Wills and Trusts

Wyatt, Tarrant & Combs, LLP

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Federal District Court Invalidates §2032A Regulation

In Carolyn Finfrock v. United States, 860 F.Supp.2d 651 (2012), a Federal District Court in Illinois held that Treas. Reg. § 20.2032A-8(a)(2) is contrary to the statute and is, therefore, invalid. This has happened before:

In Miller v. United States, 680 F.Supp. 1269, the district court found Treasury Regulation § 20.2032A-8(a)(2) invalid by using the test that preceded the test articulated by the United States Supreme Court in Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984). The Miller court found that the Treasury Regulation was an interpretive regulation, promulgated under the general rule-making power of the Code, and represented an invalid exercise of that power. Miller, 680 F. Supp. at 1273-74. The court concluded that Treasury Regulation § 20.2032A-8(a)(2) added a requirement not found in the underlying statute that was inconsistent with the statute. Id.

The opinion summarizes the difficulty:

To qualify for the special use valuation, several conditions must be met. One of those conditions is that “25 percent or more of the adjusted value of the gross estate consists of the adjusted value of real property which meets the requirements of subparagraphs (A)(ii) and (C).” 26 U.S.C. § 2032A(b)(1)(B). The parties agree that Items 1 through 4 represented approximately 68% of the adjusted value of the gross estate.

The Treasury Regulations, however, provide that while an estate need not elect special use valuation with respect to all of the qualifying property, the property actually elected for the special use valuation must constitute at least 25% of the adjusted value of the gross estate. See 26 C.F.R. § 20.2032A-8(a)(2) (“An election under section 2032A need not include all real property included in an estate which is eligible for special use valuation, but sufficient property to satisfy the threshold requirements of section 2032A(b)(1)(B) must be specially valued under the election”); see also Miller v. United States, 680 F. Supp. 1269, 1270 n. 1 (C.D. Ill. 1988) (noting the interpretation of the regulation is that the election must be made on property valued at 25% or more of the adjusted value of the gross estate). Defendant argues that this regulation is valid and, because the property elected for special use valuation (Item 4) constituted only 15% of the adjusted value of the gross estate, Plaintiff is not entitled to the refund. Plaintiff argues that the regulation is invalid and in conflict with the statute.

The Court applied Chevron and held that the regulation is invalid:

Therefore, under the plain language of the statute, to meet the definition of “qualified real property,” 25% or more of the adjusted value of the gross estate must consist of real property that (1) “was acquired from or passed from the decedent to a qualified heir of the decedent” (26 U.S.C. § 2032A(b)(1)(A)(ii)); and (2) has been used for a qualified use for 5 of the 8 years preceding the decedent’s death and for which there was material participation by the decedent or a member of the decedent’s family in the operation of the farm (26 U.S.C. § 2032A(b)(1)(C)). Subparagraph (D) further defines “qualified real property” as “such real property” that is designated in the agreement required by subsection (d)(2). 26 U.S.C. § 2032A(b)(1)(D).

Notably, the statute does not require that real property constituting 25% or more of the adjusted value of the gross estate be “designated in an agreement referred to in subsection (d)(2).” 26 U.S.C. § 2032A(b)(1)(D). The 25% or more requirement is a means to limit the benefit of the special use valuation to family farms and family businesses. Nonetheless, under the plain language of the statute, once the estate meets the thresholds identified in subsections (1)(A), (1)(B), and (1)(C), the only other requirement to qualify as “qualified real property” is to designate the property in the required agreement. Congress did not require that the designation be of all or a certain percentage of the real property in the estate that meets the requirements of 1(A), 1(B), and 1(C). See, e.g., Miller, 680 F. Supp. at 1273 (finding “[t]he language of Code § 2032A(b)(1)(B) . . . cannot be said to be ambiguous with respect to the 25% requirement which the regulation imposes”).

This Court finds that § 2032A(b) is neither silent nor ambiguous on the precise issue — whether an executor can elect for special valuation property that constitutes less than 25% of the gross value of the adjusted value of the gross estate. The statute unambiguously provides that an executor can do so.

Having found the statute unambiguous, the Court next determines if the plain meaning of the statute supports or opposes Treasury Regulation § 20.2032A-8(a)(2). See Bankers Life & Casualty Co., 142 F.3d at 982 (explaining step one of the Chevron test). Here, the regulation imposes an additional requirement that the property designated by the agreement referenced in § 2032A(b)(1)(D) and (d)(2) for special use valuation must constitute at least 25% of the adjusted value of the gross estate. This additional requirement is contrary to the plain language of the statute. See, e.g., Miller, 680 F. Supp. at 1273 (finding that “the regulation clearly imposes an additional, substantive requirement not authorized by the statute”). The regulation neither clarifies an ambiguity in the statute, because the statute contains no ambiguity, nor fills any gap, as there is no gap to fill. Therefore, Treasury Regulation § 20.2032A-8(a)(2) is invalid.

Because this Court finds that the statute is unambiguous and that Treasury Regulation § 20.2032A-8(a)(2) conflicts with the statute, this Court need not proceed to step two of the Chevron test or address Defendant’s arguments with regard to step two of the Chevron test.

