There’s been a lot of chatter in the news lately about the potential for the federal estate tax to be repealed. One argument often made in favor of repealing the estate tax is that it will protect small family farms from being sold to pay off an estate-tax liability. That raises an interesting question: How does the estate tax deal with farms? In this post, I’ll provide an answer to that question.

General Rule: Property is Valued Based on its Highest and Best Use

Farm property, like all other property owned when a person dies, is included in his or her gross estate for federal estate tax purposes. If the total value of all property included in the gross estate (after deductions) exceeds the lifetime exclusion amount—which is $5.49 million for those dying in 2017—then the estate will be subject to an estate tax liability. Normally, the value of property included in the gross estate is the fair market value of the property based on its “highest and best use.” This means that land isn’t valued based on how it is being used, but based on how it could be used to maximize its value. For instance, if you own farmland on the outskirts of a city, it would likely be worth more if sold to a real estate developer than if it keeps being used as a farm. The IRS normally looks at that higher value for estate-tax purposes.

Exception: Special Use Valuation

Recognizing that the normal method of valuing property could result in family farms being sold to pay off an estate-tax debt, Congress has included a special exception for them in section 2032A of the Internal Revenue Code. If certain prerequisites are met, land used in a farm for farming purposes is valued based on its farming use, not its “highest and best use.” However, the amount by which the special valuation can reduce the value of the farm in the gross estate is limited to $1.12 million in 2017. For instance, if the “highest and best use” value of farmland near a city is $7 million, and the farming-use value is $5 million, then the special use valuation would be $5.88 million, which is $1.12 million less than the “highest and best use” value.

Payment in Installments

The Internal Revenue Code includes some other benefits for family farms. Among them is the ability to pay some or all of any estate-tax liability over a term of 15 years. When the estate meets certain prerequisites, any estate-tax liability attributable to the interest in the farm can be paid in up to 10 installments, the start of which can be deferred by up to five years.

In reality, not many family farms are subject to the estate tax. Most are covered by the $5.49 million lifetime exclusion. But, for farmers concerned about the estate tax, the Internal Revenue Code includes some beneficial provisions. If that’s still not enough, please call me and we can talk about what other planning opportunities exist for you.

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