The value of a family business or farm is generally included in the gross estate at its fair market value as of the date of the decedent's death. However, there are provisions under the Internal Revenue Code (IRC) that allow for special valuation methods and potential reductions in value for estate tax purposes, particularly for family farms and closely held businesses.
Special Use Valuation (IRC § 2032A)
For certain qualifying family farms, IRC § 2032A allows for a special use valuation, which can significantly reduce the value of the property for estate tax purposes. This provision is designed to provide tax relief to family farms and businesses by valuing the property based on its current use rather than its highest and best use. The maximum reduction in value is adjusted annually for inflation. For example, the maximum reduction for the year 2023 is $1,310,000.
Requirements for Special Use Valuation:
- Qualified Real Property: The property must be real property located in the United States and used as a farm or in another qualifying business.
- Family Ownership and Use: The property must have been owned and used by the decedent or a member of the decedent's family for farming or another qualifying business purpose for at least five of the eight years preceding the decedent's death.
- Material Participation: There must have been material participation by the decedent or a family member in the operation of the farm or business.
- Percentage Tests: At least 50% of the adjusted value of the gross estate must consist of the adjusted value of real or personal property used in a qualifying business, and at least 25% must consist of the adjusted value of real property used in a qualifying business.
- Election and Agreement: The executor must make an election on the estate tax return and file an agreement to use the property for its qualified use for at least 10 years following the decedent's death.
Installment Payment of Estate Tax (IRC § 6166)
If the value of an interest in a closely held business exceeds 35% of the adjusted gross estate, the estate may elect to pay the estate tax attributable to the business interest in installments over a period of up to 10 years. This provision helps to ease the liquidity burden on estates that include significant business interests.
Requirements for Installment Payment:
- Closely Held Business: The business must be closely held, meaning it is operated as a sole proprietorship, partnership, or corporation with a limited number of owners.
- Percentage Test: The value of the business interest must exceed 35% of the adjusted gross estate.
- Election: The executor must make the election on a timely filed estate tax return.
Case Examples and Rulings
- LTR 8803054: This letter ruling discusses the eligibility of an estate to elect special use valuation under IRC § 2032A and to pay estate taxes in installments under IRC § 6166. The decedent's farm property qualified for special use valuation, and the estate was allowed to pay the estate tax in installments because the value of the farm exceeded 35% of the adjusted gross estate.
- Rev. Rul. 86-99: This revenue ruling addresses the valuation of farmland used in conjunction with a federal grazing permit. The fair market value of the farmland must reflect the value of the grazing permit, and the special use value under IRC § 2032A must consider the total rent received for comparable land, including the grazing permit.
- PLR 201015003: This private letter ruling confirms that an estate can elect special use valuation for farm property under IRC § 2032A and treat the farm property as a qualified family-owned business interest under IRC § 2057, even if the estate tax return was filed late, provided it was the first return filed.
Conclusion
For family farms and closely held businesses, special provisions under the IRC, such as special use valuation and installment payment of estate tax, can provide significant tax relief. Executors should carefully consider these options and ensure that all requirements are met to take advantage of these beneficial provisions.
Sources:
Publication 225 (2023)
Publication 535 (2022)
LTR 8803054
Rev. Rul. 86-99
PLR 201015003
Rev. Rul. 82-62
