Farm Transition Planning Strategies for Second Marriages – Part 2, Divorce

In the last post, we looked at strategies to deal with second marriages using trusts. In this post, we look at the risks of divorce on the farm transition plan and strategies to minimize the risk.

Marital Versus Separate Assets

To address the issue of divorce, it is first helpful to know what assets are subject to a divorce. According to Ohio law, marital assets are to be divided “equitably” in the event of a divorce. Equitable does not necessarily mean equal although an equal division of marital assets between the spouses is often the result. Divorces can be especially threatening to farmland because of the “land rich, cash poor” dilemma for farmers. In a farm divorce, it is usually not equitable for one spouse to receive all the farm assets if there are not sufficient non-farm assets for the other spouse. Thus, both spouses may receive farmland in the divorce settlement. Once the farmland is divided, either spouse can sell or transfer the land out of the family.

It is important to note that Ohio law only requires “marital” assets to be divided. Non-marital assets, referred to as “separate” assets, are retained by the spouse who brought the assets to the marriage. Understanding the difference between a separate asset and a marital asset is critical when attempting to mitigate the risks of divorce.

Separate assets include the following:

• Property acquired by a spouse prior to the date of the marriage.
• Passive income and appreciation from separate property received by a spouse during the marriage.
• An inheritance received by a spouse during the marriage.
• A gift received by a spouse during the marriage.

The above list would seem to make it an easy exercise to determine which assets are marital and which are separate in a divorce situation. However, like many legal issues, the application of the concept is more complicated than it may appear. This is because Ohio law also provides that income or appreciation on separate property can become a marital asset.

Ohio law includes as marital property:

“… all income and appreciation on separate property, due to the labor, monetary, or in-kind contribution of either or both of the spouses that occurred during the marriage. ”

So, it is possible for an asset to be partially separate (the initial property) and partially marital (the income and appreciation on the property).

Consider the following example:

Andy and Beth are farmers in the process of divorcing. Shortly after they were married, Beth inherited a 100-acre farm from her grandmother. When she inherited the farm, it was valued at $600,000. A few years after inheriting the farm, Andy and Beth’s farming operation paid for and installed $80,000 of drainage tile on the farm. The current value of the farm is $1 million.

In this example, the farm was Beth’s separate asset upon inheritance. However, the tile that improved the quality and value of the farm was a result of Andy and Beth’s joint farming operation. Andy likely has a valid claim that at least part of the $400,000 increase in value is a marital asset due to the tile installation.

Perhaps Andy further argues that most of the increase in value was due to fertilizer, tillage and other soil improvements made while Andy and Beth farmed the land. It is in Andy’s interest to make the $400,000 increase in value a marital asset. Conversely, Beth could argue that the increase was not a result of the marital farming operation but was merely a passive value increase due to market pressure. It is in Beth’s interest to argue the $400,000 increase as her separate asset.

As this example illustrates, an asset that is initially a separate asset can become, at least in part, a marital asset. Both Andy and Beth have valid arguments. It is not hard to imagine how much time and legal fees could be spent resolving or litigating the issue in a contentious divorce.

Co-mingling assets can also cause a separate asset to become a marital asset. If the spouse owning the asset voluntarily allows the other spouse to become an owner of the asset, it is likely to become a marital asset. Using the example above, after Beth receives the farm, she adds Andy’s name to the deed as co-tenant. Because she voluntarily added Andy to the deed and gave him half ownership, Beth has likely changed the property from a separate to a marital asset.

Another example might be as follows:

Beth receives a $100,000 inheritance from her grandmother. Beth deposits the money in a bank account owned by both her and Andy.

By co-mingling the inherited money with other money owned jointly with Andy, Beth has probably made the $100,000 inheritance a marital asset. If Beth would have deposited the money in an account owned only by her, the inheritance would have remained a separate asset. While co-mingling does not automatically make an asset become marital property, the spouse owning the asset should avoid co-mingling if wanting to keep the asset separate.

