John and Sherry – Midwest
If there is one thing we’ve learned over the years it is that families connect with the land. Without these connections, forests lose some of their special qualities and, with time, families go their own ways. — Sherry
I first met John and Sherry at their summer home, far from their forest holdings. There are few tree farmers in the Midwest that are better known than this couple, the perfect team when it comes to putting a face on America’s family forest owners. John is the business person: quiet, pensive, and more apt to listen carefully and deliberate before making a decision. Sherry is pure public relations, the sort of person who is easy to get to know and she’s willing to strike up a conversation with anyone, but especially those who share her passion for forests.
John went to work for the family business, started by his father in the late 1920’s, and Sherry was a school teacher, exactly like that one teacher we all remember from grammar school days who was a favorite for her sunny disposition and her infectious spirit of inquiry, which is the secret of every good educator.
As a young couple in the early 1960’s, with a prosperous business and some cash they could afford to invest, John started looking for land in the northern regions of their state. A few years later, while returning from a short vacation, John suggested they take a detour on the ride home to visit a 40-acre tract for sale.
“I’ve always had a passion for trees,” says John, and so this first small investment of $4,000 for a formerly abused farmstead on sandy soils was the stuff of dreams. Of the 40 acres in the parcel, 15 had been cleared by a former owner who tried to grow corn, and the rest was forest. The property also came with a house, small barn, and an even smaller silo. Before the purchase, John brought his father to show him the land and to seek his approval for the investment. Dad’s only comment upon seeing the farmstead was, “You know John, one can always judge the quality of a farm’s soil by the height of its silo.”
“The silo is six feet tall, so you can imagine how poor the soils are,” John says with a smile.
After purchasing the land in 1966, they opted to burn down the house and barn – to save on property taxes since they had no intentions of ever living there – but kept the short silo and converted it into living space. “Rough living space,” according to Sherry, “but the rest of family likes to stay there.”
In the spring following purchase, John and Sherry tested the bonds of their marriage proving they were soul mates for life. They planted 15 acres with thousands of white and red pine seedlings, species that John has confessed a passion for.
After planting, the local state service forester explained the advantages of enrolling their land under their state’s tax abatement for forestlands program, a statute that defers taxes on timber for up to 50 years or whenever the timber is harvested. Significantly, it was this incentive program and others that followed, that allowed the family to invest in planting trees. The 15 acres established in 1967 was the first of many plantings over the years on the first of three forested parcels that they now own and manage as a Family Limited Partnership (FLP – See Glossary for definitions).
Even though their first tract of land may have had the poorest soils of all the forests they own, the parcel still has special meaning for the family. Near a creek that crosses a corner of the land is a tree under which Sherry used to take breaks to nurse their newly born daughter. Since then all of their three children – and a number of grandchildren – have nursed over the years under what Sherry refers to as the family tree.
“It wasn’t that great a tree farm,” says Sherry, “but the family tree has become the roots of our family’s connections to forests, and our commitment to growing trees.”
In 1989, John retired from the family business at the age of 55, turning over the keys to his two sons. Actually, he still has an ownership interest in the business, but as a silent partner. Now the family owns a total of five tree farms with a combined 875 acres, 650 of which they estimate are productive forests. The closest tract is 175 miles from their primary residence, and the farthest is 225 miles.
Clearly John and Sherry are enjoying retirement, but both are reluctant to flaunt what, they have come to know, is wealth beyond measure: their forests.
“I grew up dirt poor,” says Sherry, “but I always felt like we had plenty. John and I have never owned a new car, we build or make what we need, and we have never sought out social circles that reflected wealth. We’re both very frugal and humble.”
“Our wealth is forests. It isn’t really much,” John pronounced, “but the land is ours and we love it. We have never been able to spend as much time with the land as we would prefer, and there is always work to be done.” Now, virtually every conifer on their lands is a tree they’ve planted and cultivated.
