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Photo of Farm Land emphasizing the importance of Washington farm tax planning

Valuing the Family Farm for Property Tax Purposes Part II

Part II: Washington and Federal Estate Tax Farm Valuation

Looking for Part I? Find it here.

When the time comes to consider transitioning the family farm (Washington farm tax planning), there are some valuation rules which are worth considering. Washington property tax provides a tax savings for lands classified as a farm. The Washington and Federal estate tax regimes provide value reductions for farm property as well. The Federal estate tax may soon become a thing of the past due to President Trump’s recent tax reform proposal, but as of yet the tax is still in effect.

Estate Tax Benefits of Farm Land

Generally, Washington and the Federal government tax the value of a person’s assets when that person dies. Both governments levy a tax on a decedent’s estate. A Washingtonian’s taxable estate will generally include the value of all the Washingtonian’s property. However, the Washington estate tax will be reduced proportionately by the amount of property located outside of Washington.[1] Both Federal and Washington estate tax regimes provide other deductions, specifically both provide a marital deduction for property passing to a surviving spouse and farm deductions. Washington also has a deduction for family business interests.[2]

A farm may qualify for reduced valuation for estate tax purposes. Both the Federal and Washington estate tax regimes allow farm families to reduce their tax bill by providing them deductions for qualified farm inheritances.[3] Generally, both regimes require fifty percent (50%) of the value of the decedent’s gross estate be derived from either real or tangible property the family has recently used for sufficient farming operations.[4] The federal rule also requires an agreement regarding the prospective ownership and use of the farm, which also consents to a tax penalty if certain rules aren’t followed.[5]

Qualification provides a deduction to the value of farm property in the gross estate. The federal deduction provides a different valuation method than fair market value, which involves dividing the rental value of comparable farm land (reduced for real estate taxes) by the five-year average interest rate on new Federal Land Bank loans.[6] There is a special rental value determination if there are not comparable rentals.[7] The Federal value reduction is limited to $1,120,000 ($750,000 adjusted for inflation).[8] Qualification under Washington’s rules provides a deduction that reduces the estate by the farms entire value (net of debt attributable to the property).[9]

A decedent’s estate must be substantially connected to farming.

Both tax systems require certain criteria of a decedent’s estate for it to receive a farm deduction. Fifty percent (50%) of the decedent’s estate must be real or personal property used in farming and passing to a family member.[10] Twenty-five percent (25%) of the gross estate must be farm real estate passing to family which meets the retroactive eight-year requirement.[11] Generally, the real property must have been owned and used by the decedent or a family member in farming for five of the last eight years before death (the retroactive eight-year requirement).

The eight-year period is shifted when the decedent was disabled or was receiving social security.[12] If the decedent was disabled or receiving social security at death, the eight years examined are those before the disability started or when social security benefits began.[13] Also, the decedent or a family member must have materially participated in the farm operation. [14]

Material participation generally requires a full-time commitment.

The material participation requirement is flexible but requires a family member to be actually employed in the farm operation. Generally, the family member on whose shoulders the material participation requirement rests (the “qualifying family member”) must work 35 hours per week or more, or a lesser amount if the individual personally manages the full operation.[15] This permits periods of little or no work during off seasons, so long as all necessary functions still occur.[16] Less than full-time involvement may also qualify as material participation if there is an arrangement providing the qualifying family member actually participates in a non-family member’s farm operation on the inherited property.[17] Both tax regimes require material participation to satisfy the retroactive eight-year requirement. And though Washington has no requirement about the future use of the property,[18] the federal deduction is conditioned on the property continuing as a farm for ten years.[19]

The Federal tax savings must be repaid if the farm is sold or stops operating within ten years.

The Federal regime requires all people with an interest in the inherited farm property to sign an agreement consenting to ten years of ownership and use restrictions.[20] Any interest sold to a non-family member within ten years of passing to a decedent’s heirs is subject to an additional tax.[21] The tax will be the lesser of the interest’s share of tax savings or the sales price reduced by the reduced estate tax value of the interest.[22] The additional tax also applies to property which is no longer used for farming, or if there is an aggregate of three years in which the decedent or a qualifying family member does not materially participate in the farm business.[23] The three years which will trigger this prospective eight-year requirement considers the period used for the retroactive eight-year requirement and proceeds for ten year from the decedent’s death. However, the heirs may choose to start the ten-year period up to two years after the decedent’s death.[24]

The size of the estate shapes the family’s farm transition plan.

A farm family needs to make a multigenerational commitment to create a transition plan that takes advantage of these tax rules. A family member must continue to operate the family farm business for the elder generation’s estate to qualify for the Federal farm estate tax deduction. However, the farm can be sold and still qualify for the state deduction. Some Washington farmers can avoid estate tax with the state deduction being earned by the farmer’s work but disregarding the Federal deduction because the next generation aren’t going to farm. However, keep in mind that if the farm is receiving open space treatment under the property tax system, there will be additional tax due if the farm operation is terminated.

As a farmer’s estate reaches the $11,000,000 level (the Federal credit protects $5,149,000 per spouse from tax liability) the family should take extra time to consider whether a family member is willing to continue the farming tradition. If not, the family should at least plan for the tax liability. Other planning techniques may be implemented to help reduce a taxable estate. Consider speaking to an estate planning professional when your family is ready to plan the transition for the family farm. Knowing your options is the best way to create a plan to fit your family.

[1] RCW 83.100.040(2)(b).
[2] RCW 83.100.48.
[3] RCW 83.100.046; 26 USC § 2032A.
[4] RCW 83.100.046(f); 26 USC § 2032A(b)(1).
[5] 26 USC § 2032A(a)(1);.26 USC § 2032A(d)(2).
[6] 26 USC § 2032A(e)(7)(A).
[7] 26 USC § 2031A(e)(7)(B).
[8] Section 3.36
[9] RCW 83.100.046(1).
[10] RCW 83.100.046(10)(f)(i)(A); 26 USC 2032A(b)(1)(A).
[11] RCW 83.100.046(10)(f)(i)(B); 26 USC 2032A(b)(1)(B).
[12] RCW 83.100.046(7)(a); 26 USC 2032A(b)(4)(A).

[13] RCW 83.100.046(7)(a); 26 USC 2032A(b)(4)(A).
[14] RCW 83.100.046(10)(f)(i)(C)(II); 26 USC 2032A(b)(1)(C)(ii).
[15] 26 CFR 20.2032A-3(e)(1).
[16] 26 CFR 20.2032A-3(e)(1).
[17] 26 CFR 20.2032A-3(e)(1).
[18] Estate tax deduction for farms
[19] 26 USC 2032A(c)(1).
[20] 26 USC 2032A(d)(2); 26 USC 2032A(c)(1).
[21] 26 USC 2032A(c)(1).
[22] 26 USC 2032A(c)(2).
[23] 26 USC 2032A(c)(6).
[24] 26 USC 2032A(c)(7).

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