Assets acquired during a marriage will almost always be considered marital property. This is true even if one spouse provided little or no contribution towards the acquisition of the asset. Ohio law considers marriage to be a partnership regardless of the contribution of the spouses. For example, farmland purchased during the marriage will be a marital asset even if only one spouse operates the farm and the other spouse is not involved with the farmland or farming operation.

Prenuptial and Postnuptial Agreements

A prenuptial agreement can help alleviate the issues with marital assets. This type of agreement entered into prior to marriage designates what assets each person is bringing to the marriage, what assets will be separate, and what assets will be marital. Especially for people who have accumulated some wealth prior to marriage, a prenuptial agreement is a good option to avoid future disputes regarding the nature of assets in a marriage and potential risks to farmland.

To be valid and enforceable, a prenuptial agreement should:

• Be in writing and signed by the parties;
• Be prepared, reviewed and executed long before the marriage;
• Provide each spouse’s assets, including values;
• Be reviewed by separate attorneys representing each spouse.

Prenuptial agreements can become outdated, especially when marriages last many years. A married couple who enters into a prenuptial agreement when they are 25 may have very different assets and goals when they are 65. Until recently, married couples in Ohio were stuck with their prenuptial agreement regardless of how unfair or obsolete the agreement had become. Recently, legislation was adopted to allow for postnuptial agreements.

A postnuptial agreement is similar to a prenuptial agreement in that it identifies which assets are to remain outside of the marriage and what assets are considered joint, marital assets. A postnuptial agreement is signed sometime after marriage begins. There are no term requirements for a postnuptial agreement – it can be entered into shortly after marriage or many years after marriage.

For a prenuptial agreement to be terminated or amended or for a postnuptial agreement to valid, the law requires the following:

• The agreement be in writing and signed by both spouses,
• The agreement is entered into freely without fraud, duress, coercion or overreaching,
• There was full disclosure, or full knowledge, and understanding of the nature, value and extent of the property of both spouses,
• The terms do not promote or encourage divorce or profiteering from divorce.

For people who are considering getting remarried or for those that are already remarried, a prenuptial or postnuptial agreement should be considered. These agreements can establish how assets are to be divided in the event of a divorce and perhaps relieve some worries regarding farm transition planning. Prenuptial and postnuptial agreements should be drafted in consultation with an attorney.

For more information on farm transition strategies to address second marriage issues, see the new bulletin FARM TRANSITION PLANNING STRATEGIES FOR SECOND MARRIAGES available at farmoffice.osu.edu.

Farm Transition Strategies for Second Marriage – Part 1, Trusts

Second marriages present unique challenges for farm transition planning.  This is especially true when the second marriage occurs later in life and the spouses have accrued significant assets and/or have children from prior marriages.  The spouses in a second marriage obviously want to help provide for each other but may have a competing interest of providing for their children but not necessarily stepchildren.  Without good planning, it is possible that farm assets will end up with a spouse or stepchildren who were not involved in the farming operation.

One of the challenges with second marriages occurs when one or both spouses have children from a prior marriage.  The spouses usually intend to provide adequate income to the surviving spouse upon the death of the first spouse to pass away.  Also, the spouses will usually want some or all of their assets to ultimately go to their children, not their spouse’s children.  So, the issue becomes, how to establish a plan to take care of the surviving spouse while ensuring the deceased spouse’s assets go to their own children?

Consider the following example, a typical second-marriage, farm transition scenario:  

Mark and Mindy each have two children from previous marriages.  Mark has farmed his entire adult life and built a large farming operation prior to marrying Mindy.  Mindy has two children and is not involved in the farming operation.  Mark’s two children plan to take over the farming operation.  If Mark dies before Mindy, he wants to make sure Mindy has adequate income for the rest of her life.  However, he wants his assets to be inherited by his children and not Mindy’s children.

Let’s first look at what poor planning might look like.  If Mark and Mindy do not have an estate plan or a simple estate plan where everything goes to the surviving spouse then to the children, Mindy’s children could end up with some or all of Mark’s assets.  In this scenario, if Mark dies first, all of his assets will go to Mindy.  At that point, Mindy will have total control of the assets and could sell them all or leave them all to her children.  For second marriages, no plan or a simple plan is usually not adequate to meet the goals of a farm transition plan.

