MLR

Special use valuation can save taxes

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If your estate potentially could be subject to federal estate tax, and you own a family farm or closely held businesses, you’ll want to know about special-use valuation.

farm

Estates smaller than $5.43 million are not subject to federal estate tax in 2015, but once the tax kicks in, the rates can be as high as 40 percent.

Special-use valuations could mean a tax break that allows qualifying family farms or closely held businesses to reduce the taxable value of the estate by as much as $1.09 million for decedents who died in 2014 and $1.1 million for decedents dying in 2015.

Normally, property in an estate must be valued based upon its highest and best use. This rule applies even if the actual use is not one that would be the most profitable.

An exception has been carved out in the tax code for valuing real estate used in certain family farms or closely held businesses based upon actual “special use” of the real estate. The tax code sets out the rules for valuing real estate according to its special use, and an appraiser knowledgeable about these rules can be hired to do the valuation in a way that satisfies the IRS requirements.

However, not all family farms and closely held businesses qualify for this tax break. The requirements to qualify are too complex to describe completely in a short article, but, briefly, all of the following must be true:

1. The farm or business is truly a family farm or business operated by family members, not a passive investment.

2. A family member materially participated in at least five of the eight years preceding the death of the decedent.

The family farm or closely held business is a significant portion of the decedent’s estate.

Establishing material participation by a family member is important. Passively collecting rents, salaries, draws, dividends or other income from the farm or other business is not sufficient for material participation – nor is merely advancing capital and reviewing a crop plan and financial reports each season or business year.

If the decedent retired or became disabled and, for that reason, ceased to participate materially, a different eight-year period might apply, ending on the date the decedent began receiving Social Security benefits or became disabled.

The farm or closely held business, including both real and personal property used in the business, must constitute at least 50 percent of the estate. The real estate must constitute at least 25 percent of the estate.

Qualified real property includes residential buildings and other structures and real property improvements regularly occupied or used by the owner or lessee of real property, or by the employees of the owner or lessee, to operate a farm or other closely held business. A farm residence that the decedent occupied is considered to have been occupied for the purpose of operating the farm even when a family member and not the decedent was the person materially participating in the operation of the farm. If there is more than one farm or business, the value of multiple businesses can be combined to meet the 50 percent and 25 percent thresholds.

There is a catch to this tax break: The property must pass to a family member. The purpose of the break is to allow the family to continue to operate the family farm or family business after the death of the decedent. If the property is transferred to a nonfamily member within 10 years, the tax savings has to be repaid to the IRS.

Transfers to family members do not trigger the recapture. Also, family members need to continue materially participating during the recapture period – ceasing to do so will trigger the recapture. The IRS actually will file a lien to secure its rights during the 10-year period. After the recapture period has passed, the lien is released.

Given the percentage rules for qualification and the need to structure affairs for an extended period both before and after death, proper planning is prudent. If your estate includes a family farm or closely held business, proper estate and business planning with the advice of qualified professionals is recommended. Given potential tax savings of over $400,000, it’s worth the expense. – Mike Wilson, J.D.