In a recent case, the IRS denied an estate a fractional interest discount on the family ranch, resulting in a seven digit tax bill and the likely liquidation of the family homestead.  The father had numerous options for securing a valuation discount on, or excluding the value of, a significant tract of property from his gross estate, but hadn’t done any planning since 1965, resulting in total denial of a discount.  When he died in 2004, the property was worth $6,390,000.  Don’t let this be your client.

The dispute between the IRS and the father’s estate centered on whether the property’s value in the gross estate was: (1) the undiscounted value of a fee simple interest in the property or (2) the aggregated value of the children’s fractional interests in the property—valued separately with fractional interest discounts.  Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of valuation discounts in Advisor’s Journal, see IRS Rebuffed by Federal Court of Appeals in Valuation Discount Case (CC 11-21) and Valuation Discounts: Only for a Bona Fide Business (CC 10-60).

For in-depth analysis of valuation discounts, see Advisor’s Main Library: A—Family Limited Partnerships and Estate & Gift Tax Valuation Discounting.

Why is this Topic Important to Wealth Managers? Discusses Internal Revenue Code Section 179 in relation to the Obama Tax Cuts.  Presents analysis of a common transaction used by small business when acquiring capital assets.

Last month we discussed Section 179 in conjunction with year-end tax planning.   As a general matter of review, businesses may take “annual deductions for depreciation and amortization to the extent they represent a reasonable allowance for the exhaustion, wear and tear of property used in a trade or business or held for the production of income.” [1] This concept is based on the matching of the actual use of the property as a deductible expense.

However, earlier this year, Congress enacted the Small Business Jobs Act of 2010, [2] which included several changes in areas concerning the tax law, in part regarding Section 179. [3]

Specifically, the Small Business Jobs Act, “increased the maximum amount deductible under [Internal Revenue Code] Section 179 which allows, under certain situations, for the expense of generally depreciable assets.” [4]

Therefore, subject to certain limitations, a taxpayer that invests in certain qualifying property may elect under section 179 to deduct (or “expense”) the cost of qualifying property, rather than to recover such costs through annual depreciation deductions occurring over the useful life of the asset.

As was discussed in an earlier blogticle, for taxable years beginning in 2010 and 2011, the maximum amount that a taxpayer may expense is $500,000 of the cost of qualifying property placed in service for the taxable year.  The $500,000 amount is reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the taxable year exceeds $2,000,000. [5]

Section 402 of the Tax Relief, Unemployment Insurance Reauthorization, And Job Creation Act of 2010 [6], amended certain deductible amounts with regards to section 179 that become effective beginning in 2012.

The new law states that, for taxable years beginning in 2012, the maximum amount a taxpayer may expense, under Section 179, is $125,000 of the cost of qualifying property placed in service for the taxable year. The $125,000 amount is reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the taxable year exceeds $500,000.

Furthermore, the new law states that, for taxable years beginning in 2013, and thereafter, the maximum amount a taxpayer may expense under Section 179 is $25,000 of the cost of qualifying property placed in service for the taxable year.  The $25,000 amount is reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the taxable year exceeds $200,000.

Tomorrow’s blog will continue to discuss pertinent provisions of the new Tax Cuts.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

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[1] AdvisorFX.  Business Income and Deductions (AUS Main Section 19, B4). http://www.advisorfx.com/articles/f19_1_8_3260.aspx?action=13.  Citing, 26 C.F.R. §1.167(a)-1, 26 U.S.C. §§167, 168, 169, 179 and related regulations.

[2] H.R. 5297.  http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=111_cong_bills&docid=f:h5297enr.txt.pdf.  Last Accessed 11/8/2010.

[3] H.R. 5297. Section 2021.

[4] Business West. Year-end Tax Planning.  http://businesswest.com/2010/11/year-end-tax-planning. 09 November 2010.   Last Accessed 11/8/2010; 113 Journal of Taxation 195.

[5] 26 U.S.C. § 179 (b)(1)(B).

[6] HR. 4853.