Estate tax special-use valuation per IRC §2032A

Generally, assets included in a decedent’s gross estate are valued at their highest and best use for estate tax purposes. However, if certain conditions are met, the property will qualify for a reduced value based on its actual special use.

An election of the special-use valuation is used to reduce the value of qualified real property included in the gross estate of a decedent. Qualified real property typically is a farm or real property used in a business or trade. Qualified property also may include residential buildings, related improvements, roads, and other structures functionally related to the qualified use.

The election is designed to ease the estate tax burden and provide for the continuity of the existing business.

The use of special-use valuation is governed by IRC §2032A.

What are the requirements to make the election?

The property will be valued at a reduced rate based on actual special use if it meets all the following conditions:

The decedent was a U.S. Citizen or resident at the time of death.
The real property is in the United States.
At the decedent’s death the real property was used by the decedent or a family member for farming, in a trade or business, or was rented for such use by either the surviving spouse or a lineal descendant of the decedent to a family member on a net cash basis.
The real property was acquired from, or passed from, the decedent to a qualified heir of the decedent.
The real property was owned and used in a qualified manner by the decedent or a member of the decedent’s family during five of the eight years before the decedent’s death.
There was material participation by the decedent or a member of the decedent’s family during five of the eight years before the decedent’s death.
The qualified property meets the following percentage requirements:

a) At least 50% of the adjusted value of the gross estate must consist of the adjusted value of real or personal property that was being used as a farm or in a closely held business, and that was acquired from or passed from, the decedent to a qualified heir of the decedent.

b) At least 25% of the adjusted value of the gross estate must consist of the adjusted value of qualified farm or closely held business real property.

For this purpose, adjusted value is the value of property determined without regard to its special-use value. The value is reduced for unpaid mortgages on the property or any indebtedness against the property if the full value of the decedent’s interest in the property (not reduced by such mortgage or indebtedness) is included in the value of the gross estate. The adjusted value of the qualified real and personal property used in different businesses may be combined to meet the 50% and 25% requirements.

What is qualified use?

The term qualified use means the use of the property as a farm for farming purposes, or the use of property in a trade or business other than farming. Trade or business applies only to the active conduct of a business. It does not apply to passive investment activities or the mere passive rental of property to a person other than a member of the decedent’s family. Also, no trade or business is present in the case of activities not engaged in for profit.

What are the ownership requirements?

To qualify as special-use property, the decedent or a member of the decedent’s family must have owned and used the property in a qualified use for five of the last eight years before the decedent’s death. Ownership may be direct or indirect through a corporation, a partnership, or a trust.

If the ownership is indirect, the business must qualify as a closely held business under IRC §6166. The ownership, when combined with periods of direct ownership, must meet the requirements of IRC §6166 on the date of the decedent’s death and for a period that equals at least five of the eight years preceding death.

If the property was leased by the decedent to a closely held business, it qualifies if the business entity to which it was rented was a closely held business with respect to the decedent on the date of the decedent’s death and for sufficient time to meet the five in eight years test explained above.

What structures and other real property improvements qualify?

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 the farm or business. A farm residence which the decedent had 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.

Qualified real property also includes roads, buildings, and other structures and improvements functionally related to the qualified use.

Elements of value such as mineral rights that are not related to the farm or business use are not eligible for special-use valuation.

Who is a qualified heir?

A person is a qualified heir if they are a member of the decedent’s family and acquired or received the property from the decedent. If a qualified heir disposes of any interest in qualified real property to any member of his or her family, that person will then be treated as the qualified heir with respect to that interest.

A member of the family includes only:

An ancestor (parent, grandparent, etc.) of the individual.
The spouse of the individual.
The lineal descendant (child, stepchild, grandchild, etc.) of the individual, the individual’s spouse, or a parent of the individual.
The spouse, widow, or widower of any lineal descendant described above.
A legally adopted child of an individual is treated as a child of that individual by blood.

What does material participation mean for the special-use valuation election?

To elect special-use valuation, either the decedent or a member of their family must have materially participated in the operation of the farm or other business for at least five of the eight years ending on the date of the decedent’s death.

The existence of material participation is a factual determination, but passively collecting rents, salaries, draws, dividends, or other income from the farm or other business does not constitute material participation. Neither does merely advancing capital and reviewing a crop plan and financial reports each season or business year.

In determining whether the required participation has occurred, disregard brief periods (i.e., 30 days or less) during which there was no material participation, if such periods were both preceded and followed by substantial periods (more than 120 days) during which there was uninterrupted material participation.

