Alternative Valuation Discount

Doug H. Moy
May 5, 2008 — 2,127 views  
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The value of a decedent’s gross estate may be determined either as of the date of death or the alternate valuation date. It is important to understand that the date of death and the alternate valuation date determine when the decedent’s property is to be valued for federal estate tax purposes—not how it is to be valued. In general, IRC Section 2032 provides for the valuation of a decedent’s gross estate at a date other than the decedent’s date of death. The decision whether to value the estate as of the date of the decedent’s death or on the alternate valuation date is one of the most important decisions the personal representative must make. The Code refers to the executor as being the fiduciary who makes the appropriate election. A trustee may also make the appropriate alternate valuation date election.

Only one valuation date for the estate can be used. Regardless of whether the personal representative chooses to value the estate as of the date of the decedent’s death or use the alternate valuation date, all assets of the gross estate must be valued as of the date chosen. State law determines the date of transfer for purposes of the alternate valuation date [Estate of Sawade v. Comm’r, 795 F.2d 45 (8th Cir. 1986), aff’g T.C. Memo 1984-626]. The decedent’s date of death cannot be used to value some of the decedent’s assets and the alternate valuation date to value other assets [Treas. Reg. § 20.2032-1(b)(2) (Jan. 4, 2005)]. The alternate valuation date may be elected only if an estate tax return is required. Unless a Form 706 is required, the election is not effective [Treas. Reg. § 20.2032-1(b)(1) (Jan. 4, 2005); IRC § 6018(a); Rev. Rul. 56-60, 1956-1 C.B. 443].

The purpose of the alternate valuation date election is to permit a reduction in the amount of federal estate tax which would otherwise be payable if the value of the gross estate decreased during a six-month period after the decedent’s death [Treas. Reg. § 20.2032-1(b)(1) (Jan. 4, 2005); Flanders v. U.S., 347 F. Supp. 95 (N.D. Calif. 1972) (the Flanders court held that the option to select the alternate valuation date is merely to allow an estate to pay a lesser tax if unfavorable market conditions [as distinguished from voluntary acts changing the character of the property] result in a lessening of its fair market value.); Ltr. Rul. 9349003 (Sept. 3, 1993)]. Prior to the Tax Reform Act of 1984 (TRA ‘84) [Pub. L. No. 98-369, 98th Cong., 2nd Sess. (18 July 1984), 1984-3 C.B. 1 (hereafter TRA ‘84)], the election could be used whether or not a reduction occurred in the total value of the decedent’s gross estate [Treas. Reg. § 20.2032-1(b)(1) (Jan. 4, 2005); TAM 9001001 (Oct. 3, 1989)]. In this regard, Congress concluded that the alternate valuation date election had been abused. The intended purpose of the election was and continues to be to provide federal estate tax relief, rather than a method to avoid income tax {The legislative history of IRC § 2032 provides: The option to value property (on the alternate valuation date) initially was provided during the depression of the early 1930s because, by the time estate taxes were paid, property values had dropped substantially, sometimes to such an extent that the proceeds of the sale would not pay the estate tax due [H. Rep. No. 1337, 83d Cong., 2d Sess., 90 (1954)]}. Consequently, TRA’84 provided that the election can only be made where both the total value of all property in the decedent’s gross estate and the federal estate tax liability of the estate are both reduced [IRC § 2032(c)].

