Special use valuation requires proper election and agreement. (Estate and Trusts)by Slott, Edward A.
Estate taxes can be saved by electing special use valuation (Sec. 2032A) to reduce the value of certain real property included in the decedent's gross estate. An election and a written agreement must be attached to the estate tax return to perfect the election.
What is Special Use Valuation
(the 2032A Election)?
The special use valuation election is used to reduce the value of qualified real property Sec. 2032A(b) used as a farm or in a trade or business. Generally this property is valued at fair market value based on its highest and best use. However, if certain conditions are met the property will qualify for a reduced estate tax value based on its actual (special) use. The election is designed to ease the estate tax burden and provide for the continuity of the existing business.
The qualified real property must be located in the U.S. and have been used by the decedent or a member of his or her family who was materially participating in the trade or business for at least five of the eight years preceding the date of death, disability or retirement Sec. 2032A(b)(4), at which time the decedent must have been a citizen or resident of the U.S. The adjusted value of the real or personal property must be 50% or more of the adjusted value of the gross estate. The adjusted value of the real property alone must be 25% or more of the adjusted value of the gross estate. The property also must pass from the decedent to a qualified heir defined in Secs. 2032A(e)(1) and (e)(2) as a member of the decedent's family who acquired the property from the decedent. Qualified property also may include residential buildings, related improvements, roads, and other structures "functionally related to the qualified useSec.2032A(e)(3).
Election and Agreement
The election for special valuation is made by the executor on the estate tax return (Form 706) by checking the "yes" box on page 2, line 2 and completing Schedule A-1 "Section 2032A Valuation" on pages 6-8.
The election may be made on a late filed return as long as it is made on the first estate tax return filed. Once made, the election is irrevocable. The reduction in fair market value cannot exceed $75,000.
Most importantly, a properly executed notice of election and a written agreement signed by each person with an interest in the property must be attached to the Estate Tax Return Secs. 2032A(a)(1)(b) and (d)(1) and (2).
It is the written agreement that has given rise to a number of recent cases and rulings deciding on the actual requirement of attaching the agreement, the proper construction, form and content as well as which parties are considered interested parties that are required to sign the agreement in order to perfect the election.
Purpose of Required Agreement
Any estate taxes saved due to the Sec. 2032A election can be recaptured if, within 10 years after the decedent's death, the property is disposed of or if the qualified heir ceases to use the property for the qualified use Se.2032A(c)(1). For example, if the qualified heir sells the farm or business property to real estate developers within the 10-year period the recapture provisions would be triggered. The death of the qualified heir before the expiration of the 10-year recapture period would eliminate recapture.
The purpose of the written agreement is to subject all qualified heirs to personal liability for payment of the recaptured estate tax and to ensure the validity of the federal estate tax lien. Reg. 20.2032A- 8(c)(1) states that the agreement must be in a form that is binding on all parties having an interest in the property. It also must designate an agent with authority to act on behalf of the interested parties in all dealings with the IRS regarding the Sec. 2032A election.
The agreement, often referred to as the recapture agreement, must be signed by all parties who have any interest in the property in that "as of the date of the decedent's death can be asserted under applicable local law so as to affect the disposition of the specially valued property" Reg. 20.2032A-8(c)(2). This definition covers a broad spectrum of interests including all present, future, vested, and contingent interests. It also includes any holders of remainder or executory interests and holders of general or special powers of appointment. Trustees of trusts and other such representatives holding any of the above interests would also be considered a party that has an interest in the property. Reg. 20.2032A-8(c)(3) allows legally authorized representatives to act on behalf of interested parties who cannot legally bind themselves due to infancy or incompetency. The agreement is included as Part 3 of Schedule A-I of Form 706 "Agreement to Special Use Valuation Under Section 2032A."
Recent Cases and Rulings
Estate of Marvin Pullin v. Commissioner, IRS Letter Ruling 9038002. IRS has acquiesced in Pullin (1985, 84 TC, 789, acq 1988-37 IRB 4) and has privately ruled that the absence of the signatures of certain qualified heirs from the special use valuation agreement did not bar the Sec. 2032A election.
The Facts. The decedent's only living qualified heirs were his daughter, granddaughter, and five children of his predeceased son. The will provided for special use property to be bequeathed to a trust to last 10 years. The property would then pass to the daughter, or if she did not survive, to the granddaughter. There were no further provisions. In the extremely remote event that both the daughter and the granddaughter did not survive the 10 years, local law would provide that the five children of the predeceased son would receive the property for which the special use valuation was elected.
According to Sec. 2032A(e) the five children would be considered qualified heirs who would be required to sign the special use valuation agreement in order to perfect the election.
The Decision. The IRS privately ruled that the absence of the signatures of all qualified heirs did not bar the election due to the extremely remote possibility of the five children ever receiving the trust property as actuarially calculated by the IRS.
The IRS based its decision on the Davis case (Estate of Davis v. Commissioner, 86 TC 1156 , 1986) which involved nonqualified heirs who held remote contingent remainder interests that followed a life estate held by the decedent's children. The Tax Court held that the property would qualify for special use valuation. The existence of a possible remainder interest passing to nonqualified heirs did not bar the election.
U.S. v. Lucille Prussner. In Prussner (1990, CA7, 896 F2d 218, 90-1 USTC) Sec. 1421 of TRA 86 (PL 99-514) provided relief allowing the estate to perfect its Sec. 2032A election even though no agreement was filed with the original estate tax return.
The Facts. The decedent died in 1981 and the estate tax return was timely filed electing special use valuation. No agreement was attached to the originally filed return. The agreement with all the required signatures of the qualified heirs was submitted four months later.
Sec. 2032A(d)(3) provides limited relief allowing certain defects in the filed agreement to be cured within 90 days after notification of such defects or missing items. However, to qualify, the agreement would have to be filed with the original return and substantially comply with the regulations.
The Decision. The Seventh Circuit found that no relief was available under Sec. 2032A(d)(3) because there was no agreement originally filed, thus no substantial compliance with the regulations.
However, the court found relief for the estate under Sec. 1421 of TRA 86 (PL 99-514), due to the fact that the estate filed the June 1982 version of Form 706, which on its face did not clearly or adequately require the agreement to be provided. The election was held valid.
In addition, the court, in disagreement with the IRS, stated that the relief provided by Sec. 1421 was not only available to estates who filed the June 1982 version of Form 706.
Estate of Georgia Merwin. In the twin case (1990, 95, TC No. 13) no agreement was attached to the estate tax return. The court however provided no relief under Sec. 1421 of TRA 86 (PL 99-514) as it did in Prussner.
The Facts. The estate, in addition to not filing any special use valuation agreement, also omitted other material information regarding the election, including the fair market and special use values of the property. Appraisals and other required schedules were also not submitted.
The Decision. The Tax Court did not allow relief as the Seventh Circuit did in Prussner, because the estate filed the 1985 version of Form 706 which specifically required an agreement to be attached. The court, in disagreement with the Seventh Circuit's position stated that the relief provisions of Sec. 1421 did not apply to the 1985 version of Form 706. The court agreed that relief under Sec. 1421 was available, but only to estates filing the June 1982 version of Form 706. Due to substantial noncompliance with the regulations, the estate could not qualify under Sec. 2032A(d)(3) to cure the defects either. The Sec. 2032A election was precluded.
The executor must be well informed of the technical requirements involved in electing special use valuation. Both the IRS and the courts are in agreement that a property executed election and written agreement must be attached to the first estate tax return filed. Although certain minor defects may be cured, a strict interpretation of substantial compliance with the regulations will be enforced and may possibly bar the election.
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