The “family forest weekend,” as Sherry calls it, is held every fall over a long, Columbus Day weekend, with the boys working out their schedules so someone is always minding the family business. But from late Saturday afternoon through Sunday, the entire family is almost always together. John and Sherry rent hotel rooms near the first tree farm – the one with the ‘family tree’ – and grandkids are lured with the promise of swimming, cookouts and time with family.
“We always go to a hotel with a pool so it’s fun for the kids; a weekend they look forward to,” according to Sherry, who makes most of the arrangements.
On Sunday morning, John spends time with his two sons, walking boundaries, checking the condition of trees, discussing projects and going over a work schedule for the next year. But making the weekend a family affair is Sherry’s doing. She realizes the power of family, and has discovered how their forests can serve as glue to bind the family, not only to one another, but also to the land.
“The tree farms belong to our family not just our three children, but to their grandchildren and, eventually, their grandchildren’s children,” she says and John agrees.
Sherry goes on to say, “If there is one thing we’ve learned over the years it is that families connect with the land. Without these connections, forests lose some of their special qualities and, with time, families go their own ways.”
Even when John and Sherry have made a decision, they still seek input from their children. This, despite the fact that the kids are apt to say, “Well, Dad, whatever you and Mom think best.” When John and Sherry take decisions to their children, they’re engaging them and that is the important thing. It is doubtful that any one of them would ever raise an objection to something their parents have proposed, but that’s not the point. Asking for opinions is a show of respect, and an indicator of how they expect their successors to work with future family, when John and Sherry are gone.
Early on, the family decided to obtain forestry guidance from a forest industry Landowner Assistance Program (LAP) offered by a local forest products company. In return for a “right-of-first-refusal” at harvest time, the LAP program provides all the necessary forestry expertise, including mapping, inventory and planning; the company even ordered the trees that John and Sherry planted. But after a fairly regular turnover of foresters, the family decided it was time to divorce the company’s LAP program and hire its own consultant.
“Well before the LAP forester could get to know our lands, she would be off to another position and the company would hire a new forester,” according to John. “I told them early on that if there is a constant turnover of foresters, then we want out.” The consultant they eventually hired came highly recommended by their former LAP forester.
“She recommended a private consulting forester with forest appraisal experience, an essential skill we needed for our estate planning efforts in 1996,” says John. “We became a little more acquainted with our forester after the appraisals, met him at a couple of meetings and knew that he had done a good job for us. He was also very well-respected and he is of an age that we can expect him to be here for quite some time. We hired him in the year 2000 and things have since worked out well.”
Of their 875 acres, 660 are in plantations composed of ten percent red pine and the balance in white pine, and some spruce. The other lands are too wet for planting but support mostly hardwood forests and are dedicated to wildlife. Under their current plan they treat approximately 60 acres per year (also known in forestry as area regulation – see Glossary) with a first thinning at about age 25 years. Each stand will be thinned two or three times before reaching a rotation age of 70 to 80 years for red pine and 100 years plus for white pine.
“Our number one goal is timber production, because I just love to raise trees,” John admits. “Wildlife is definitely secondary on our lands.”
Even though their state’s forest tax abatement program tends to discourage posting of lands, the family discovered that by transferring their tracts into Limited Liability Companies (LLCs) they could both meet the law’s requirements and still leave open at least a portion of their holdings for lease hunting. Although they’re not proud of “bending the rules,” the extra income from hunting leases helps pay some of the costs of owning land. And, according to Sherry, “The extra sets of eyes help prevent abuse from those who take advantage of our land.”
Keeping forest in the family is clearly a high priority for the family. The decision to buy forest was not simply an investment so much as a life choice, one they believed would help keep their family together. Of the many different strategies available to forest owners who want to keep lands intact and in the family, John and Sherry chose a Family Limited Partnership (FLP). Their ultimate goal is to have the partnership and its forests passed from one generation to the next, and the FLP is a fairly common method of, first sharing land with successors, then passing the land when the current titleholders have passed.
John and Sherry formed the FLP in 1990 and transferred all their holdings into the partnership by gifting virtually all of the assets equally to their three children. They retain a one percent interest in their own names, thus allowing them to serve as general partners, who are largely responsible for day to day decisions. The partnership includes residential real estate and other assets, but their forests are the most important of their holdings.
