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When transition plans fail: the case for regular reviews

4 min read

The following is a fictional case study created by BDO.

Ingrid and Hans prided themselves on being proactive on the transition plan they had in place for their operation. As they neared retirement, they were looking forward to executing the plan and moving on to the next phase of their lives.

No plan can fully account for unforeseen changes, especially over 10 or 15 years.

More than 15 years ago they had decided to roll all assets, including farmland, into a corporation. The primary motivation to incorporate the operation was to manage their annual tax liability, but they also decided to take advantage of the one-time capital gains exemption to increase the value of the land transferred into the company and to shift as much debt as possible to the corporation.

No plan can fully account for unforeseen changes, especially over 10 or 15 years. For example, there was no way Ingrid and Hans could know that the capital gains allowance would increase later, and that land values would skyrocket to where they are today.

Fair, or equal?

The plan was that when they were ready to retire, they’d split the company and the assets between their two children, Andreas and Thomas, who were now in their late 40s. Andreas had come home after university to farm with Ingrid and Hans. Thomas had never expressed an interest in farming and had moved to the city after he married. The family had talked through the plan, which would see Thomas receive one of the larger parcels of land from the corporation and Andreas would get the rest of the company.

To take the plan a step further, Ingrid and Hans had taken out a life insurance policy worth $500,000 to cover the cost of removing the farmland that Thomas would receive from the company. At the time, everyone felt this was a fair arrangement. Andreas had invested close to 30 years in the farm and was fully committed to the enterprise. Thomas was not involved and only came home to visit once or twice a year. Ingrid and Hans felt good that it was all out in the open and above board.

Sitting down with their accountant, Ingrid and Hans learned that they could follow through with the original plan and split the company, but there would be costs and hoops to jump through. As the accountant explained, they’d benefited from the decision to roll the land into the corporation when that decision was made, but they would now face the costs of that strategy.

An unexpected tragedy

The challenges delayed the execution of the plan – no one involved felt any urgency to address the issues and move forward and while they were discussing next steps, tragedy struck the family. Ingrid and Hans were involved in a car accident on slippery winter road conditions, and both passed away.

The brothers pulled together to get through the shock and grief of the loss. When Andreas eventually brought up the transition plan and the need to move forward with it, Thomas commented that he was so relieved that their mom and dad had put the plan in place. But they soon realized there were real problems to address.

The life insurance policy Mom and Dad had taken out to cover the cost of removing the property that was to go to Thomas was for $500,000, which was more than reasonable when they put the plan in place. However, the property was now worth at least $2 million. There would be major tax implications for the estate if they followed through as planned.

Assets in joint ownership

Both brothers initially agreed it made no sense to trigger a large tax bill to extract the farm promised to Thomas. And while Thomas was agreeable to accepting cash instead of the land as his share of the family wealth, he did believe his parents intended for him to receive an inheritance equal to the fair market value of the farm he had been promised. Andreas believed the $500,000 of life insurance payable to the company was intended to be extent of value that his parents wished for Thomas to receive. They faced a difference in opinion that amounted to $1.5 million. It would test their relationship.

Unfortunately, the wording in Hans and Ingrid’s wills left the brothers owning the company together without a clear plan of how to untangle the mess. As the brothers learned from their accountants, it’s often problematic to create a transition plan whereby siblings end up owning assets together. It’s particularly a problem if they co-own operational assets where one sibling farms and one doesn’t.

The lesson in all of this is to think of a transition plan as one that must evolve to address shifting realities. Taxes and laws change. Valuations change. And people change. Ingrid and Hans did so many things right based on where they were at 15 years ago, but not revisiting the plan in the interim negated their good will and intentions.

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From an AgriSuccess article.

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