With Low Interest Rates, Special Use Valuation May Not Save Much Estate Tax!

Published on: 07:56AM Jun 15, 2012

With the explosive increase in cash rents and the continued decrease of interest rates, the savings by electing special use valuation for estate tax purposes may not be available in 2012.

One of the special estate tax provisions for farmers is the option to elect to reduce the value of the estate to reflect the value based upon capitalization of rental income of their farmland.  If this resulting number is substantially lower than the normal fair market value of the farmland, the estate can elect to reduce the value to this number.  The rules and regulations on this Statute are complex and the penalties for failing to properly make this election can be extreme, but the purposes of this post is to see how high cash rents and low interest rates affect this election.

For 2012, an estate can be worth $5.12 million and pay no federal estate tax.  The estate can elect to use special use valuation on up to $1.040 million of value.

The IRS issues each year a list of the interest rates charged by the appropriate Farm Credit System bank for each region of the country.  For example, AgriBank, FCB covers most of the Midwest states such as Iowa, Minnesota, Nebraska, Missouri, etc.  The interest rate to be used for 2010 was 6.41% and for 201a, the rate was 6.12%.  The 2012 rates will most likely be issued in a couple of months and I would expect these rates to be at least 50 basis points lower and perhaps even lower.

Let's assume we have a farmer living in Iowa whose only asset is 640 acres of good Iowa farmground that is currently worth exactly $6,160,000 ($9,625 per acre) if it was sold on the open market.  The current federal estate tax for this property passing to his son who has farmed the property for many years would be $364,000.  However, the estate could elect to reduce the value of the property by taking the comparable net cash rent for similar property, reducing this rent by any applicable property taxes and then dividing by the interest charged of 6.12% (using the 2011 rates).  To get the value down to exactly $5.12 million, which is the amount where there is no federal estate tax due, would require a net cash rental rate of $489.60 per acre.

It is likely even with the rise in cash rental rates for 2012, the estate could make the argument that most cash rents, even for good Iowa farmland, are less than $490 per acre, net of property taxes.

However, if the 2012 interest rate comes in at 5.62%, this lowers the cash rental rate hurdle to $450 per acre and if the rate is 5.12%, it is about $410 per acre.  Most of the cash rents that I am hearing about for very good Iowa farmland are approaching, if not exceeding $450 per acre.  Therefore, instead of being able to fully reduce the farmland value by the full $1.04 million available, the estate may only get half that amount and still owe perhaps $200,000 in federal  estate taxes.

In years past, it was usually easier to reduce the estate using special use valuation than it may now be with low interest rates and high cash rents.