If the participant (or participants) is self-employed with respect to the farm or other trade or business, their income from the farm or other business must be earned income for purposes of the tax on self-employment income before the participant is materially participating under section 2032A. If no self-employment taxes have been paid, however, material participation is presumed not to have occurred unless the executor demonstrates to the satisfaction of the Department of Revenue that material participation did in fact occur.

In determining whether the material participation requirement is satisfied, the activities of each participant are viewed separately from the activities of all other participants, and at any given time, the activities of at least one participant must be material. If the involvement is less than full-time, it must be pursuant to an arrangement providing for actual participation in the production or management of production where the land is used by any nonfamily member, or any trust or business entity, in farming or another business.

The arrangement may be oral or written but must be formalized in some manner capable of proof. Activities not contemplated by the arrangement will not support a finding of material participation under section 2032A, and activities of any agent or employee other than a family member may not be considered in determining the presence of material participation. Activities of family members are considered only if the family relationship existed at the time the activities occurred.

What if the decedent had retired from the business, or became disabled before death?

If, on the date of death, the time for material participation could not be met because the decedent had retired or was disabled, a substitute period may apply. The decedent must have retired on Social Security or been disabled for a continuous period ending with death. A person is disabled for this purpose if he or she was mentally or physically unable to materially participate in the operation of the farm or other business.

The substitute period for material participation for these decedents is a period totaling at least five years out of the eight-year period that ended on the earlier of one of the following:

The date the decedent began receiving social security benefits.
The date the decedent became disabled.

What are the requirements for the surviving spouse?

A surviving spouse who received qualified real property from the predeceased spouse is considered to have materially participated if he or she was engaged in the active management of the farm or other business. If the surviving spouse died within eight years of the first spouse’s death, you may add the period of material participation of the predeceased spouse to the period of active management by the surviving spouse to determine if the surviving spouse’s estate qualifies for special-use valuation.

To qualify for this, the property must have been eligible for special-use valuation in the predeceased spouse’s estate, though it does not have to have been elected by that estate.

What are the valuation methods?

The primary method of valuing special-use value property that is used for farming purposes is the annual gross cash rental method. If comparable gross cash rentals are not available, you can substitute comparable average annual net share rentals. If neither of these are available, or if you so elect, you can use the method for valuing real property in a closely held business.

Average annual gross cash rental

Generally, the special-use value of property that is used for farming purposes is determined in both of the following ways:

Subtract the average annual state and local real estate taxes on actual tracts of comparable real property from the average annual gross cash rental for that same comparable property.
Divide the result by the average annual effective interest rate charged for all new Federal Land Bank loans.

The computation of each average annual amount is based on the five most recent calendar years ending before the date of the decedent’s death.

Gross cash rental

Generally, gross cash rental is the total amount of cash received in a calendar year for the use of actual tracts of comparable farm real property in the same locality as the property being specially valued. You may not use appraisals or other statements regarding rental value or area wide averages of rentals. You may not use rents that are paid wholly or partly in kind, and the amount of rent may not be based on production. The rental must have resulted from an arm’s-length transaction. Also, the amount of rent is not reduced by the amount of any expenses or liabilities associated with the farm operation or the lease.

Comparable property

Comparable property must be situated in the same locality as the specially valued property as determined by generally accepted real property valuation rules. The determination of comparability is based on all the facts and circumstances. It is often necessary to value land in segments where there are different uses or land characteristics included in the specially valued land. The following list contains some of the factors considered in determining comparability.

Similarity of soil.
Whether the crops grown would deplete the soil in a similar manner.
Types of soil conservation techniques that have been practiced on the two properties.
Whether the two properties are subject to flooding.
Slope of the land.
For livestock operations, the carrying capacity of the land.
For timbered land, whether the timber is comparable.
Whether the property is unified or segmented. If segmented, the availability of the means necessary for movement among the different sections.
Number, types, and conditions of all buildings and other fixed improvements located on the properties and their location as it affects efficient management, use, and value of the property.
Availability and type of transportation facilities in terms of costs and of proximity of the properties to local markets.

You must specifically identify on the return the property being used as comparable property. Use the type of descriptions used to list real property on Schedule A.

Effective interest rate

View the annual interest rates.

Net share rental

You may use average annual net share rental from comparable land only if there is no comparable land from which average annual gross cash rental can be determined. Net share rental is the difference between the gross value of produce received by the lessor from the comparable land and the cash operating expenses (other than real estate taxes) of growing the produce that, under the lease, are paid by the lessor. The production of the produce must be the business purpose of the farming operation. For this purpose, produce includes livestock.

The gross value of the produce is generally the gross amount received if the produce was disposed of in an arm’s length transaction within the period established by the federal Department of Agriculture for its price support program. Otherwise, the value is the weighted average price for which the produce sold on the closest national or regional commodities market. The value is figured for the date or dates on which the lessor received (or constructively received) the produce.