The family decided to form the partnership under Florida law, since they were living a significant portion of each year there. During the gifting process, John and Sherry used the bulk of their combined IRS-allowed, taxable gift exclusion available that year to pass undivided interests in the partnership to their children. Their goal was twofold: 1) To vest their children into real estate the family had acquired over the years, while also retaining control as general partners; and, 2) To gift the bulk of their taxable estate to children while also taking advantage of exemptions that were available to them at the time. In other words, rather than using the annual IRS-allowed gift exclusion (equal to $14,000 per spouse, per gift, per donee, per year in 2013), John and Sherry used the lifetime taxable gift exclusion available to them in 1990.
In 2013, the lifetime taxable gift and estate tax exemption increased to $5.25 million; double this for a qualified husband and wife – or other qualified couple – who hold assets in trusts (discussed in subsequent chapters, and in detail in Chapter 17).
Since the terms of the family’s FLP limit the marketability of the gifted shares, they were able to take full advantage of IRS rules allowing them to discount the value of gifts; in their case by 41 percent. So, for example, if the fair market value of all the assets in the partnership equaled $2 million in 1990, because the FLP limits the marketability of gifts (which is a common strategy when the gift is an undivided interest in farm or forest-land), Congress allows them to discount the actual value of the gift by 41 percent. With discounting they can, for example, give $100,000 worth of forest to create a gift worth $59,000 in the eyes of IRS. At a discount rate of 41 percent, the family is able to give $2 million in fair market value to create a gift equal to $1.18 million ($2 million less 41 percent. See discounting in Glossary).
Discounting allowed the family to lower their taxable estate to a point below the exemptions available to them at the time ($600,000 per spouse or a total of $1.2 million for both). Although these figures are purely hypothetical, by forming a family limited partnership and gifting the bulk of assets to their children (while retaining control until they’re ready to pass responsibility on to one or more of their heirs), John and Sherry are able to keep their forest holdings intact while sheltering the value of these assets from estate taxation.
The subject of discounting gifts requires highly specialized advice, usually from lawyers or accountants that are experienced with such matters. Significantly, discounting – although widely used by families that want to shelter forest assets from estate tax – is not something to be taken lightly. It is a strategy discussed further in subsequent chapters. And, significant lifetime taxable gifts (although not actually taxed until the final estate), are almost always audited by IRS. This last point is all the more reason to seek qualified professional assistance for such gifts.
Even though they’re fairly certain which of their children will take on the job of general partner, they’re not sure about the issue of compensation. When John settled his father’s estate, he refused compensation even though the role required a considerable effort. Now, John is not sure if it is reasonable to ensure compensation for the executor of their estate, and new general partner. Sherry, on the other hand, believes that compensation is not only necessary, it is essential, and I agree with Sherry.
Another issue the family has had to deal with is how to protect the FLP from a disgruntled spouse that tries to convince a family court that he or she has an interest in the partnership because it is a marital property. One of their children actually tried to get a spouse to sign a postnuptial agreement to secure this type of protection but gave up at the first sign of reluctance. John and Sherry’s experience notwithstanding, forest-owning families that employ strategies to keep lands intact and in the family should always encourage their children to sign prenuptial agreements. Family forests should never be exposed to family disputes that could jeopardize the long-term disposition of forests, and any loving prospective spouse would readily agree (but sometimes he or she needs reminding).
Where are the Flaws in their Planning?
Family Limited Partnerships are a fairly common tool used by husbands and wives to vest children in a family business but without sharing control (for reasons unknown, this is more common east of the Mississippi than in the West). In this case, John and Sherry are the general partners and their three children are limited partners even though the children own 99 percent of the partnership. This means that the parents make all decisions and they alone are liable for any lawsuits that befall the family limited partnership. Eventually, John and Sherry will need to designate a new general partner and turn the reins over to one or more of their children.
One fairly innovative thing the family did was to provide guidance on what to do if one or more of their tracts is too threatened with development to maintain as forest. The general partner is advised to sell the land to a highest bidder and use the proceeds to purchase forestland in an area less threatened.
