9035 / What special estate tax valuation issues must be considered in the small business context?
In recognition of the limited marketability of closely-held family businesses, and in an effort to encourage the continued operation of these businesses after the death of the business owner, Congress enacted IRC Section 2032A to potentially ease the estate tax liability of successors to family businesses. If the family business includes ownership of real estate used in the business, the estate may be able to take advantage of this special use valuation provision in valuing the real property for inclusion in the gross estate.
Generally, real property is valued based upon its "highest and best use," which typically leads to a valuation that reflects the upper limit of the property's potential value. However, a "current use" approach is available for qualified real property used for farming purposes or in certain trades or businesses. "Qualified real property" used in a closely-held business may also qualify for special use valuation.1 An estate's executor can elect to value qualified real property used in a closely-held business on the basis of its actual use in the business, rather than its highest and best use, if the requirements of IRC Section 2032A, discussed below, are satisfied.
Planning Point: As it applies to real property, farmers and ranchers often feel asset rich and cash poor. The estate tax issues they face are significant and not easily solved. One option to consider are "land grant" non-profit organizations that preserve the ranching/farming heritage and avoid liquidation due to taxes.
The aggregate decrease in the business value permitted through special use valuation under Section 2032A is $1,390,000 in 2024 for decedents dying in 2024 ($1,310,000 for decedents dying in 2023 and $1,230,000 in 2022), as indexed annually for inflation.2
Section 2032A valuation may be elected if: (1) the qualified property is owned by a U.S. citizen or resident and (2) the executor makes the election under Section 2032A(d)(2).3 Qualified real property is real property located in the United States where the following additional conditions are satisfied:
(1) Substantial and historical usage. The IRC Section 2032A election is only available to estates in which a farming or other closely held business comprises a substantial part of the estate. The following requirements apply:
(a) (i) 25 percent or more of the adjusted value of the decedent's gross estate must consist of the adjusted value of real property used in the business, and (ii) 50 percent or more of the adjusted value of the gross estate must consist of the adjusted value of real or personal property used in the business;4 and
(b) During the eight years immediately preceding the decedent's death, the decedent, or a member of his family, must have (i) owned and used the property5 and (ii) materially participated in the business.6
(2) Future usage to prevent recapture. Because IRC Section 2032A is intended to encourage continued future use of the property, each person with an interest in the property must sign a written consent to a special recapture tax set forth in IRC Section 2032A(c).7 This requirement is imposed in furtherance of the goal of encouraging the decedent's heirs to continue the business rather than being forced to sell in order to meet tax liabilities.8
The recapture tax is imposed if the heir (1) disposes of any interest in the qualified small business property to a non-family member or (2) ceases to use the property for a qualified use (meaning use within the closely-held business) within 10 years of the death of the decedent and before the death of the qualified heir.9 Essentially, a "qualified heir" is an heir who is either (1) a surviving spouse; (2) an heir who has not yet reached the age of 21; (3) a disabled individual; or (4) a student.10
The numerous requirements imposed under IRC Section 2032A, along with its limited applicability in the estate tax context, naturally mean that the valuation approach will only be useful in limited circumstances.
1. IRC § 2032A(a)(1).
2. Rev. Proc. 2021-45, Rev. Proc. 2022-38, Rev. Proc. 2023-34.
3. IRC § 2032A(b).
4. IRC § 2032A(b)(1)(A) and (B).
5. IRC § 2032A(b)(1)(C) and (A)(i); Treas. Reg. § 20.2032A-3(c)(1) and (d).
6. IRC § 2032A(e)(6) provides that material participation will be determined as under IRC § 1402(a)(1).
7. IRC § 2032A(d)(2).
8. Stovall v. Comm., 101 TC 140 (1993).
9. IRC § 2032A(c).
10. IRC § 2032A(c)(7)(C).