Your business is part of your legacy. So you probably don’t want the company’s building to be sold and bulldozed right after you die. However, your heirs may be strapped for cash if they have to pay federal estate tax on the value of the inherited business.
Strategy: Point out the special use valuation break. If this election is made by your executor, it may reduce the value of the estate by hundreds of thousands of dollars. The special use valuation break was resurrected by the 2010 Tax Relief Act for 2011 and 2012.
Here’s the whole story: The fair market value of property owned by a decedent at death must be included in his or her taxable estate. Generally, the fair market value is determined by the property’s “highest and best use.” In other words, if the property is raw land that would be worth a small fortune to real estate developers, the higher value as real estate development property is treated as the “fair market value” for estate tax purposes.
But the story doesn’t end there for farms and property of a closely held business. As long as certain requirements are met, a business owner’s property is valued according to its current actual use upon the owner’s death, not the highest and best use.
Note: The reduction in the estate tax value under this election can’t exceed an inflation-adjusted amount. The maximum for decedents dying in 2011 is $1.02 million.
Secure ‘special use’ valuation
To secure a lower “special use” valuation on business property, the following requirements must be met:
- The net value of the business property must be at least 50% of the decedent’s gross estate and 25% of the decedent’s adjusted gross estate (the gross estate reduced by certain deductible debts, expenses, claims and losses).
- The decedent must have transferred the business to a qualified heir or heirs (i.e., close family relatives).
- The business must have been owned and operated by the decedent or a close family relative for five out of the last eight years before the death of the decedent.
These requirements are relatively easy to meet, but there’s still another catch: If your heirs sell or otherwise dispose of the property to outsiders within 10 years of death or they begin using the property for another purpose, the estate tax savings must be recaptured.
Therefore, it’s important that all parties fully understand the 10-year restriction and comply with the rules.
Tip: The election for special use valuation on Form 706 must be accompanied by a written agreement signed by each person with an interest in the property. Once the election is made, it’s irrevocable.