Estate tax exemption for farmers and ranchers | Baker Tilly
Article
How farmers and ranchers can save money with estate tax exemption options
Dec. 23, 2024 · Authored by Eric Farmer, Rachael Gieseke
Estate planning can be complex for anyone, however, estate planning for farmers has its own unique challenges and opportunities; there are estate tax savings opportunities specific farmers and ranchers. Knowing how to leverage these opportunities can reduce exposure to unnecessary estate and gift taxes, potentially preserving more wealth.
Discover unique, farm-specific estate tax exemption opportunities and how they can benefit farm and ranch owners.
Background on the lifetime estate tax exemption
Most taxpayers know that there’s a high lifetime estate tax exemption that’s indexed to inflation — $13.61 million for 2024. However, this high lifetime exemption is scheduled to be cut in half starting in 2026. Current estimates are that the exemption will be approximately $7 million.
This will likely lead many farm couples with estates exceeding $20 million to consider making large gifts between now and Dec. 31, 2025. It’s important to begin planning now as there’s no guarantee that this bonus exemption will be extended.
Joint versus individual gifting strategies
Most married couples usually make joint gifts. However, for major gifts, couples should consider having only one spouse make gifts. This allows the couple to efficiently leverage the bonus exemption; otherwise, the couple may end up with little or no exemption left in 2026.
But what does that mean? The current lifetime exemption is comprised of a base exemption of $6.8 million and a bonus exemption of the same amount. All gifts come out of the base exemption first and the bonus exemption has no value until you fully use the base amount.
Example scenarios
Bill and Jane are interested in making a gift of $13.6 million.
They have two options:
Joint gifting. Bill and Jane each give $6.8 million
Individual gifting. Bill gives the full $13.6 million
If Bill and Jane employ option one, they’ll use the base exemption. If the lifetime exemption reverts to $7 million in 2026, they’ll each have $400,000 of exemption available.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.
However, if they use option two and Bill gives the full gift, he’ll have $400,000 and Jane will have $7 million in 2026. As a married couple, they’ll have an extra $6.8 million to make further tax-free gifts.
This can be more difficult in community property states since each person is deemed to own half of all marital property no matter what the property title is. It can be done but takes extra effort and time.
Estate tax exemption strategies for farm operations
There are two areas to consider when approaching gift and estate tax:
Tax deferral
Partially reducing land values
Tax deferral
How many times has a family had to sell the farm because of estate taxes? Rarely. In most cases the heirs were waiting for mom and dad to pass so they could sell the farm.
The primary reason heirs don’t need to sell the farm is that the federal government allows heirs to pay farm-related estate tax over time at a very low interest rate. Given the first $7 or $14 million of net value escapes all federal estate taxes, it’s only the excess that’s subject to the 40% estate tax.
The executor of a qualifying estate elects under Section 6166 to defer paying a portion of the estate taxes. Normally, the estate tax is due in full nine months after the date of death. However, the portion of the estate tax related to active assets, such as a farm, can be deferred. The active farm assets must be at least 35% of the adjusted taxable estate.
Most farmers easily meet this requirement. However, if the farmer is no longer farming and simply cash renting the ground or collecting a crop share without participating in the farming, the estate may not qualify.
Interest considerations
The deferral can be interest only for up to five years — first principal payment owed five years and nine months after death — and then amortized over the remaining nine years for a maximum 14-year deferral.
There are two components to the interest rate:
The first $740,000 — inflation adjusted — bears interest at 2%
The remaining amount bears interest at 45% of the applicable IRS underpayment interest rate. This is based on short-term interest rates plus 3% and becomes fixed at the time of election. The current rate is 3.6%.
The good news is that this is a very low rate. The bad news is it’s only available for the portion of the estate tax related to the active farm assets and may require a lien or other security. Estate tax on all other assets is due nine months after death.
Example
Assume Bill passes away with an adjusted gross estate of $20 million and farm assets are $15 million. Total estate tax is $2.56 million with $640,000 due nine months after death. The remaining tax of $1,920,000 can be deferred — 75% of $2.56 million. The first $740,000 bears interest at 2% and the remainder of $1,180,000 bears interest at an estimated 3.6%.
