Democrats’ massive Build Back Better bill not only protects stepped-up basis, it also includes a long-sought change in an estate-tax provision that could have far-reaching benefits for many farms.
Congress created the provision, known as Section 2032A, in 1997 to allow farm families to lower or eliminate their estate tax bill by reducing the value of their real property to reflect its use as farmland rather than its market value.
The problem is, that valuation reduction was set at $750,000 and indexed for inflation, putting the 2021 limit at about $1.2 million. But adjusting the cap for inflation hasn’t come close to keeping up with increases in the price of land. Farmland values have increased by 223% between 1997 and 2019, according to a study by the American Farm Bureau Federation.
Farm groups have been lobbying for years to get the limit increased, and finally succeeded when Rep. Jimmy Panetta, D-Calif., and other lawmakers inserted the provision in the bill’s revenue section to increase the 2032A limit to $11.7 million.
The change to the cap is paired with a cut to the individual estate tax exemption, and there are rules around the special-use valuation that can limit its overall benefit to heirs.
But tax experts say the higher cap will still help many farms and will offset the impact of slashing the estate tax exemption, something that’s scheduled to happen in 2026 regardless of what happens with the Build Back Better bill.
The existing limit is so low in relation to land values that the Section 2032 provision is “pretty close to worthless,” said Paul Neiffer, an agricultural tax specialist with CliftonLarsonAllen.
Paul Neiffer, CliftonLarsonAllen
“A lot of farm operations are actually better off” under the Democratic legislation, he said. Even though the estate tax exemption would be cut by about $6 million, the value of the Section 2032 provision would be increased by about $11 million, he said.
Danielle Beck, senior executive director of government affairs for the National Cattlemen’s Beef Association, told Agri-Pulse the higher limit “does represent a meaningful opportunity for producers to potentially lower their estate tax burden, but there are a number of parameters around that provision of the code that really must be satisfied in order to effectively make that election and reap the full benefits.”
The changes in tax policy are far from being law yet.
The size and makeup of the Build Back Better bill also are still in some doubt. House Budget Committee Chairman John Yarmuth, D-Ky., told reporters Monday there were ongoing talks between the House and Senate on issues including the tax provisions to come up with a compromise on which Democrats in both chambers can agree.
“We could pass our own bill now, but it probably wouldn't stand much of a chance” in the Senate, he said.
Some Senate Democrats have continued to call for imposing taxes on capital gains at death, an issue that has alarmed farm groups since heirs would effectively lose the benefit of stepped-up basis.
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The Section 2032A provision allows the farm family to calculate an agricultural-use valuation for land based on the cash rental value and Farm Credit System loan rates. The resulting valuation can be significantly below the market value for the land.
Neiffer gives the example of a farmer who owns 1,200 acres of land worth $15,000 per acre, bringing the total land value to $18 million. Without Section 2032A, the farmer's family would owe about $4.8 million in estate taxes, assuming the personal exemption, now $11.7 million, is lowered to about $6 million in 2022, as the Build Back Better would do. The tax rate on estates, which the bill wouldn't change, ranges up to 40%.
Using Section 2032 and assuming an average rental income of $300 an acre, the valuation for the land would drop to $7.9 million, more than $10 million below the market value. The estate tax on the land would drop to $780,000.
Restrictions on the use of the provision are significant. The land must remain in farming for another 10 years and the special-use valuation only applies to spouses, parents and lineal descendants. Cousins aren’t eligible, for example.
“You're gonna have to have a son or daughter that's in farming. That’s getting tougher and tougher these days,” Neiffer said.
Moreover, if the heirs decide to sell the land at some point they could face a stiff capital gains tax on it. When Section 2032A is used, the basis for the land becomes that special-use valuation — $7.9 million in Neiffer’s example — not the fair market value of $18 million.
Danielle Beck, NCBA
Heirs who sell the land would be taxed on the gain above $7.9 million, not the increase above the market value at the time the property was inherited. If the land were to sell for $20 million, the heirs would owe tax on a gain of more than $12 million.
And yet another potential challenge for heirs is that the Internal Revenue Service will attach a lien to the property on which Section 2032A is used in case it is sold during the 10-year period. That IRS lien could deter some banks from making loans against the value of the land, Neiffer said.
“When there's a lack of capitalization in agriculture across the board, any additional barriers or restrictions to credit is something that you're going to have to really weigh carefully when you're deciding whether or not 2032A is a good fit for you,” said NCBA’s Beck. “It works for some, it doesn't work for everybody.”
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