Case — Valuing Estate Assets

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TL Case Summ

THE QUESTION

Does property transferred to heirs prior to death qualify for a reduced value on the estate return?

THE DISPUTE

Taxpayer Says: Each of the five children owned an interest in the property. Because of the fractional ownership, the property should be reported at a discounted value on the estate return.

Internal Revenue Service Says: Since the taxpayer owned and controlled the property throughout his life, it was never divided among the children and should be reported at full value at date of death.

THE LAW

From Internal Revenue Code Section 2001(a): Imposes the estate tax on the transfer of the taxable estate of a decedent.

From Internal Revenue Code Section 2033: Includes “the value of all property to the extent of the interest therein of the decedent at the time of his death” in the value of the gross estate.

From Federal Tax Regulation 20.2031-1(b): If section 2033 or section 2036 includes the value of property in the value of the gross estate, the amount included is the property’s fair market value at the time of death (or on the alternate valuation date, if the executor so elects).

From Federal Tax Regulation 20.2036-1(a): Includes the value of transferred property in the value of the gross estate if three conditions are met: (i) the decedent transferred an interest in the property during life, (ii) the transfer was not a sale, and (iii) the decedent retained possession or enjoyment of the property for life.

THE CAUSE OF THE DISPUTE

Generally, assets are included in an estate at fair market value as of the date of death. Some assets, such as property where two or more people hold the title, may include a discount, which lowers the reported value. That’s because when property ownership is split, each owner has only a fractional interest, meaning less control and/or ability to sell or otherwise dispose of the property. This “discounting” of the property’s value reduces the amount of the estate, resulting in lower estate tax.

A fractional interest discount can apply when property ownership is split during your lifetime. If the split occurs at death, such as when your heirs inherit a portion of the property under your will, the property is valued without a discount on the estate return.

In this case, the taxpayer owned 1,100 acres of land. In 1965, he deeded a one-fifth interest to each of his five children. He received no consideration for the transfer. The deed granted him full use of the property for his lifetime, and he continued to live there and pay all costs of upkeep.

After the taxpayer’s death in 2004, his estate administrator included the property on the tax return. The reported value included a discount for the fractional interests, based on the 1965 deed.

The IRS says the estate should include the full value of the land. Though the taxpayer transferred interests in the property before his death, the transfer was not a sale and the taxpayer retained use of the property for life. That meant the transfer was essentially the same as if it had been made under the will, at the date of death, and the entire amount is reportable.

WHAT WOULD YOU DECIDE?

Make your selection, then see “The Court’s Decision” below for a full explanation

For the or for the

THE COURT’S DECISION

Download (PDF, 18KB)

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HL Carpenter, an experienced investor and a CPA, specializes in reader friendly articles on taxes and investing for individuals and small businesses, and publishes two newsletters: Taxing Lessons and Top Drawer Ink. Visit TaxingLessons.com and HLCarpenter.com.

This information should not be considered legal, investment or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment or tax advice. Always consult your legal, investment and/or tax advisor regarding your personal situation.

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Right answer!
For the IRS. It is consistent with section 2036 to value the property as if the children’s interests were transferred only at the taxpayer’s death. A property interest transferred to separate owners at death is not valued separately for estate tax purposes. The taxpayer controlled the property. He transferred remainder interests in the property in 1965, and he retained a life estate in the property from 1965 until his death in 2004. No discount is appropriate because the taxpayer controlled the disposition of the entire property, and to apply a discount in this situation would value the property according to the number of recipients. Thus the value included in the value of the gross estate is the property’s fair market value as of the date of death.
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