Valuing the Family Farm for Property Tax Purposes Part II

Part II: Washington and Federal Estate Tax Farm Valuation

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]

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).

Material participation generally requires a full-time commitment.

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

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.

References

[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).