The better plan is to use a trust.  A trust can hold the deceased spouse’s assets for the surviving spouse’s life, thus providing income.  Then, at the surviving spouse’s death, the assets are distributed to the deceased spouse’s children.  The surviving spouse never has ownership of the deceased spouse’s trust assets, so the assets are never in danger of ending up with the surviving spouse’s children.

Continuing the previous example, Mark establishes a trust with the following terms: 

“Upon my death, my farm assets shall be held in trust for the life of Mindy.  While held in trust for Mindy, my Trustee shall distribute all income to Mindy.  Upon the death of Mindy, my Trustee shall distribute the assets to my children.”  

These trust provisions will meet Mark’s goals of providing for Mindy while having his children eventually inherit his assets.  

Sometimes we may want some assets to go directly to the deceased spouse’s children at death and some held in trust.  This is very common for farm plans.  When children will be taking over the farming operation, we may not want to tie up the operating assets in trust but instead have those go directly to the farming children.  To implement this plan, the trust may have provisions similar to the following: 

“Upon my death, my Trustee shall distribute all my farm machinery, grain, crops and other farm operating assets to my children.  The remainder of my assets, including my farmland, shall be held in trust for Mindy.  While held in trust for Mindy, my Trustee shall distribute all income to Mindy.  My Trustee shall offer to lease the farmland to my children for 80% of the county cash rent average.  Upon the death of Mindy, my Trustee shall distribute all remaining trust assets to my children.”

These trust provisions allow the farming operation to be inherited directly by Mark’s children, allowing a seamless transfer of the farming operation.  The farmland is held in trust and leased by the children.  The rental income from the farmland is provided to Mindy for the remainder of her life.

A third variation provides some assets outright to the children, some assets outright to the surviving spouse and some assets held in trust.  This type of plan might be used when the spouses wish for some assets to go directly to the surviving spouse, without being held in trust.  This is often done with cash or other financial accounts to provide immediate and freely available money to the surviving spouse.  Trust provisions reflecting this type of plan may be as follows:

“Upon my death, my Trustee shall distribute all my farm machinery, grain, crops and other farm operating assets to my children.  My Trustee shall distribute my First National Bank account and Acme Financial Account to Mindy, outright and free of trust.  The remainder of my assets, including my farmland, shall be held in trust for Mindy.  While held in trust for Mindy, my Trustee shall distribute all income to Mindy.  My Trustee shall offer to lease the farmland to my children for 80% of the county cash rent average.  Upon the death of Mindy, my Trustee shall distribute all remaining trust assets to my children.”

These trust provisions provide cash to Mindy for which she has immediate access and control.  The farm assets continue to go directly to the children so that they can continue the farming operation and the farmland is held in trust to provide income for Mindy.

In conclusion, a trust can be designed with a great deal of flexibility and creativity. The surviving spouse can be provided with adequate income while protecting the assets for the deceased spouse’s children.  A simple transition plan or no plan at all can result in some or all the deceased spouse’s assets being inherited by the surviving spouse’s children.  Trusts are often an important component of a farm transition plan for second marriage scenarios.

In Part 2, we will discuss prenuptial and postnuptial agreements.

New Publication Discusses Second Marriages and Farm Transition Planning

Second marriages present unique challenges for farm transition planning. This is especially true when the second marriage occurs later in life and the spouses have accrued significant assets and/or have children from prior marriages. The spouses in a second marriage obviously want to help provide for each other but may have a competing interest of providing for their children but not necessarily stepchildren. Without good planning, it is possible that farm assets will end up with a spouse or stepchildren who were not involved in the farming operation.

Farm Transition Planning Strategies for Second Marriages, a new bulletin available at farmoffice.osu.edu, addresses the two most common sources of risk to farming operations when a second marriage is involved – death and divorce. While these risks cannot be eliminated, there are strategies to help minimize the risks to ensure, as best we can, that farm assets stay with the farm family. The bulletin discusses the strategies and how they can be integrated into a farm transition plan.

