Which IRC rules apply to the division of farmland at the death of a spouse? What options are available for valuing agricultural property? How might the pending phase-out of the estate tax and the step-up in basis rule impact farmers and ranchers?
Answers to these questions, among others, were the focus of an audio/web conference sponsored recently by the Society of Financial Service Professionals, Bryn Mawr, Pa. Titled “Transferring Your Farm or Ranch to the Next Generation,” the educational session was hosted by Roger McEowen, an associate professor of agricultural law at Iowa State University, Ames, Iowa.
How a farm or ranch is divvied up after the death of a first spouse will depend on when the husband and wife established the spousal joint tenancy governing their interests in the property, McEowen said. In cases involving a post-1981 death and a marital joint tenancy established after 1977, the surviving spouse may invoke a “fractional share rule.” One half of the property is therein taxed at the death of the first spouse if husband and wife are the only joint tenants.
But McEowen observed that court rulings now require use of the less favorable “consideration furnished rule” where the couples established a spousal joint tenancy prior to 1976 and where the first spouse died after 1981. Upshot: All of the property is taxed in the estate of the first spouse to die except to the extent the surviving spouse proves that he or she contributed to the property’s acquisition.
“The solution to this problem is to sever joint tenancies and transfer the property through the terms of the will or trust at the time of death,” said McEowen.
And what if the will needs updating? Rather than amending the document, which can be time-consuming, McEowen advised that farm clients list tangible property (such as household furnishings) in separate, written memoranda. Many states permit such memoranda for the disposal of property not identified in the will or trust documents.
Advisors also should counsel clients to prepare power of attorney (durable or springing) and health care power documents. Should the client’s health seriously deteriorate, the party in whom these powers are vested can act on the client’s desires with respect to the disposition of the estate.
How much of the farm or ranch escapes estate tax will hinge in part on the property’s valuation at the time of death, McEowen said. Eligible clients can leverage a special use valuation permitted under IRC Section 2032A, potentially reducing a farm property’s value (and, hence, estate tax to be paid) to an amount less than its fair market value. For 2006, the special use rule allows for a reduction in a land’s valuation by up to an inflation-adjusted $900,000.
McEowen cautioned, however, that the IRC section is highly technical; without a firm grasp of the code, advisors easily can miss provisions that can invalidate eligibility. Among them: a requirement that heirs continue to own and operate the farm or ranch for at least 10 years; and satisfaction of varied post-mortem tests.
But for those who qualify, the benefits can be substantial. “Individuals electing this special use valuation will generally see drops in the estate value as reported on their estate tax return of between 40% and 60%,” said McEowen.