Valuing a real property interest in closely held business

Use this method to determine the special-use valuation for qualifying real property used in a trade or business other than farming. You may also use this method for qualifying farm property if there is no comparable land or if you elect to use it.

Under this method, the following factors are considered:

The capitalization of income that the property can be expected to yield for farming or for closely held business purposes over a reasonable period with prudent management and traditional cropping patterns for the area, taking into account soil capacity, terrain configuration, and similar factors.
The capitalization of the fair rental value of the land for farming or for closely held business purposes.
The assessed land values in a state that provides a differential or use value assessment law for farmland or closely held business.
Comparable sales of other farm or closely held business land in the same geographical area far enough removed from a metropolitan or resort area so that nonagricultural use is not a significant factor in the sales price.
Any other factor that fairly values the farm or closely held business value of the property.

How do I make the election?

Under the Elections by Executor section of the return, there is a question that asks, “Do you elect special-use valuation?”. To elect special-use valuation, answer this question “yes”.
Complete Schedule A-1 according to its instructions for “Regular Election” and submit all the required statements outlined on this schedule.
The election may be made on a late filed return if it is made on the first estate tax return filed.
Once made, the election is irrevocable.
The reduction in fair market value of the gross estate cannot exceed the amount listed in the table below for the year of decedent’s death:

Year of Date of Death	Maximum Adjustment Allowed
2022	$ 1,230,000.00
2023	$ 1,310,000.00
2024	$ 1,390,000.00

For amounts before 2022, contact us.

Additional information about making the election:

An election under IRC §2032A does not need to include all the property in an estate that is eligible for special-use valuation, but sufficient property to satisfy the threshold requirements of IRC §2032A(b)(1)(B) must be specially valued under the election.
Include the words “IRC §2032A valuation” in the “Description” column of any return schedule if IRC §2032A property is included in the decedent’s gross estate.
If joint or undivided interests (i.e., interests as joint tenants or tenants in common) in the same property are received from a decedent by qualified heirs, an election with respect to one heir’s joint or undivided interest need not include any other heir’s interest in the same property if the electing heir’s interest plus other property to be specially valued satisfies the requirements of IRC §2032A(b)(1)(B).
If successive interests (i.e., life estates and remainder interests) are created by a decedent in otherwise qualified property, an election under IRC §2032A is available only with respect to that property (or part) in which qualified heirs of the decedent receive all the successive interests, and such an election must include the interests of all of those heirs.
For example, if a surviving spouse receives a life estate in otherwise qualified property and the spouse’s brother receives a remainder interest in fee, no part of the property may be valued pursuant to an election under IRC §2032A.
Where successive interests in specially valued property are created, remainder interests are treated as being received by qualified heirs only if the remainder interests are not contingent on surviving a non-family member or are not subject to divestment in favor of a non-family member.

Can I make a protective election?

You may make a protective election to specially value qualified real property. Under this election, whether you may ultimately use special-use valuation depends upon values as finally determined (or agreed to following examination of the return) meeting the requirements of IRC §2032A.

To make a protective election, check “Yes” on line 2 and complete Schedule A-1 according to its instructions for “Protective Election.”

If you make a protective election, you should complete the return by valuing all property at its fair market value. Do not use special-use valuation. Usually, this will result in higher estate tax liabilities than will be ultimately determined if special-use valuation is allowed. The protective election does not extend the time to pay the taxes shown on the return.

If it is found that the estate qualifies for special-use valuation based on the values as finally determined (or agreed to following examination of the return), you must file an amended return (with a complete IRC §2032A election) within 60 days after the date of this determination. Complete the amended return using special-use values under the rules of IRC §2032A, and complete Schedule A-1 and submit all the required statements.

What are the post death requirements of making this election?

Certain requirements must continue to be met during a 10-year recapture period measured from the decedent’s date of death. However, the qualified heirs have a maximum 2-year grace period from that date to begin the qualified use and material participation. The 10-year period is extended by whatever portion is used of the 2-year grace period.

Any estate taxes saved due to the special-use 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.

Here is a list of the post death requirements that must be met to avoid the recapture tax:

Ownership of the specially valued property must continue solely within the decedent’s family.
The qualified heir must continue to materially participate in the active trade or business for the entire 10-year recapture period.
The property must continue to be used and managed for the qualified use.

The qualified heir shall be personally liable for the additional tax. The additional tax imposed by this subsection shall become due and payable on the day which is 6 months after the date of the disposition or cessation.

Can I elect special-use valuation in addition to the alternate valuation election?