How the $15 Million Estate Tax Exemption Affects Your Farm Succession Plan

Most family farms no longer have to worry about paying federal estate tax since the federal estate tax exemption is at an all-time high. Focus on preparing for income tax and keeping the step-up in basis after death.

The One Big Beautiful Bill Act has made a big difference in the area of estate planning for farmers. This made the lifetime gift and estate tax exemption permanently higher, effective on January 1. It is now $15 million indexed. Most family farms are no longer at danger of having to pay federal estate tax since the federal estate tax exemption is at an all-time high. But this change has made income tax planning more important and made it clear how important it is to keep the step-up in basis upon death.

Get to know the Step-Up in Basis

When someone dies, the value of their property usually goes back to what it was worth on the day they died. This is called a "step-up in basis." This is a very important advantage for agricultural households. Over time, farmland and other agricultural assets frequently become much more valuable. If heirs get these assets, they get them at the new, higher value. This implies that if they sell the property later, they won't have to pay much or any income tax on the increase in value that happened while the original owner was alive.

Why Estate Tax Isn't as Big of a Deal

With the existing high exemption, only the biggest agricultural estates incur federal estate tax. For most families, the main danger is not inheritance tax; it’s the possibility for hefty income taxes if the step-up in basis is lost. This may happen if assets are handed away during the owner’s lifetime, rather than being passed on upon death.

The Pitfalls of Lifetime Gifting

Many farmers contemplate making big contributions during their lifetime, afraid that the estate tax exemption could decline in the future. While this might be a smart technique for extremely large estates, it can be pricey for smaller agricultural operations. When assets are given during life, the receiver takes over the original owner’s basis, which is generally substantially lower than today’s value.

If the beneficiary then sells the property, they might face a hefty income tax liability. In contrast, if the property is inherited, the basis is stepped up to current value, lowering or eliminating income tax.

Likely the finest asset to give throughout lifetime is farmland that will be kept in the family for numerous generations. The step-up in this scenario is not as valuable since we can’t depreciate farmland, and if it is not going to be sold, the successors are not worse off. Plus, appreciation in farmland may be quite unpredictable and might force the farm couple to incur estate tax.

Hidden Cost of Gifting Negative Capital

Many farm businesses are organized as a partnership for income tax reasons and farms with debt will often produce what is termed a negative capital account and, in many circumstances, this may easily approach $5 to $10 million for bigger farm operations. Gifting any stake in these partnerships throughout a lifetime will provide ordinary income to the farmer since the “debt” erased exceeds the basis in the partnership’s assets, which is normally nil. Whereas retaining till death removes the tax on their heirs. However, a downside is that the elder generation can remain be on the hook for the debt until they depart.