Landowners should be aware of estate tax implications associated with land ownership structure and the use of tax valuation alternatives. Tax liability can be significantly affected by whether real property, including farms and timberland, is owned as an asset by an individual with 100.0% ownership or as an asset owned by a corporation or partnership. In the latter case, the value of the landowner’s interest in a corporation or partnership, can be far less than the value of the asset (land) owned by the corporation or partnership.
This value reduction will be potentially greater when minority interests in corporations or partnerships are considered. A minority interest in a corporation or partnership is typically worth far less than a majority interest in the company and in the underlying real estate owned by the company. An individual with a minority interest in a corporation or partnership does not generally have the ability to make exclusive decisions regarding the distribution of dividends or liquidation of the company. For this reason and numerous others, the value of a minority interest in a corporation is significantly less than an equivalent pro rata interest in the full value of the company on a controlling basis.
Tax valuation alternatives are available to landowners regardless of ownership structure. For example, land used by a family farm may qualify to use IRS Section 2032A special use valuation methodology. This election allows the farm to be valued based solely on its agricultural earnings capacity, which could be far less than its value predicated on the land’s highest and best use. The election to employ this valuation method has qualifying requirements.
Section 2032A was originally enacted to help preserve family farms and was also applicable to timberland holdings. However, the IRS added Section 2032A (e) (13) in 1981, which provided special rules for woodlands. This Section proscribes two valuation methodologies. The first, called the “formula” method, values timberland based on the capitalization of the difference between the “average” annual market cash rent and the “average” annual property taxes. The applicable capitalization rate is based on the average annual effective interest rate for all new Federal Land Bank loans. The second, entitled the “multiple factor” method, can be used when no cash rent information is available or at the discretion of the executor subject to qualifying criteria. This valuation method must be used if no cash rents are available. This valuation method considers: 1) Capitalization of income the property can be expected to yield for farming, 2) Capitalization of the fair rental value for farmland, 3) The assessed value of the land for ad valorem tax purposes, 4) The sale price of comparable parcels of farmland in the geographic area, and 5) Any other factor which fairly values the farm. There may be a cap on the tax reduction resulting from the employment of Section 2032A depending on the circumstances of each case.
This article was written to encourage land owners to seek professional assistance when considering decisions regarding ownership structure and tax valuation methodology as such decisions can have a huge effect on estate tax liability. The author is not an expert on tax law or business law related to legal ownership entities. The author is experienced in the valuation of timberland and farm real estate, and sole proprietorships, partnerships, and privately-held corporations for gift and estate tax purposes. Certain facts related to this article were taken from an article entitled “”Special Use Valuation Can Reduce Estate Tax for Timber Owners” written by James John Jurinski, which was published in the January/February 2002 edition of Valuation Strategies.
Lawrence H. Saucer, ARA, ASA, MAI
Saucer Valuation Associates
905 SW Baya Drive
Lake City, Florida 32025
(386) 754-1168 fax
(386) 365-1794 mobile