AgDM newsletter article, March 2003
By Neil Harl, Charles F. Curtiss Distinguished Professor of Agriculture, professor of economics, 515-294-6354, firstname.lastname@example.org
Typically, assets in a qualified family-owned business interest (QFOBI) pass by inheritance to qualified heirs. The statute requires that the aggregate value of the decedent’s qualified family-owned business interests exceed 50 percent of the adjusted gross estate (gross estate less allowable deductions), and that amount or more must be “acquired by any qualified heir from, or passed to any qualified heir from, the decedent….” The question is whether QFOBI assets can pass to qualified heirs by purchase with eligibility retained for the family-owned business deduction and, if so, what the income tax consequences of the sale are to a qualified heir or heirs.
Purchase of land under special use valuation from the estate
Many of the provisions of the family-owned business deduction parallel those for special use valuation. For purposes of special use valuation, the statute specified that, for eligibility for the provision, it was necessary for qualified real property to be “acquired from or passed from the decedent to a qualified heir of the decedent.” Until a 1981 amendment was enacted, property was deemed to have been acquired from the decedent if so considered under I.R.C. § 1014(b) which meant that land was ineligible if purchases occurred or options were exercised before the land passed to the qualified heirs. The fact that the title to realty passed immediately to the heirs as a matter of state law subject to being retaken by the estate representative to pay debts and costs apparently was sufficient to meet the test.
The 1981 amendment, retroactive to January 1, 1977, permits property to pass by purchase and not lose eligibility for special use valuation. Under the 1981 amendment, land is considered to have been acquired from or to have passed from the decedent if:
1) the property is so considered
to have passed under I.R.C. § 1014(b) relating to income tax basis of
property acquired from the decedent;
2) the property is acquired by “any person” from the estate; or
3) the property was acquired by “any person” from a trust (to the extent the property was includible in the decedent’s estate.)
Purchase of qualified family-owned business interests
Under the provision for a deduction for qualified family-owned business interests, the assets are eligible for a deduction if the qualified family-owned business interests “…are acquired by any qualified heir from, or passed to any qualified heir from, the decedent….” That statement is conditioned by the qualifying requirement that the passage must be within the meaning of I.R.C. § 2032A(e)(9). That is the passage, added in 1981, that allowed property to pass from the estate to qualified heirs by purchase from the estate for purposes of special use valuation. That assures that property can pass by purchase and not lose eligibility for purposes of the family-owned business deduction if the purchase transaction meets any one of the three tests applicable to special use valuation purchases from the estate.
What about the income tax basis?
I.R.C. § 1040, enacted to solve problems of income tax basis where land is purchased from the estate, assures that the only gain recognized to an estate in the event of a sale or taxable exchange by the estate is the difference between the fair market value on disposition and the federal estate tax value. That provision was needed for special use valuation because, otherwise, the difference between the special use value and the value on disposition would be taxable gain to the estate.
In the case of the family-owned business deduction, a basis is assured for the assets comprising the qualified family-owned business interest (or for the entity holding those assets) equal to the fair market value at death or the alternate valuation date. Therefore, the gain recognized on sale of qualified family-owned business interests is the difference between the federal estate tax value (fair market value at death or the alternate valuation date) and the value on sale or taxable exchange. If the purchase of assets from the estate is at the federal estate tax value (and fair market value on purchase is no greater than the federal estate tax value), there should be no gain on sale by the estate to a qualified heir or heirs.
Repeal of the family-owned business deduction
The family-owned business deduction does not apply to estates of decedents dying after December 31, 2003. Thus, it appears that the provision will remain in effect for purposes of recapture for estates of decedents dying before January 1, 2004, if an election was made under I.R.C. § 2057.
** Reprinted with permission from the January 10, 2003 issue of Agricultural Law Digest, Agricultural Law Press publications, Eugene, Oregon. Footnotes not included.