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By Deborah M. Beers, Esq.
Buchanan Ingersoll & Rooney PC, Washington, DC
Section 2032(a) provides that the value of the gross estate may be determined, if the executor so elects, by valuing all the property includible in the gross estate as follows. Property distributed, sold, exchanged, or otherwise disposed of during the 6-month period immediately after the date of death (alternate valuation period) is valued as of the date of distribution, sale, exchange, or other disposition (transaction date).1 Property not distributed, sold, exchanged, or otherwise disposed of during the alternate valuation period is valued as of the date that is 6 months after the decedent's death (6-month date).2 Any interest or estate that is affected by the mere lapse of time is includible at its value as of the date of death (instead of any later date), with adjustment for any difference in its value as of the later date that is not due to the mere lapse of time.3 The election to use the alternate valuation date may only be made if it has the effect of decreasing the value of the gross estate and the sum of the estate tax and the generation- skipping transfer tax imposed with respect to decedent's property.4
The 2008 Proposed Regulations. On April 25, 2008, the IRS published proposed regulations5 to clarify that the election to use the alternate valuation method under §2032 is available to estates that experience a reduction in the value of the gross estate during the alternate valuation period, but only to the extent that the reduction in value is due to market conditions and not to other post-death events (events occurring during the alternate valuation period). The term "market conditions" was defined as events outside of the control of the decedent (or the decedent's executor or trustee) or other person whose property is being valued that affect the fair market value of the property includible in the decedent's gross estate. Changes in value due to mere lapse of time or to other post-death events would be ignored in determining the value of the decedent's gross estate under the alternate valuation method.
Kohler v. Comr. The 2008 proposed regulations were issued in response to the Tax Court's decision in Kohler v. Comr.,6 a taxpayer victory that allowed the election of the alternate valuation date following a post-death tax-free reorganization. The IRS announced its non-acquiescence to the decision,7 and then promulgated its position as a proposed regulation.
In Kohler, the decedent died on March 4, 1998, owning stock in a privately-held corporation. A tax-free reorganization of the corporation was completed and became effective a little over two months later, on May 11, 1998. The estate, which owned 12.85% of the voting stock of the corporation prior to the reorganization, did not have an interest sufficient to block or approve the reorganization by itself. The reorganization was undertaken to remove outside shareholders, who held approximately 4% of the stock in March 1988, and to facilitate family estate planning and management of the company. As part of the reorganization old shares of common stock were replaced with new classes of shares, which were all subject to transfer restrictions and a purchase option to ensure that the corporation would be family-owned. After the reorganization the decedent's estate held 14.45% of the outstanding shares of the corporation.
The Tax Court held for the taxpayer and found that the value of the stock for estate tax purposes was its post-reorganization value - taking into account discounts attributable to the transfer restrictions and purchase option - on the alternate valuation date. In making its finding, the Tax Court rejected the IRS's argument that value of the stock had to be measured according to its pre-reorganization value on the grounds that neither §2032 nor regulations thereunder contained any provision that would require disregarding a tax-free reorganization.
The 2011 Proposed Regulations. After more than three years had passed, the original proposed regulations had not been finalized, and the IRS, in response to comments, decided to abandon the "events outside of the control of the decedent (or his representative)" test and to re-propose the regulations.8 The 2011 proposed regulations identify transactions that constitute distributions, sales, exchanges, or dispositions of property.9 If an estate's (or other holder's) property is subject to such a transaction during the alternate valuation period, the estate must value that property on the transaction date. The value included in the gross estate is the fair market value of that property on the date of and immediately prior to the transaction. This test precludes taking post-transaction changes in value into account.
Example: At D's death, D owned property with a fair market value of $100x. Two months after D's death (Date 1), D's executor and D's family members formed a limited partnership. D's executor contributed all of the property to the partnership and received an interest in the partnership in exchange. The alternate valuation date of the property is the date of its contribution and the value to be included in D's gross estate is the fair market value of the property immediately prior to its contribution to the partnership. The result would be the same if D's estate instead had contributed property to a limited partnership formed prior to D's death by D and/or other parties, related or unrelated to D. Further, the result would be the same if D's estate had contributed the property to a corporation, publicly traded or otherwise, or other entity after D's death and prior to the 6-month date.10
This example, one of many included in the proposed regulations, is clearly aimed at preventing the Kohler result, even though it does not explicitly posit the existence of any post-transaction discounts. Transactions that create fractional interests in real property or minority interests in an LLC are similarly targeted.11 The valuation of the portion distributed is accelerated to the date of distribution, and the portion retained by the estate may not be discounted. Changes due to economic market conditions or theft or casualty losses that are uncompensated may nevertheless continue to be taken into account for purposes of §2032.