In a case study that follows we explore a couple of situations where families used special IRS rules called 1031 transactions to sell forestland while using the proceeds to buy forest in another location. By using a 1031 transaction the owners are able to avoid an otherwise taxable event (i.e., paying capital gains on sale of the first property, since the proceeds are turned over into purchase of like-kind property). John and Sherry are to be applauded for their forward thinking in this regard, so much so that every inter-generational strategy for passing forests should address the issue of a forced sale and what to do with sale income.
Family Limited Partnerships can be a useful tool for passing forestlands intact provided the partnership agreement is very clear about what the general partner can and cannot do as it relates to the sale of assets. Clearly, John and Sherry are in a good position to select a general partner from among their children, but what will happen in the future as the family grows into new generations?
If all subsequent generations follow the same pattern as John and Sherry – that is three children per family – at the turn of the next century there could be as many as 350 prospective partners. By selecting one of their children to be the new general partner, there is a higher probability that all subsequent general managers will be selected from that child’s offspring, which will severely limit the opportunity for other, possibly more qualified, family members to be involved. That is, unless the FLP provides guidance on passing responsibilities.
Another potential problem involves liability. The new general partner will assume all the liability now held by John and Sherry, a burden the son or daughter they select may not be willing to accept. For this reason many family partnerships will form a limited liability company or corporation and designate it as the general partner. In John and Sherry’s case, they may be able to convert their one percent interest into just such a entity. The corporate board can then vote on leadership and also hire expertise such as forestry services when necessary.
Even with a corporate partner, there is still an issue concerning ownership interests. Presumably each eligible parent will bequeath his or her limited partnership interests to their children (they can benefit from forests without control over how forests are used). But unless the partnership agreement is very clear about who can and who cannot become a limited partner, there is nothing to stop any one of them from selling their interest to someone other than eligible family.
The Family Limited Partnership is a useful way to vest heirs into the family forest, but unless it is crafted very carefully, the partnership will begin to fail as more and more eligible family get involved.
Finally, the partnership documents have to consider future prospective partners that want out of the FLP. And, if an heir in one generation wants out, will the FLP acknowledge the rights of this person’s future generations to get back in? If so, what are the particulars for buying out an eligible family member, and how do his or her issues (i.e., children and grandchildren) buy back in assuming the FLP allows? Generally, buyout options are specified in the FLP at rates significantly less than the actual current value of a partner’s interests. This usually serves as a sufficient deterrent for future family wanting nothing to do with the family forest.
In mid-January, 2013, I sent all chapter interviewees a copy of their story. I wanted their comments with respect to facts, and I also asked if they had any updates. Not every person I interviewed replied, and a few said their chapters are fine as is. But John and Sherry had some significant updates to share.
In 2008, they folded their FLP into an LLC. According to Sherry, “Our state laws on LLC’s were amended at that time, making the move to an LLC far more favorable.” They held their 16th annual family forest weekend over the Columbus Day holiday in 2012.
“Our three oldest granddaughters, all now in college, made a point of attending,” Sherry remarks. “They see the changes on our forests from year to year and are eager to express their opinions on what should be done.”
“We also added new provisions to our estate plan: Each year our grandchildren and children of succeeding generations, will have the right to a substantial gift for college expenses; but with conditions. If a child decides to get a tattoo, multiple body piercings (with the exception of earrings), takes up smoking, drugs, is involved in a pregnancy out of wedlock (or under any circumstances during their studies), or fails to graduate from high school within four years, or from an accredited University, the whole deal is off,” according to Sherry, and John concurs.
Although I have no idea how they plan to enforce the piercing and tattoo conditions, since such body art is not always located in places for public consumption, these are the rules. Significantly, not all of the family agrees.
“One mother criticized us for dictating how individuals use their bodies; do we have the right to do so?” Both admit, “The answer is no; but we do have the right to spend money as we see fit. Our fourth of ten granddaughters will graduate in May and, so far, our success rate in perfect.”