Starting nine months after death the estate pays annual interest of $14,800 — 2% — plus $42,480 — 3.6% — for five years. On the anniversary of the fifth year, the estate will also pay 10% of the remaining 75% estate tax or $192,000 each year — shrinking annual payments. The estate can elect to pay the tax sooner if appropriate.
Partially reduce land values
Another strategy is the ability to partially reduce land values. Section 2032A allows an estate to value farmland at lower values compared to its actual higher fair market value. However, the maximum reduction for 2024 is $1,390,000 — inflation adjusted.
To qualify the taxpayer must meet the following requirements:
The farm estate must be made up of real property used in farming that has a fair market value of at least 25% of the total value of the adjusted estate.
The farm assets, both real and personal, must make up at least 50% of the estate.
The farm real property must have been owned by the deceased or a family member for five of the previous eight years.
The real property qualifying for special land use must pass to a qualifying heir — usually a family member.
For five of the preceding eight years, the qualifying real property must have been farmed or materially participated in by the deceased or a member of the family.
The executor or personal representative must file an election for 2032A, with an agreement signed by each person having an interest in the property, consenting to the liability for any estate tax recapture that may occur later.
One of the heirs must continue to be materially engaged in the farming operation for at least 10 years.
The reduction in value reduces the step-up in basis on the land.
If the farmland is taken out of production or sold to a non-family member during the 10-year period, any estate tax deferred under Section 2032A is owed. An election may be made to increase the basis of the land to its fair market value at the time of the decedent’s death. This can be beneficial if the farmland is sold. However, if the election is made, interest must be paid on the deferred estate tax.
Raising the Section 2032A exclusion to $14 million has been proposed, but it hasn’t been passed. It may pass in the future.
The reduction is based on an assumed cash rental value. The estate determines the five-year average cash rental for comparable land per acre. It reduces it by applicable real estate taxes and then capitalizes it using one of four Farm credit national banks applicable annual interest rates. For most states in the West, the applicable Farm Credit Bank is Co-Bank with an applicable interest rate of 5.30% for 2024. This rate is issued by the IRS each year typically in August.
Example
Assume Bill’s estate meets the Section 2032A requirements and includes 200 acres of farmland worth $20,000 per acre. Comparable average five-year cash rents were $630 and real estate taxes were $20. $610 divided by 5.30% equals $11,509. This allows the estate to reduce the per acre value by $8,491 for a total reduction of $1,698,200. However, the estate is limited to a maximum reduction of $1,390,000 on his estate tax return for 2024.
The election is placed on specific parcels of ground which allows the estate to pick and choose the most appropriate ground for the election. This is especially important if some of the ground may be sold within the first 10 years; there wouldn’t be election on that farmland.
Oregon and Washington state opportunities
If you live in Oregon or Washington state, there’s additional estate tax information to be aware of.
Washington
Farmers in Washington state are eligible for an unlimited farm deduction equal to 100% of the farm value under the state's estate tax law, which has the highest rate in the country at 20% on taxable estates over $9 million.
If certain conditions are met, the estate may deduct the total value of the farm from the estate tax return, potentially saving significant amounts in estate tax. Unlike federal rules, Washington state doesn’t require heirs to own the property for at least 10 years after death. After the decedent's death, the heirs are free to do as they wish with the assets.
It’s crucial for farm owners to closely monitor farm values versus total estate values to maintain the necessary ratios for the full farm deduction.
Oregon
Oregon only allows a $1 million exemption for estate taxes; however, it does have a special Natural Resource credit available to estates of less than $15 million and a new Natural Resource Exemption of $15 million. The two Natural Resource estate tax programs cannot be combined on the same estate tax return.
The credit is calculated as a ratio of the elected natural resource credit to the total estate times the actual tax paid. Cash used in the farm operation may also qualify for the credit, but recapture is required if this cash is used to pay federal or state estate taxes.
The Oregon Natural Resources credit can be valuable for Oregon farmers, but its value decreases if the total farm value exceeds $7.5 million or the estate is greater than $15 million.
The Natural Resource Exemption applies to estates of decedents dying on or after July 1, 2023. This new exemption may be more beneficial to certain estates than the natural resource credit as it can reduce the taxable estate value up to $15 million without regards to the total value of the decedent’s estate. However, the qualifications and recapture rules with the exemption program are different and more restrictive than that of the credit.
Careful consideration should be given to both programs when filing an Oregon estate tax return.