As mentioned above, "the date of death and the alternate valuation date determine when the decedent’s property is to be valued for federal estate tax purposes—not how it is to be valued" or valued by "voluntary acts changing the character of the property." [Emphasis added] In these regards, the position of the Service is that IRC Section 2032 does not allow a discount (i.e., a valuation adjustment) for transfer restrictions and a purchase option ("restrictions") imposed on closely-held corporate stock pursuant to a post-death tax-free reorganization in determining the fair market value of the decedent’s stock on the alternate valuation date [Herbert V. Kohler, Jr. et al. v. Comm’r; T.C. Memo. 2006-152; Nonacq. action on decision, 2008-01]. Here, the court focused on whether the reorganization was a "disposition" for purposes of IRC Section 2032(a)(1) and Treasury Regulation Section 20.2032-1(c)(1). The court appeared to reason that, because Treasury Regulation Section 20.2032-1(c)(1) provides that a tax-free reorganization under IRC Section 368(a) does not constitute a disposition [which would otherwise require valuation on the date of disposition under IRC Section 2032(a)(1)], the court had to value the property in the condition it existed as of the date six months after the decedent’s death pursuant to IRC Section 2032(a)(2). By that point in time, the character of the property had changed because the estate had exchanged the stock it held on the date of death for different stock that was subject to restrictions.

The Service argued, among other things, that the court should ignore the post-death restrictions in valuing the stock. In making that argument, the Service relied on the legislative history of the predecessor to IRC Section 2032, which indicates that Congress intended to provide relief for post-death decreases in the value of estate property resulting from market forces when valuing estate property on the alternate valuation date [See, S. Rep. No. 1240, at 9 (1935) and 79 Cong. Rec. 14632 (1935) (statement of Mr. Samuel B. Hill); see, also, Maass v. Higgins, 312 U.S. 443, 446 (1941) (purpose of predecessor to IRC Section 2032 was to "mitigate the hardship consequent upon shrinkage in the value of estates during the year following death")]. Thus, post-death restrictions that reduce the value of estate property should not support a discount [See, Flanders v. United States, 347 F. Supp. 95 (N.D. Cal. 1972) (estate may not claim a discount for a land conservation easement placed on estate property after the decedent’s death)]. In Kohler, the Tax Court disagreed and held for the taxpayer.

Further, the Service posited that the court erred in focusing on whether a disposition had occurred, rather than on whether it should take into account a change in the character of the property which had occurred during the alternate valuation period. In this regard, the Service cited Treasury Regulation Section 20.2032-1(c)(1), which addresses what constitutes a disposition for purposes of determining when to value property (either on the date of disposition or the date six months after the decedent’s death)—not the character of the property to be valued. In similar circumstances, the district court in Flanders held that, "Congress intended that the character of the property be established for valuation purposes at the date of death. The option to select the alternative valuation date is merely to allow an estate to pay a lesser tax if unfavorable market conditions (as distinguished from voluntary acts changing the character of the property) result in a lessening of its fair market value" [Flanders v. United States, 347 F. Supp. 95, at 98 (N.D. Cal. 1972); c.f. Estate of Holl v. Comm’r, 967 F.2d 1437 (10th Cir. 1992) (Oil and gas extracted after death must be valued in its condition as of the date of death, i.e., as minerals in place, citing Flanders for the proposition that the value of the asset must recognize its condition as of the date of death or its "pre-change value")]. Consistent with the valuation approach in Flanders, the character of the property to be valued in Kohler was established for valuation purposes as of the date of death. Consequently, opined the Service, the court should have ignored changes in the character of the stock due to the post-death restrictions in determining the value of the stock on the alternate valuation date [Nonacq. action on decision, 2008-01].

Doug H. Moy


Doug H. Moy is a nationally recognized author, consulting specialist, seminar instructor and educator. He has an undergraduate degree from Willamette University and a Masters degree from Washington State University. Since 1979, Mr. Moy has consulted to attorneys, tax practitioners and their clients, as well as assisted practitioners representing clients before the IRS Conference of Right and Appeals Division and Settlement Conference Negotiations. He is noted for his ability to communicate his unparalleled knowledge and experience to practitioners at all levels in his field of expertise; namely, estate/gift taxation and planning, with special expertise in living trusts; community property; lottery prize winnings; structured settlement trusts; extricating clients from abusive trust tax shelters; designing effective estate plans; and preparation of Form 706 Estate Tax Returns and 709 Gift Tax Returns. He offers particular assistance and exceptional skill designing creative, practical solutions to challenging and difficult estate planning situations.