The fair market value of property within an estate is the real retail value of the property. It ideally depends on the standard of “highest and best use.” It usually results in much higher taxes, and the heirs are likely to pay a lot more than the estate planner had estimated. It often results in the heirs selling the land or property to pay the taxes. The Congress has enacted the IRC Sec 2032A to provide some relief to the heirs by allowing special use valuation when the assets involve real property being used by a closely held business.
Is the “current use” valuation helping doctors protect their business assets?
Doctors usually acquire real estate, equipment, and other tangible assets during their long years of practice. It usually includes their clinics and other co-owned sites of personal practice as well. In such an event, the executor of the will or estate can choose to value this real property as a part of the closely held business.
The valuation will then depend on the property’s “current use” instead of its “highest and best use.” It is the special use valuation of business property that eases estate tax and federal income tax burdens on the heirs. It also provides enough relief to the liquidity needs of the estate.
Doctors are partial to the “current use” valuation since it allows the property to remain within their family. It is especially true when the doctor’s family has more physicians or specialty doctors practicing on the same premise. For example – a doctor, whose son is also a doctor, might want his clinic to pass onto his son.
If the post-death transfer of real business property does not involve high estate tax payments, it becomes much easier for the son to continue his practice at the same site.
Every good comes with strict clauses
The maximum tax reduction under this provision is $1.12 million as per the updates of 2017. Therefore, there are quite a few stringent and somewhat complex conditions that your real property has to meet, to qualify for the special use valuation:
- The value of the closely held business assets in the estate has to be at least 50% of the adjusted value of the total estate. Here, the IRS values the property according to the “highest and best use” basis.
- The unpaid mortgages and the other debts against the property become a part of the “adjusted value of the gross estate.”
- At least 25% of the “adjusted value” should come from real property of the closely held real business property.
- The property that is qualifying for the exemption needs to pass on to the deceased’s spouse, child, ancestor or a grandchild. The child or grandchild can be biological, adopted or half-blood.
- The real property in question should have been owned by the estate owner or their family, as a part of their closely held business, at least five years of the last eight years of the decedent’s demise.
Most doctors make enough to establish their own practice and buy their own clinic real estate. Their children and grandchildren usually benefit from practicing at these established locations, but the “highest and best use” valuation keep them from enjoying the benefit. They are forced to liquidate the business asset and move on to new locations, jeopardizing their careers. When a closely held business becomes a part of a gross estate, it produces a huge tax liability on the next generations. That is where Section 6166 becomes so crucial during estate planning for business owners.
How to keep your rightful property within your family?
Section 6166 allows the qualifying estates to distribute their payable taxes over the next 14 years. It includes all estate tax payments in easy installments. It can prevent the forced sale of a business or business share upon execution of the estate plan. However, you must also remember that when an executor elects Section 6166 treatment, he or she automatically agrees to the IRS imposing a tax lien on the property until the final tax installment.
For your business to qualify for Section 6166, it must be a part of your gross estate, and it should represent at least 35% of your adjusted gross estate valuation. A doctor may have multiple clinics, and if you have two or more businesses, the IRS usually lumps them together to meet the 35% criterion. It is also under the condition that you continue to owe at least 20% of each business until the time you die. Here are a few details of companies that qualify for Section 6166:
- Any sole proprietorship
- A partnership with 45 or fewer partners
- A partnership where you own 20% or more of the interest included in the gross interest
- Stock in a corporation, out of which you own 20% or more of the voting stock as a part of your gross estate
- Stock in a company with 45 or fewer shareholders
There is a milieu of Attribution Rules that help the estate meet the 45/20% owners test. However, this cannot help you with the “35% of the adjusted gross estate” qualification rule.
IRS is always keeping a close watch
In case, the heir sells at least 50% or more of the business interest or withdraws money from the estate that is equivalent to 50% of its value, and the IRS usually accelerates the due date of the tax. You may be relieved to know that transfer among family because of death does not attract any tax acceleration from the IRS.
In this case, the approved family members who can become the receivers of transfer include the spouse, ancestors, siblings and lineal descendants. However, the failure to pay the installment of tax can also trigger an acceleration. The estate usually enjoys a six month grace period from the IRS during which the heir can catch up with the overdue payment. It also attracts a 5% fine.
It is time you took a deep breath and let the experienced financial planning experts take charge. Beam A Life can show you economic, smart and IRS permitted ways to save your income, preserve your business and chalk out an estate plan before time. Visit https://beamalife.com/ to get in touch with the experts!