Section 2032A — Special Use Valuation (Portfolio 833)

Generally, assets included in a decedent's gross estate are valued at their “highest and best use” for estate tax purposes. As discussed in this Tax Management Portfolio, Section 2032A — Special Use Valuation, No. 833-3rd, if specific requirements are met, §2032A permits an alternative method for valuing certain real property used either as a farm for a farming purpose or in a trade or business other than farming. 

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Generally, assets included in a decedent's gross estate are valued at their “highest and best use” for estate tax purposes. As discussed in this Tax Management Portfolio, Section 2032A — Special Use Valuation, No. 833-3rd, if specific requirements are met, §2032A permits an alternative method for valuing certain real property used either as a farm for a farming purpose or in a trade or business other than farming. This alternative method is intended to reflect the (lower) value of the property in its current use.
To qualify for the §2032A special use valuation election, substantiality and historical usage requirements must be met. The substantiality component is established by demonstrating that 25% of the adjusted value of the decedent's gross estate consists of the adjusted value of real property used in the business, and that 50% of the adjusted value of the decedent's gross estate consists of real or personal property used in the business. The historical usage component is established by demonstrating that the decedent or a family member has materially participated in the business and used the real property for a qualified use for five of the eight years preceding the decedent's death, disability, or retirement. To avoid a later recapture of the special use valuation benefit, a future usage component must also be satisfied: The property must pass to a qualified heir of the decedent, and, during the 10-year period following the decedent's death, the decedent's family must continue to materially participate in the business and employ the property in a qualified use.
Section 2032A qualification criteria and election procedures are discussed extensively in this Portfolio. Since the significant tax savings available through a §2032A election require careful pre- and post-mortem planning, and substantially limits the freedom of heirs to dispose of the qualifying property during the recapture period, this Portfolio also includes comprehensive analysis of the implications that §2032A and its alternatives have on business and tax planning.
For additional relevant materials, see 809 T.M., Estate Planning for Owners of Closely Held Business Interests; 829 T.M., The Family-Owned Business Deduction — Section 2057; and 830 T.M., Valuation: General and Real Estate.
This Portfolio may be cited as Zumbach, Reames and Krishna, 833-3rd T.M., Section 2032A — Special Use Valuation.


Steven E. Zumbach, Esq.

Steven E. Zumbach, B.S., Iowa State University; Ph.D. in Economics, Iowa State University; J.D., University of Iowa; Certified Public Accountant; member of law firm of Belin McCormick, P.C.

Wayne E. Reames, Esq.

Wayne E. Reames, B.A., Luther College; J.D., University of Michigan; LL.M. (Taxation), New York University; Certified Public Accountant; member of law firm of Belin McCormick, P.C.

Dean V. Krishna, Esq.

Dean V. Krishna, B.A., Dartmouth College; M.A. (Education), San Jose State University; J.D., University of Pennsylvania; LL.M. (Taxation), New York University; associate of law firm of Belin McCormick, P.C.

