Farm Financial Planner: Lending Your Cash to The Kids

This article was originally published in Grainews. Grainews is an agricultural based publication written for farmers, and often by farmers, in a style they understand. Don and Erik work closely with author Andrew Allentuck, providing the background financial plans and theoretical analysis for Andrew’s Farm Financial Planner column.

A couple we’ll call Bob and Tess, both 59, have farmed in central Manitoba for four decades. Their farm has 3,000 acres, mostly in grain. Bob’s health has declined, and he feels he cannot carry on much longer. Their son, Fred, is 24. He hasn’t been farming, but would like to supplement his income from his job in town. Fred returning to the farm could keep the farm in the family and perhaps provide a legacy for Bob and Tess’s grandchildren. Their daughter, Alice, is 29 and would like financial assistance to buy her first home. A second son, Pete, has a good off-farm job and is not interested in the farm.

Bob and Tess came to us with their situation to create a plan for eventual disposition of their estate.

For other recent farm financial planning articles see Transferring Farmland; Minimizing Taxes, and No Profits Means a Change of Plans.

The Family Bank

With two generations to consider, it’s complicated and estate distribution may not be finalized for decades. Rather than make Bob and Tess’s children wait, it’s useful to consider the idea of a family bank. The family bank concept is to have the parents be the lenders for inter-generational families. Each generation should get bank financing from their inheritance.

That requires the children or other heirs to develop a written business plan. The main purpose of the plan is to show how they will use the financing they will receive. Each proposal should include a repayment schedule, interest rate, and collateral. If a loan defaults, the parent’s wills would specify that the outstanding loan balance be deducted from the beneficiary’s own legacy during the estate settlement in the future.

The Implementation

In this case, Fred proposes that Bob and Tess provide financing for a part-time farming operation he can manage in the future. Borrowing $200,000 amortized over 25 years at a four per cent interest rate would result in monthly payments of $1,052. Over the period, the accumulated interest of $115,000 would be deductible from farm revenues for tax purposes.

Bob and Tess can give Fred a favorable deal on farm machinery at a transfer or sale price close to book value. Values above book value would be taxable to the parent’s estate.

As a long-term incentive for Fred, Bob and Tess can transfer a quarter section to him every five years. The home quarter would be an optional extra when the parents decide to move to town.

Transferring Farmland

When transferring the title of a quarter section to Fred, Bob and Tess can take a zero interest, promissory note equal to market value. This protects the parent’s future income stream if Fred has creditor or marital issues in the future. Fred can still pay a small land rent to Bob and Tess to enhance their retirement income.

This process ensures that if a spouse divorces, the eligibility would be only for half the gain in value above the stated value on the promissory note. Without the promissory note, the divorcing spouse would be entitled to half the entire value of the parent’s gift. Furthermore, it would be prudent to add a clause specifying that, if Fred decides to rent out the land in the future and no longer actively farms it, the parents would receive the rental income.

Alice, Bob and Tess’s daughter, is newly married and wants to purchase a new home. Bob and Tess, as potential lenders or co-signers for the mortgage loan, should ask for a written proposal on how the mortgage will be paid including amounts, terms, etc. It would be prudent to register the mortgage against the title in the parent’s name.

Bob and Tess’s Income

Income from renting the farmland not farmed by Fred will generate a monthly income of $3,200 for Bob and Tess. Add to this $1,666 combined monthly dividends from taxable stocks in an investment portfolio, and $4,320 per month in capital gains, and they will have a total income of $9,186 per month – roughly $8,000 per month after taxes. Once they turn 65, they can add Old Age Security and Canada Pension Plans to their income.

The core of this estate is solid. The challenge is to divide assets fairly for the children and for the parents with suitable protections. We have done that in this plan.

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Disclaimer: This Forbes Wealth Blog is for informational purposes only and does not constitute financial, legal, or tax advice of any kind. Please consult your legal, accounting, tax, investment, banking, and life insurance professionals to get precise advice relating to your particular situation before acting upon any strategy

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