the neighboring ground. This more than likely will cause the LLC to provide less income to all members for a period of years, while at the same time, the on-farm heir’s operating entity will pick up more acres to farm and thus more income at the operating level. So, what should a planner do?
In the above example, I believe an operator needs to be realistic about their operation and their family. While an operator may dream of all of their kids coming back or being treated as on-farm heirs, that is often not realistic. I encourage splitting the ground between heirs and not putting it all together. In this case, I would attempt to have them set up LLCs for each child with specific parcels of land. If the operator is worried about the on-farm heir losing the family ground to operate on, then leases of some length should be part of the plan. However, an operator should have to treat their siblings and their ground with respect and not rely on a “lease for life.”
Land ownership is complicated, and there is no one-size-fits-all approach. Family dynamics and long-range plans are what should be considered in setting up an entity to own the land.
John M. Kragt is an attorney with the law firm of McGuire, DeWulf, Kragt & Johnson, P.S. He and his partners work with farm families and other agricultural businesses for the majority of their needs throughout Eastern Washington. The firm has offices in Davenport, Odessa, Ritzville, Colfax, St. John, Rosalia and Fairfield.