Special Use Valuation and Recapture Tax

Special use valuation is back in vogue. With agricultural land values on the rise over the past few years, the frequency of special use valuation elections in estates is increasing. The concept of special use originated in the 1970s and was spurred-on by the idea that commercial development was driving up ag land values and making ag estates more likely to be taxable at death. So, a special use value election allows the estate to value the property in the estate at its ag use value, rather than fair market value and eliminate the effect of the upward price pressure from nearby development. But, among other requirements, the land must stay in the family for 10 years after the decedent dies and the farming use must continue for that period of time. But, what if the property is sold under an agreement that guarantees that the land will continue to be farm? IRS says that triggers recapture tax.

In a recent ruling, a father owned a farm that was used, at least in part, as a dairy. The father died, a special use valuation election was made, and the taxpayer (as heir) continued the farming use of the property. But, the taxpayer proposed to sell a permanent conservation easement to a Land Trust which would protect the “agricultural soils, agricultural viability, and agricultural productive capacity” of the property in perpetuity. The Internal Revenue Code says that a qualified conservation contribution by gift or (OTHERWISE) [emphasis added] is not a disposition that triggers recapture tax. But, IRS ruled that “otherwise” does not necessarily include sales and exchanges of conservation easements for valuable consideration, and that the exception from the recapture tax for qualified conservation contributions does not apply to sales of permanent conservation easements. In the IRS view, the exception only applies to “contributions” of such easements.

The IRS position seems kind of silly. If the intent of the statute is to make sure that elected land stays in farming for a minimum of 10 years after the decedent’s death, putting a permanent conservation easement restriction on the property that guarantees such use certainly fulfills that requirement. What difference does it make if the heirs financially benefit from guaranteeing such farming use? Perhaps the father should have donated the property to the Land Trust as part of his estate plan to take effect at death. Priv. Ltr. Rul. 200840018 (May 13, 2008).