Special Use Valuation (IRC Section 2032A)
Farm families face a unique challenge of transferring the farmland from one generation to the next, especially with the increase in farmland values the last fifteen years. A typical central Iowa high-quality farm that sold for $2,848 in 2002 now sells for approximately $9,299 per acre according to the Iowa State University Land Value Survey. This is more than a threefold increase in value of a typical central Iowa farm. This increase in value has made it increasingly difficult to pass the family farm to the next generation as many farm family estates are large enough to be subject to state and federal estate taxes. Many farm families find themselves asset rich and cash poor when a parent or spouse dies.
However, early and effective estate planning can help reduce the estate tax burden of transferring family owned assets to the next generation by using several methods as set forth in the Internal Revenue tax code. Using Special Use Valuation Internal Revenue Code (IRC) §2032A is one-way farm families can reduce the estate tax burden for family farms.
Special Use Valuation, IRC Section 2032A, was created during the Farm Crisis of the 1980s as a way to help farmers keep their farms. During the Farm Crisis, many family farms were being sold to pay estate taxes. Orville Bloethe, a Victor, Iowa attorney, and a handful of others helped develop the idea of "Special Use Valuation”; valuing farmland at production value instead of fair market value. Orville testified before Congress, which adopted "Special Use Valuation." This legislation saved countless family farms from being lost due to the need to pay estate taxes and continues to shelter these family farms today.
Special Use Valuation is an alternative valuation method of valuing of farm property based upon its production capacity rather than fair market value. Many believe 2032A is easy, uncomplicated, and the primary method of solving farm estate planning problems. Regrettably, that perception often is based on a lack of accurate information concerning the complexities of how 2032A works, and of its true advantages and disadvantages.
The essence of how Section 2032A works is to allow farmland to be valued by establishing a farm’s productive value, which is usually less than the farmland's fair market value (what it would bring if sold for its highest and best use). Valuing farmland at its productive value can save a significant amount of estate tax versus valuing it at fair market value. However, in order to qualify for Special Use Valuation, there are a number of specific requirements that must be met in order for an estate to use IRC Section 2032A to value farm property. Families should consult their estate attorney to make certain the farm qualifies for IRC Section 2032A, as it is imperative that all of the rules be followed closely. In addition to the requirements to qualify for Special Use Valuation, the family must maintain ownership of the farm for a minimum of ten years to avoid repayment of the estate taxes saved by using IRC Section 2032A.
Let's look at an example:
Section 2032A reduces estate taxes by establishing an alternative value based on a formula calculation. The value of the land is determined by using the excess of the annual gross cash rental for comparable farmland in the same vicinity, reduced by annual state and local real estate taxes, both determined on a five-year average, then divided by the average annual effective interest rate of all new Federal Land Bank loans.
Therefore, if cash rents in your area have been, $250 on average for the past five years and real estate taxes have been, $25 per acre on average for same time period, and the new average Federal Land Bank loan rate is 4.44%, we would calculate the value as follows:
A 120-acre farm that has a
Market value of $10,000 per acre = $1,200,000
Typical Cash Rent = $250
Real Estate Taxes = - $25
Farm Credit Service Interest Rate Factor
for Estates in 2016 was 4.44%
Value of Land = $5,068 per acre Special Use Value
($225 divided by 4.44%)
120 acres at $5,068 per acre = $608,160
Difference = $591,840
The $5,068 per acre value is the alternative value of your qualified land to calculate your estate taxes. Assuming the fair market value of this farm is $10,000 per acre, the reduction in value of the farm would be $4,932 per acre. Therefore, on a 120-acre farm, the value used to calculate the estate tax would be reduced from $1,200,000 to $608,160. This is a reduction of $591,840.
This is a simple example but provides a quick illustration of how using IRC Section 2032A has the potential to reduce the farm’s value (for estate tax purposes). This can make the difference between a family being able to retain the family’s Century farm or having to sell the farm to pay the estate taxes.
I have helped many families reduce their estate tax burdens using the alternative valuation methodology set forth in IRC Section 2032A. Please call if you have a situation that may warrant using Special Use Valuation.
You should consult a qualified estate tax professional to provide assistance in preparing state and federal estate tax returns when using IRC Section 2032A.