Duty of consistency thwarts inheritors’ basis step-up

The Tax Court held that the duty-of-consistency doctrine prevented two taxpayers from using fair market value (FMV) as the basis of inherited property where the estate had previously valued the property using the special valuation election of Sec. 2032A.

The value of property included in a decedent’s estate is its FMV, determined on the basis of its highest and best use. Sec. 2032A permits an estate to instead value property based on its current use if the executor so elects and (1) the decedent is a U.S. citizen or resident, (2) the property is qualified real property, and (3) each person with an interest in the property signs and files a personal liability agreement. Real property is qualified within the meaning of Sec. 2032A if it was passed to or acquired by a family member of the decedent, and on the date of the decedent’s death it was used by the decedent or family member as a farm or in another trade or business (qualified use). There are also requirements regarding the percentage of the adjusted value of the gross estate the property represents and the period of material participation in a qualified use by the decedent or a member of the decedent’s family. The resulting decrease in value cannot exceed an inflation-adjusted amount (for decedents dying in 2013, $1.07 million).

Generally, taxpayers who inherit property have a basis in that property equal to its value used for estate tax purposes. However, Rev. Rul. 54-97 permits taxpayers to challenge that value by providing clear and convincing evidence, unless they are prevented by their previous actions. The courts have applied a duty of consistency that forbids taxpayers from making a representation that conflicts with a past one after the expiration of the statute of limitation that was previously relied upon by the IRS, if that change would be detrimental to the Service.

Joseph Van Alen, a resident of California, died in 1994, leaving his interest in a 2,345-acre cattle ranch to a trust. His daughter, Shana, 18, and his son, Brett, 14, were equal beneficiaries in the trust. A probate referee appraised the ranch interest at $1.963 million; however, the interest was valued for estate tax purposes at $144,823 after the estate made a Sec. 2032A election. All the qualified heirs including the two children signed the Sec. 2032A agreement (Brett via his mother as guardian ad litem), which made them personally liable for any additional estate tax if they sold the ranch or quit using it for agricultural purposes.

In 2007, the trust received $910,000 from the sale of a conservation easement on the ranch and filed a trust return reporting more than $300,000 of capital gain on each beneficiary’s Form K-1, Beneficiary’s Share of Income, Deductions, Credits, etc. Neither taxpayer reported any gain on his or her 2007 income tax return. Each of the taxpayers received a notice of deficiency. After contacting the appraiser used for probate purposes, the trust’s accountant, relying on Rev. Rul. 54-97, filed an amended 2007 return showing a much higher basis and no capital gain to the siblings. Both petitioned the Tax Court for relief, arguing the estate’s election should not bind the trust.

The court held that the duty-of-consistency principle overruled Rev. Rul. 54-97 and rejected the taxpayers’ argument that Rev. Rul. 54-97 allowed the trust to use a different basis than that of the estate. The parties agreed that the IRS had relied on a representation on the estate tax return and that an attempt had been made after the statute of limitation had expired on that return to change that representation to the IRS’s detriment.

The taxpayers, however, argued that the duty of consistency did not apply because they were merely beneficiaries of the estate and had no control over it and had no fiduciary powers, and thus they never made any representation on the estate tax return. The court explained that if two parties make representations, and the parties have sufficiently identical economic interests, the duty of consistency will encompass representations by both parties. The court found that the economic interests of the estate and the taxpayers were sufficiently identical, since both the estate and the beneficiaries benefited from the estate tax savings. In addition, the court noted, both taxpayers (one through his guardian ad litem) had signed agreements necessary for the estate to make the Sec. 2032A election, further binding the taxpayers to the estate’s representations on the estate tax return.

The court also upheld the assessment of a 20% accuracy-related penalty because neither taxpayer had relied on any professional advice before filing his or her 2007 returns that reported no capital gain.

  Van Alen, T.C. Memo. 2013-235

By Charles J. Reichert, CPA, instructor of accounting, University of Minnesota–Duluth.