Table of Contents

Detailed Analysis

I. Introduction

Introductory Material

A. Estate Tax Valuation and Purpose of § 2032A

B. Summary of § 2032A

1. Substantiality and Historical Usage

2. Future Use

3. Methods of Valuation

4. Limitations on Benefits

C. Legislative History

1. The Tax Reform Act of 1976

2. Major Changes Since 1976

II. Eligibility Criteria

Introductory Material

A. Eligibility Criteria with Respect to the Estate

1. Citizen or Resident

2. Twenty-Five Percent Test

3. Fifty Percent Test

B. Eligibility Criteria with Respect to the Property

1. Real Property

2. Qualified Real Property

3. Qualified Use in Five of Eight Years

4. Material Participation in Five of Eight Years

C. Election and Agreement

III. Definitions

A. Material Participation

1. In General

2. Section 1402(a)(1) Material Participation

a. Arrangement

b. Production

c. Management of Production

3. Social Security Act Material Participation

a. Production

b. Management of Production

4. Material Participation and Passive Loss Restrictions

5. Section 2057 and Former § 2033A Material Participation

6. Section 2032A Regulations: Material Participation

a. In General

b. Material Participation by Arrangement

c. Material Participation Under Lease

(1) Material Participation Found

(2) Material Participation Not Found

d. Material Participation Despite Failure to Pay Self-Employment Tax

7. Material Participation: Real Property Owned by or Leased to an Entity

a. Owned by Corporation or Partnership

b. Owned by Trust

c. Owned by Estate

d. Leased to Entity

8. Material Participation and Self-Employment Tax

9. Material Participation and Social Security Benefits

10. Material Participation by Conservator

11. Material Participation and Government Programs

12. Exchanges or Involuntary Conversions

13. Conclusion

B. Active Management

1. Active Management in the Pre-Death Period

2. Active Management in the Post-Death Period

3. Requirements of Active Management

C. Qualified Use

1. Farm vs. Closely Held Business

2. Land, Buildings and Other Property

3. Special Rule for Woodlands

4. Community Property

5. Point in Time and Period Test

6. Equity Interest “At Risk” vs. Passive Interests

a. In General

b. Lease Arrangements

(1) Crop Share

(2) Cash Rent

(3) Mixed

c. Property Sold Prior to Death

d. Use in a Trade or Business

7. Grace Period

8. Exchanges and Involuntary Conversions

D. Acquired from or Passed from Decedent to Qualified Heir

1. Acquired from or Passed from

2. To a Qualified Heir

3. Redemptions

4. Basis Issues

5. Buy-Outs of Nonqualified Heirs

6. Holding Period

E. Member of the Family

F. Qualified Heir

G. Present/Successive Interests

1. Present Interest

a. History

b. Decedent's Interest

c. Qualified Heir's Interest

2. Successive Interests

a. IRS Regulations

b. Court Rulings

IV. Valuation

A. In General

B. Capitalization of Rents

1. Application of the Capitalization of Rents Method

2. Comparable Real Property

C. Five-Factor Method

D. Inadvertent Five-Factor Election

V. Reduction Limitation

VI. Recapture: The Additional Estate Tax

Introductory Material

A. Recapture Period

B. Amount of Recapture

C. Due Date and Filing Return

D. Events Triggering Recapture

1. Disposition

a. In General

b. Involuntary Conversion

c. Tax-Free Exchange

d. Transfer to Entity

e. Mortgage on Property

f. Redemption of Stock

g. Transfer of Subsurface Property Rights

h. Transfers to the Bankruptcy Estate

i. Foreclosures as a Disposition

j. Conservation Contributions as a Disposition

2. Cessation of Qualified Use

a. Changes in Use

b. Equity Interest

(1) In General

(2) Surviving Spouse and Lineal Descendant Exception

(3) Qualified Heirs as Lessors

c. Material Participation

(1) In General

(2) Active Management by Surviving Spouse

(3) Active Management by Eligible Qualified Heir

E. Special Rule for Timber

F. Liability for Recapture Tax

G. Pre-Death Retirement or Disability

H. Additional Estate Tax and § 6166

I. Credit for Tax on Prior Transfers and the Additional Estate Tax

J. Successive Interests

VII. Election

Introductory Material

A. Timing

1. In General

2. Death Prior to 1982

3. Retroactive Elections Under TAMRA

4. Extensions of Time

B. Notice of Election

1. In General

2. Content of Notice

C. Agreement

1. In General

2. Binding Effect

a. Individuals

b. Corporations

3. Designated Agent

4. Interest in Designated Property

a. In General

b. Alternate Present Interests

c. Undivided Interests

d. Successive Interests

e. Trusts, Partnerships and Corporations

D. Elections for Less Than All of the Qualified Real Property

E. Protective Elections

1. Making the Protective Election

2. Perfecting the Protective Election

3. Circumstances Allowing for Protective Elections

F. Perfection of Defective Election

1. Pre-1984 Law

2. The 1984 Amendments and the Birth of “Substantial Compliance”

a. In General

b. Common Law Substantial Compliance

c. Former § 2032A(d)(3) Substantial Compliance

(1) In General

(2) Perfection Not Permitted

(a) Interest Holders Not Party to Consent Agreement

(b) Parties Insufficiently Bound

(c) Defects Concerning Appraisal and/or Identification of Property

(d) No Notice and/or No Agreement

(e) Miscellaneous Defects

(3) Perfection Permitted

(a) Minor Consent Agreement Defects

(b) Other Minor Omissions

(4) Section 1421 of the Tax Reform Act of 1986

3. The 1997 Amendments and the Death of Substantial Compliance

G. Change in Valuation Method After Election

H. Amendment of Valid Election

VIII. Special Lien

IX. Adjusted Basis and Gain on Transfer

X. Corporations, Partnerships and Trusts

Introductory Material

A. Interest in Closely Held Business

B. Property Transferred to a Partnership or Corporation

C. Look-Through Concept

D. Capitalization of the Entity and the Equity Interest Requirement

E. Section 2032A and § 303 Redemptions

F. Valuation Discounts and Premiums

XI. Section 2032A and § 2032 Alternate Valuation

XII. Gift and Generation-Skipping Transfer Taxes

A. Gift Tax

B. Gifts Within Three Years of Death

C. Generation-Skipping Transfer Tax

XIII. Planning

Introductory Material

A. Whether or Not to Use Special Use Valuation

B. Gifting Programs and Use Valuation

C. Gifting May Disqualify

D. Sale of Farm, Trade or Business Assets

E. Special Use Valuation and Financing

1. Qualification for Special Use Valuation

2. Estate Tax Mortgage Deductions

F. Building Sites, Homes and Pastures

G. Asset Freeze

H. Planning Between Husband and Wife

I. Funding the Marital Bequest

1. Pecuniary Marital Bequest Funded at Fair Market Value at Date of Distribution

2. Pecuniary Marital Bequest Funded at Federal Estate Tax Value

3. Fractional Share Marital Bequest

J. Marital Deduction

K. Section 2032A and Qualifying for § 6166

L. Transfers Within Three Years of Death

M. Qualified Terminable Interest Property and § 2032A Election

N. On-Farm/Off-Farm Heir Conflict

O. Material Participation and Income in Respect of a Decedent

P. Gifts of Use Valuation Property

Q. Nonfarm Real Property and Use Valuation

R. Use Valuation and Federal Agricultural Programs

S. Use Valuation Election Not a Gift

Working Papers

Working Papers

Table of Worksheets

Worksheet 1 Checklist: Items to Be Included in § 2032A Election

Worksheet 2 Form 706, Schedule A–1: Election for § 2032A Use Valuation

Worksheet 3 Affidavit Re Material Participation

Worksheet 4 Descriptive Calculation of Special Use Value

Worksheet 5 Application of 50 Percent and 25 Percent Tests

Worksheet 6 Members of Decedent's Family and Qualified Heir's Family - Deaths After 1981

Worksheet 7 Members of Decedent's Family and Qualified Heir's Family - Deaths Before 1982

Worksheet 8 Material Participation Farm Lease

Worksheet 9 Farm Credit Bank Interest Rates 1995 – 2008

Worksheet 10 42 USC § 411(a)(1)




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Prior to 1977