Real estate is normally valued at an amount that reflects its “highest and best use” for reasons concerning the federal estate tax. In fact, the general rule is that a property’s fair market value (FMV) upon the owner’s date of death is the value that reflects its highest and best use.
However, such valuation can yield results that are unfair. An example of an unjust outcome is where a family farm is situated next to commercial real estate that is considered to be more valuable. In response to these unfair results, the Internal Revenue Code allows certain real estate to be appraised at its “actual use” instead of its “highest and best use.” This type of appraisal applies specifically to the owners of farms and small businesses, provided that certain requirements are met.
There are three requirements of special use valuation of property:
- The business property’s net value must be a minimum of 50 percent of the gross estate of the decedent, and the business real estate’s net value must be a minimum of 25 percent of the adjusted gross estate of the decedent. This is the gross estate, less certain debts, expenses, claims, and losses that are deductible.
- The decedent must have conveyed the business to an heir or heirs who are qualified; this means that the heirs must be close family relatives.
- The business must have been under the ownership and operation of the decedent or a close relative of the family for five of the last eight years prior to the decedent’s demise, disability, or retirement.
The “10 year rule” is that your heirs may be unable to benefit from the special use valuation if, within 10 years of your demise, they sell or get rid of the property in some other way by transferring it to people who are not considered to be close family members. This rule also applies if your heirs start using the property for a different purpose within 10 years after you die.
If you would like to take advantage of the special use real estate valuation for your business or farm, you should consult an estate attorney. They can advise you as to whether you qualify.