The regulations12 identify two exceptions to the foregoing rule. If either exception applies, the estate may use the 6-month date and value the property held on that date. The first exception proposes that, if, during the alternate valuation period, the interest in an entity includible in the gross estate is exchanged for a different interest in the same entity, or in an acquiring or resulting entity or entities, and if the fair market value of the interest on the date of the exchange equals the fair market value of the property for which it was exchanged, then the transaction will not be treated as an exchange for purposes of §2032(a)(1). As a result, the estate may use the 6-month date to value the interest in the same entity or in the acquiring or resulting entity or entities received in the exchange. For this purpose, the fair market values of the surrendered property and received interest are deemed to be equal if the difference between the fair market values of the surrendered property and the received interest does not exceed 5 percent of the fair market value of the surrendered property as of the transaction date.
Example: At D's death, D owned common stock in Y, a corporation. Two months after D's death (Date 1), there was a reorganization of Y. In the reorganization, D's estate exchanged all of its stock for a new class of stock in X. On the date of the reorganization, the difference between the fair market value of the stock D's estate received and the fair market value on that date of the stock includible in D's gross estate at death was greater than 5% of the fair market value, as of the date of the reorganization, of the stock D held at death. The reorganization does not satisfy the exception for exchanges of equal value. Thus, the alternate valuation date is the date of the reorganization and the value to be included in D's gross estate is the fair market value of the stock immediately prior to the reorganization. This result is not affected by whether or not the reorganization is a tax-free reorganization for Federal income tax purposes. The result would be the same if the stock had been held, for example, in an IRA with designated beneficiaries.
If, instead, the difference between the two fair market values as of the date of the reorganization was equal to or less than 5% of the fair market value, as of the date of the reorganization, of the stock D held at death, the reorganization would satisfy the exception. Thus, the alternate valuation date would be the 6-month date. The value to be included in D's gross estate would be the fair market value, determined as of the 6-month date, of the new class of stock in Y that D's estate received in the reorganization.13
The second exception proposes that, if, during the alternate valuation period, an estate (or other holder) receives a distribution from a business entity, bank account, or retirement trust (entity) and an interest in that entity is includible in the decedent's gross estate, the estate may use the 6-month date to value the property held in the estate if the fair market value of the interest in the entity includible in the gross estate immediately before the distribution equals the sum of the fair market value of the distributed property on the date of the distribution and the fair market value of the interest in the entity includible in the gross estate immediately after the distribution. If this requirement is not satisfied, the estate must use the fair market value as of the distribution date and immediately prior to the distribution of the entire interest in the entity includible in the gross estate.
Example: (i) At D's death, D owned an interest in Partnership X that is includible in D's gross estate. During the alternate valuation period, X made a cash out of included property to each of the partners. On the date of the distribution, the fair market value of D's interest in X before the distribution equaled the sum of the distribution paid to D's estate and the fair market value of D's interest in X immediately after the distribution. Thus, the alternate valuation date of the property distributed is the date of the distribution, and the alternate valuation date of D's interest in X is the 6-month date.
(ii) If, instead, the fair market value of D's interest in X before the distribution did not equal the sum of the distribution paid to D's estate and the fair market value of D's interest in X (not including any excluded property) immediately after the distribution, then the alternate valuation date of D's entire interest in X would be the date of the distribution.
Miscellaneous other situations are addressed, including the effect of a postmortem grant of a conservation easement, re-titling an account in the name of the new account owner, and the effect of dividing a trust or retirement account into separate accounts for multiple beneficiaries, none of which will trigger acceleration. The proposed regulations also address the proper post-mortem value of a GRIT that continues to make annuity payments to the decedent's estate and the treatment of post-death earnings on estate assets.
Effective Date. While the original proposed regulations were applicable to estates of decedents dying on or after April 25, 2008 (the date that the proposed regulation was published in the Federal Register, the regulations as re-proposed are effective on the date that the final regulation will be published in the Federal Register.
For more information, in the Tax Management Portfolios, see Hood, 830 T.M., Valuation: General and Real Estate, and in Tax Practice Series, see ¶6290, Valuation - Generally.
5 REG-112196-07, 73 Fed. Reg. 22300-22303 (4/25/08).
6 T.C. Memo 2006-152.
7 AOD 2008-1 (3/4/08).
8 REG-112196-07, 76 Fed. Reg. 71561-71562 (11/18/11).
9 See Prop. Regs. §20.2032-1(c)(1)(i).
10 Prop. Regs. §20.2032-1(c)(5), Ex. 1.
11 Id., Exs. 7 and 8.
12 Prop. Regs. §§20.2032-1(c)(1)(ii) and (c)(1)(iii)(A).
13 Prop. Regs. §20.2032-1(c)(5), Ex. 5, (i) and (ii).
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