Estate Tax – Valuation Date
Valuation: The value is the fair market value. This is construed to mean the price at which the property would change hands in an arm’s length transaction between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of the relevant facts. The valuation issue may arise in the context of inclusion of property in the estate or in computing a deduction or exemption.
- Date: The valuation date is the date of the decedent’s death. An alternate date six months later may be elected but only if it decreases both the estate and the tax. If an alternative date is used, that date will be used for all assets of the estate. The election can be used for a late filed return and is irrevocable. Although date of death or alternative date are used, some post death events can effect valuation, such as post death sales or expectation of board approval which might result in a discount in value.
- Personal property: The value of household and personal effects is determined by retail price to the general public and not what an executor might receive. However, if property is sold at public auction, the sale price controls. Each item is valued separately unless the only market is in bulk. Cash and bank accounts are fully included, less any checks written before death. Notes are presumed to be worth face value plus interest whether secured or unsecured. Insurance on the decedent’s life, if includible in the estate, is valued at the amount of the proceeds. Insurance on the life of another is valued in the usual way (at the policy’s interpolated terminal reserve).
- Real estate: There is no simple rule here. An arm’s length sale within a reasonably short period after the decedent’s death will normally control. Absent such an actual sale, the matter is a contest between the estate’s appraiser and the government’s appraiser. Three valuation methods are commonly used. The comparable sales approach uses actual sales prices with adjustments as necessary for differences between the comparable and the subject property. For income producing properties, a capitalized income approach is used, capitalizing the net income from the property at a fair rate of return. For example, once you have determined the income and the rate of return, merely calculate the value of the asset needed to produce that return. The third method is reconstructed cost, which uses the current replacement cost for the building, adjusted for accrued depreciation plus the value of the land. Fractional interests may be discounted below the proportionate share of the value of the entire property. A special use rule is applied to real estate held in a closely held business. Farmland is the most common application of this rule, but is not the only one. An exclusion equal to 40% of the property’s value up to $500,000 is allowed for a qualified conservation easement given to charity or governmental entity. Some limitations may apply.
- Business real estate: Farm property, or other real estate used in a closely held business, may at the election of the estate be valued at its current use rather than at its potential highest and best use. This favorable valuation method has specific limitations as to the reduction in gross estate. For 2013, the limit is $1,070,000. Other qualifications apply.
- Listed securities: The mean between the day’s highs and lows on the valuation date is used. If the shares are sold ex-dividend, the amount that the estate will receive is used. The valuation of bonds includes the interest to the valuation date. Restrictions to or an impediment to sale can result in a discount to value. Mechanical valuation is used(unit value times number of units) unless there is a blockage discount or premium. Where the decedent’s holdings are so large that the sale within a reasonable time following death would depress the market, or where the holdings constitute control, the value may be either discounted or enlarged as the case may be. Shares of mutual funds are valued at the “bid price”, asset less redemption value. Publicly traded shares owned by decedent’s controlled investment company are valued at net asset value less liquidation costs. Options are generally valued with consideration of the potentials during the option period, including but not limited to the spread between the option price and the value as of the option grant. Specialized formulas are used.
- Closely held business: Discounts are allowed for minority and marketability. A minority business interest may be worth less than its proportional value. Lack of marketability of the stock can result in a further discount. The same applies to other ownership interests such as an interest in a partnership or LLC. State law ownership requirements for liquidation may also result in a further discount where the decedent’s ownership does not equal the statutory minimum to require liquidation. Valuation of preferred shares utilizes special rules. Generally, value is arrived at by negotiation with the revenue agent on audit after the estate reports the business at the lowest justifiable appraised value. The amount shown on the return is an admission and can only be lowered upon a showing of error. The most important factors in valuation are net worth and prospective earning power. Earnings are more important for an operating company and asset values are more important for an investment company. For operating corporations, the valuation often focuses on good will using formulas. In a stable business, the service will take the average earnings for 5 years reduced by 8% of the average tangible assets, and the difference is capitalized at 15% (8-15 formula). If the business is not stable with regular earnings, the service will use a 10-20 formula. A special 14 year deferral of estate tax payment with a reduced rate of interest may be available where a business is a significant part of the estate.
- Business freeze: A controlling shareholder recapitalizes (tax free) the stock interests into common and preferred shares and gives the common stock to the children when it has little value but significant appreciation potential. The same procedure can to used for a partnership or an LLC. The value of the gift is the value of what is given away. If the parent retains some common stock, the value of the gift is both the value of the preferred and the common stock retained. The appreciation in the value of the common stock gifted to children escapes tax. If the gifting parent dies still holding the retained interest (usually the preferred stock), it can be subject to taxation both as a gift and as part of the estate requiring adjustments to prevent a double taxation result.
- Buy-Sell agreement: This agreement is utilized to protect the decedent’s spouse or family, fix the value of the business interest for estate tax purposes and preserve business management. So long as the agreement is a true business agreement and not a device to pass property at less than fair market value, and its terms are comparable to similar arrangements between arm’s length individuals, the values agreed upon will be accepted. The agreement must place a restriction on the stockholder for disposal of his or her interest during life. The restriction may be a mere right of first refusal. The restriction may be expressed in the agreement or in the corporate by-laws or may be implicit in the capital structure of the business. So long as death or retirement are not imminent, such an agreement with a substantial majority holder and which provides for the purchase of so much of the decedent’s interest at the agreed value as is necessary for the payment of estate taxes and administrative expenses will be accepted. Between family members, the value of goodwill can be excluded in determining the value of the decedent’s interest.
- Present and future interests: Tables are provided by the government setting forth valuation factors for life estates as well as other forms of future interests, such as terms certain, remainders and reversions. The tables do not distinguish between longevity of males and females and use an interest rate that changes monthly. The life expectancies are based on census data.