Joseph “Pop” Preuschoff acquired the Preuschoff Ranch, a 2,345 acre cattle ranch in Madera, California in the early 1900s. Joseph had a daughter, Mary Valen Alen. Mary had a son, Joseph. Joseph inherited a 13/16th interest in the ranch at his mother’s death. Joseph married three times and had six children, four by his first marriage and two by his second marriage. His Will left his four children by his first marriage small gifts and left the bulk of his estate, including the ranch, to his two children from the second marriage, Shana and Brett, who were ages 18 and 14 at the time of his death. Joseph’s third wife, Bonnie, was named executor and trustee of the testamentary trusts for Shana and Brett. Bonnie received just over $800,000 in specific gifts as her share of the estate. Shana and Brett described Bonnie as a very dominant person with whom they had a tumultuous relationship.
Bonnie hired a probate referee (court appraiser) to value the ranch for the probate proceedings. The probate referee, Richard Grey, valued the ranch at $1.963 million. On the estate tax return, Form 706, Bonnie gave the ranch a value of $144,823. The lower value was in large part due to an election under Internal Revenue Code § 2032A. This election allows the executor to value farmland at below fair market value, if the property is going to continue to be used as a farm by the heirs to the estate. The election on the estate tax return was signed by Bonnie, Shana, and Virginia, as the guardian ad litem for Brett.
The IRS audited the estate tax return and disputed the value of the ranch. After the dispute with the IRS arose, Bonnie amended the estate tax return to show the § 2032A value of the ranch as $98,735. After further negotiations, the IRS accepted the lower valuation for the ranch, perhaps because the estate increased the value of two other properties for which it had also made a § 2032A election and entirely eliminated the election on a third property. The net result of the audit was the value of the entire estate was increased by approximately $1 million and the estate tax to be paid was increased by $20,000, to $120,000. Later, at trial, the U.S. Tax Court held that Shana and Brett benefitted greatly by the efforts of Bonnie and her tax attorney, saving hundreds of thousands of dollars in estate taxes at their father’s death.
Almost ten years after the estate settled its estate tax liability, California Rangeland Trust purchased a conservation easement on the Preuschoff Ranch for $1.12 million. Shana and Brett’s share (13/16th) was $910,000. After subtracting various trust-level deductions, the trust reported almost $720,000 in income, which was in turn reported fifty percent each to Shana and Brett as their share of the income.
Shana and Brett elected not to report the trust income on their personal income tax returns. Naturally, the IRS questioned why the income shown on their returns did not match the income reported to the IRS by the trustee of the trust. The IRS issued notices of deficiency and the cases were consolidated at trial (Brett Van Alen et al. v. Commissioner, T.C. Memo 2013-235). Shana and Brett argued that their tax basis in the ranch was much higher than the basis used by the trustee, who used the value reported on Joseph’s estate tax return. They retained an expert who testified to the ranch’s value. (Is it coincidental that the expert was the same Richard Grey, who had originally valued the interest in the farm at $1.963 million?) Shana and Brett’s tax expert testified that the correct basis for each was approximately $900,000, meaning that each had virtually no capital gain to report on their respective tax returns. The expert testified that Shana and Brett should not be bound by the value reported on the estate tax return, as when the executor determined the value, Shana was barely 18 years old and Brett was still a minor.
However, the Tax Court found that Shana and Brett benefited substantially from the position taken by the executor and that the duty of consistency “serves to prevent inequitable shifting of positions by taxpayers.” The Ninth Circuit Court of Appeals has listed conditions that the court must find to invoke the duty of consistency: (1) a representation by the taxpayer, (2) reliance by the IRS, and (3) an attempt by the taxpayer, after the statute of limitations has run, to change the previous representation or to recharacterize the situation in a way that harms the IRS. The big dispute here is that Shana and Brett assert they did not make a representation on which the IRS relied – the executor of the estate, Bonnie, did. They believe they are not bound by Bonnie’s representation, especially given the nature of their relationship with Bonnie and their ages at the time the representation was made. The Tax Court examined cases which held that the duty of consistency encompasses parties with sufficiently identical economic interests, including beneficiaries of an estate. The court held that Brett and Shana, as well as their father’s estate, benefited from the position taken by Bonnie as executor. It stated that the savings in estate tax was in excess of a half million dollars. As such, the Tax Court found in the IRS’ favor and agreed that the § 2032A value should be used for purposes of determining the tax basis of Shana and Brett in the ranch property. To rule otherwise would have allowed Shana and Brett to benefit both from the position taken on the estate tax return, as well as from the position they are taking on their income tax returns, effectively benefiting twice from inconsistent positions relating to the same property.
Our office focuses on estate planning and administration, including probate, trust administration, and post mortem tax planning. We work with clients of all wealth levels, including clients who will be subject to estate tax at death. As a member of the American Academy of Estate Planning Attorneys, our firm is kept up to date with information regarding tax developments and new cases such as the one that is the subject of this alert. You can get more information about a complimentary review of your clients’ existing estate plans and our planning and administration services by calling our office.