Turney P. Berry
Louisville, Kentucky


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The Nature of Particular Assets

  1. Generally

Understanding how and to what extent assets will benefit from a “step-up” in basis is critical to the estate planning process today.  Obviously, certain assets like highly-appreciated assets will benefit more from the “step-up” in basis at death than cash (which has a basis equal to its face value which is equal to its fair market value) or property at a loss (a “step-down” in basis).  Moreover, appreciated assets like gold that are considered “collectibles”[1] under the Code, benefit more from a step-up in basis than other appreciated capital assets because the Federal long-term capital gain tax rate for collectibles is 28%, rather than 20%.

If one were to list asset categories or types, starting with those that benefit the most from the “step-up” in basis and ending with those that benefit the least (or actually suffer a “step-down” in basis), it might look as follows:

(1) Creator-owned intellectual property (copyrights, patents, and trademarks), intangible assets, and artwork;

(2) “Negative basis” commercial real property limited partnership interests;

(3) Investor/collector-owned artwork, gold, and other collectibles;

(4) Low basis stock or other capital asset;

(5) Roth IRA assets;

(6) High basis stock;

(7) Cash;

(8) Stock or other capital asset that is at a loss;

(9) Variable annuities; and

(10) Traditional IRA and qualified plan assets.

A full discussion of every asset type listed above is beyond the scope of these materials, but a number of them deserve additional consideration and discussion and will be featured in the upcoming posts under this topic.

Turney P. Berry

Louisville, Kentucky

[1] § 1(h)(4).

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Community Property and Elective/Consensual Community Property

As mentioned in part one of this series of posts, the Code provides a special rule for community property.  section 1014(b)(6) of the Code provides that “property which represents the surviving spouse’s one-half share of community property held by the decedent and the surviving spouse under the community property laws of any State, or possession of the United States or any foreign country, if at least one-half of the whole of the community interest in such property was includible in determining the value of the decedent’s gross estate”[1] shall be deemed to have been acquired from or to have passed from the decedent.

There are currently nine community property states.: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.  There are two states that are separate property states but they allow couples to convert or elect to treat their property as community property: Alaska[2] and Tennessee.[3]  Generally, these elective or “consensual community property” laws allow resident and nonresident couples to classify property as community property by transferring the property to a qualifying trust.  Generally, for nonresidents, a qualifying trust requires at least one trustee who is a resident of the state or a company authorized to act as a fiduciary of such state, and specific language declaring the trust asset as community property.

Clearly, for residents of separate property states, taking advantage of the “consensual community property” laws of another state has the potential for a basis adjustment under section 1014(b)(6) of the Code.  There has been no direct ruling on whether that would be the case under the laws of Alaska or Tennessee.  However, a number of commentators have argued that assets in such “consensual community property” arrangements would, indeed, receive a full “step-up” in basis under section 1014(b)(6) of the Code.[4]  A professional fiduciary must be designated in Alaska or Tennessee in order to invoke the respective statutes and the administrative expense ought be weighed against the potential benefit, taking into consideration the uncertainty.

Turney P. Berry

Louisville, Kentucky

[1] § 1014(b)(6).

[2] Alaska Stat. 34.77.010 et al.  (Alaska Community Property Act).

[3] Tenn. Code Ann. § 35-17-101 et al. (Tennessee Community Property Trust Act of 2010).

[4] Jonathan G. Blattmachr and Howard M. Zaritsky, Alaska Consensual Community Property Law and Property Trust, __ Trusts & Estates 65 (Nov. 1998), Jonathan G. Blattmachr, Howard M. Zaritsky and Mark L. Ascher. Tax Planning with Consensual Community Property: Alaska’s New Community Property Law, 33 Real Prop. Probate and Tr. J. 615 (Winter 1999).

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General Rule: The “Step-Up” in Basis to Fair Market Value

Generally, under section 1014(a)(1) of the Code, the “basis of property in the hands of a person acquiring the property from a decedent or to whom the property passed from a decedent” is the “fair market value of the property at the date of the decedent’s death.”[1]  The foregoing general rule is often referred to as the “step-up” in basis at death, under the assumption that assets generally appreciate in value.  However, many assets depreciate in value, and this general rule will mean a loss of tax basis to fair market value at date of death (a “step-down” in basis).  For purposes of this outline, we refer to the general rule of section 1014(a)(1) as a “step-up” in basis, whether the asset is appreciated or at a loss at the time of the decedent’s death.

The Code goes on to say that if the executor of the estate elects an alternate valuation date under section 2032 of the Code or special use valuation under section 2032A of the Code, then the basis is equal to the value prescribe under those Code sections.[2]

If land or some portion of such land that is subject to a qualified conservation easement is excluded from the estate tax under section 2031(c) of the Code, then “to the extent of the applicability of the exclusion,” the basis will be the “basis in the hands of the decedent”[3] (“carryover basis”).[4]

If appreciated property (determined on date of the gift) was gifted to the decedent within 1-year prior to the date of death, and the decedent transfers the property back to the original donor of such property (or the spouse of the donor), the property will not receive a “step-up” in basis and it will have the basis in the hands of the decedent before the date of death.[5]  This rule does not apply if the property passes to the issue of the original donor, and it is unclear whether this rule applies if the property is placed in trust where the original donor or donor’s spouse is a potential beneficiary.

 Turney P. Berry

Louisville, Kentucky

[1] § 1014(a)(1).

[2] §§ 1014(a)(2) and (3).

[3] § 1014(a)(4).

[4] § 1015.

[5] § 1014(e).