Strategies to protect farms from the death of a second spouse mostly involves incorporating a trust in the farm transition plan.  A trust can hold assets for the surviving spouse without giving legal ownership to the spouse.  The trust serves the dual purpose of providing  income and other resources for the surviving spouse while also protecting those assets to ultimately be inherited by the deceased spouse’s heirs.  Trusts are an excellent tool to both provide for spouses and protect assets for future generations.

Prenuptial and postnuptial agreements can be used to reduce the risks of divorce.  These agreements between spouses specifically identify which assets are considered joint, marital assets and which assets are to be considered outside of the marriage.  These designations can help safeguard farm assets by keeping them immune from a division of assets in a divorce.   A recent change in the law allows spouses to enter into such an agreement even after the marriage has occurred.

Any farmers who are in a second marriage should consider including a trust and/or pre/postnuptial agreement into their farm transition plan.  An attorney experienced in farm transition planning can assist with deciding if a trust or marriage agreement is needed and how best to integrate into a farm transition plan.  The Farm Transition Planning Strategies for Second Marriages bulletin provides a detailed discussion of trusts and marriage agreements and their potential impact on farm transition planning.

What Assets are Subject to Divorce?

A well-known statistic is that one-half of all marriages end in divorce.  While there is some debate as to the accuracy of this statistic, there is no doubt that many marriages do end in divorce.  According to Ohio law, all marital assets are to be divided equitably in the event of a divorce.  Equitable does not necessarily mean equal although an equal division of assets between the spouses is often the result.  It is important to note that only martial assets are subject to the equitable division between the spouses.  Non-marital assets, or separate assets, are retained by the spouse who owns the asset.

Separate assets include the following:

• An inheritance received by a spouse during marriage
• A gift received by a spouse during marriage
• Property acquired by one spouse prior to the date of marriage
• Passive income and appreciation from separate property by one spouse during marriage

The above list would seem to make it an easy exercise to determine what are marital assets and what are separate assets in a divorce.  However, like many legal issues, this is often not the case. Determining whether an asset is a marital assets or a separate asset can be complicated.  For example, Ohio law also provides that the following is a marital asset:

“… all income and appreciation on separate property, due to the labor, monetary, or in-kind contribution of either or both of the spouses that occurred during the marriage.”

So, it is possible for an asset to be partially a marital asset and partially a separate asset.

Consider the following example:

Andy and Beth are farmers and in the process of divorcing.  Shortly after they were married, Beth inherited a 100-acre farm from her grandmother. When she inherited the farm, it was valued at $600,000.  A few years after inheriting the farm, $80,000 of drainage tile was installed on the farm paid for by Andy and Beth’s farming operation.  The current value of the farm is $1,000,000.

In this example, when Beth initially inherited the farm it was a separate asset.  However, the tile that improved the quality and value of the farm was paid for by Andy and Beth’s joint farming operation.  Therefore, Andy likely has a valid claim that at least part of the $400,000 increase in value is a marital asset due to the tile installation paid for by money earned during the marriage.

Perhaps Andy further argues that most of the increase in value was due to the fertilizer, tillage and other soil improvements made while Andy and Beth farmed the land.  Andy’s argument tries to make the entire $400,000 increase a marital asset.  Conversely, Beth argues that the land value increase was not actually earned during marriage but was merely a passive value increase due to market pressure and nothing that Andy did. Beth’s argument tries to make most of the $400,000 increase a separate asset.

As this example illustrates, an asset that is initially a separate asset can become, at least in part, a marital asset.  Both Andy and Beth have valid arguments as to their positions.  It is not hard to imagine how much time and legal fees could be spent resolving or litigating the issue in a contentious divorce.

People who own significant assets prior to marriage or may inherit assets during the marriage should consider a prenuptial agreement that will clearly identify which assets are to be marital and which assets are to be non-marital.  If the couple did not enter into a prenuptial agreement, the spouses should be careful not to taint any assets they wish to keep separate. For farm assets, this may be difficult due to the nature of improving the assets as part of the farming operation.  For some non-farm assets, such as financial accounts, it may be easier to maintain the separate status of the assets.