When a farmer has a taxable estate, we usually try to obtain a discount by splitting up land ownership into "fractional" ownership. This is usually accomplished by putting the land into some type of limited liability entity (LLE). Most of the court cases have found that a discount of around 35% is permissible when farmland is owned in this manner.
However, what happens when there is not a taxable estate. In that case, we do not want to have any type of discount since that will increase the amount of capital gains that heirs will eventually have to pay. We may still suggest setting up a LLE to own the land for non-tax reasons (you always want non-tax reasons to set up a LLE), however, we may suggest that the farmer retain 100% of the ownership in his/her name and then pass the asset onto their heirs. In this case, the ownership will be reported 100% in their name and not subject to any discount. This will allow the heirs to step into ownership of the LLE which will have guidelines in place for how to operate the LLE and allow the heirs to sell with reduced capital gains tax.
Let's look at an example:
Farmer Brown own $4 million of farm land at his death. During his lifetime, he has placed the land into a LLE and given some of the units away to his kids and grandkids. Because of these gifts, the valuation of the LLE results in a 35% discount which lowers the basis in the LLE to $2,600,000. He had given away during lifetime $1 million of farmland with a basis of $100,000. This results in the heirs having a basis in the LLE of only $2.7 million. When they sell the land for $5 million, they will have a capital gain of about $2.3 million (5 million less $2.6 million less $100,000).
However, instead of Farmer Brown giving away unts during his lifetime, he holds onto all of the land in his wholly owned LLE. This means at his death, his heirs will increase the tax cost basis to $5 million and be able to sell it for that price and pay no capital gains taxes.
I have heard some commentators indicate that they would not take a discount in the case of the farmer passing away in this situation. Remember, if you argue for a discount due to fractional ownership, this applies whether there is an estate tax or not. The IRS can just easily argue for a discount in this case as argue against it when there is a taxable estate.
It is always important to know how this type of ownership affects the heirs and the farmer. If you don't the result can negatively surprise you when you sell the asset.