Many families in South Dakota have created corporations to govern their farming operations. While a corporate structure can provide you with many benefits, such as reduced liability, it can also increase the amount of taxes you must pay. One such tax implication can arise when farmland is distributed to shareholders within the corporation.
If your corporate structure has real estate, such as farmland, included as an asset there are important tax ramifications you should consider before distributing that land. When distributed to the shareholders, the transaction is taxed by the IRS as a sale. [1] It is also taxed as a distribution equal to the fair market value of property.[2]
This is an expensive transfer if your family members are the shareholders of the corporation. The corporation pays the income tax on the increase in value of the land and likewise, the shareholders (family members) pay taxes on the dividend on the fair market value of the land.[3]
In addition, there is no “step-up” basis for land held in a C-Corporation.[4] Normally, the “step-up” basis allows a person to limit capital gains taxes by not taxing the increase in value on certain asserts that are transferred at a person’s death. This “step-up” allows the beneficiary to avoid a large tax on assets that have grown in value. Without this “step-up” basis, the beneficiary would be taxed on the same basis that the decedent was subject to at the time of their death (“carryover basis”).[5] As a result, a beneficiary would have to pay capital gains tax if and when they sold the assets.[6]
If you hold your farmland in a corporation it is important to consider all tax repercussions before removing the land from the corporation. To avoid these potential tax liabilities, you may want to consider holding your land in a separate entity then a corporation. An experienced financial planning attorney can help assess your situation and provide you with guidance tailored to your specific needs.
[1] Williams, Elizabeth, “Avoid the Land Trap,” http://dtnpf-digital.com/article/Avoid+The+Land+Trap/1565221/184555/article.html
[2] Id.
[3] Id.
[4] Id.
[5] Sullivan, Paul, “The Estate Tax May Change Under Biden, Affecting Far More People,” January 15, 2021 athttps://www.nytimes.com/2021/01/15/your-money/estate-tax-biden.html
[6] Id.
