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Such an argument would raise additional issues such as how to identify and value the gift portion of the transaction and how to apply section 483 to the remainder of the transaction. In addition, since section 483 may be relied on by taxpayers to recharacterize transactions, the Treasury may find taxpayers on different sides of the same transaction taking inconsistent positions. For example, in a sale of property by a parent to a child at its fair market value with no provision for interest, the parent might argue that a gift had been made of the interest (i.e., no ordinary income to the parent), the child might rely on section 483 to impute interest (i.e., a deduction from income for the child) and the Treasury might value the gift by relying on section 483 to recompute the purchase price and then treat the difference between the fair market value and the recomputed price as the gift.

Structuring transaction to avoid section 483 If taxpayers wish to avoid the imputation of interest at the imputed rate, they can structure the sale so that the stated interest rate is at least as much as the test rate under section 483, which is 1 percent lower than the imputed rate. The effect of increasing the stated interest rate depends on whether there is a corresponding reduction in sales price or simply an additional amount of interest charged. If there is a corresponding reduction in sales price, so that the total payments are not increased, the result is similar to that resulting from application of section 483 except that less of the sales price is converted to interest.

On the other hand, the total payments would be increased if the sales price were left unchanged and additional interest were charged. In this case, the seller would have additional interest income and no reduction in capital gain. The buyer would have additional interest expenses, but no reduction in basis for determining depreciation allowances, tax credits, or gain on later disposition. This type of structuring results in more income and more tax liability for the seller. The buyer incurs extra interest expenses and has extra interest deductions that provide some offset. This type of structuring might be preferred by related taxpayers who wish to avoid any possible gift issues raised by a reduction in sales price.

C. Issues Concerning Treasury Implementation On August 29, 1980, the Treasury published proposed regulations to adjust the interest rates imputed under sections 482 and 483 to more accurately reflect market interest rates. Under the proposed regulations, the safe haven rule for loans and advances under section 482 would consist of a range from 11 percent to 13 percent per annum simple interest. If the interest charge is within this range, that the rate actually charged is presumed to be at arm's length. If the rate actually charged does not fall within this range and the taxpayer does not establish a more appropriate rate (i.e., an arm's-length rate), the interest rate imputed under section 482 would be 12 percent per annum simple interest.2

The interest rate imputed under section 483 on the sale of property subject to deferred payments would be 10 percent compounded-semiannually. The test rate used to determine whether the imputed rate will be applied would be changed to 9 percent per annum simple interest. The notice of proposed rule making states that the difference between the interest rates under sections 482 and 483 is explained by the fact that the 10-percent rate in section 483 is absolutely binding whereas the range of interest rates in section 482 is only a safe harbor. Therefore, the Treasury decided that the proposed regulations should take a more lenient approach under section 483 than under section 482.

In response to concerns raised by members of the Congress with respect to the proposed regulations, former Assistant Secretary of the Treasury Lubick agreed in a letter to Senator Melcher that no final action would be taken on the proposed regulations before July 1, 1981.

The Treasury also announced, as part of the notice of proposed rulemaking, its intention to consider whether the interest rates under sections 482 and 483 should be adjusted automatically in the future.

In addition to increasing concern over existing issues such as whether section 482 applies to intra-family transactions or whether section 483 should provide for an array of interest rates depending upon the kind of property sold or the seller's location, the notice raises several other issues.

The first issue is whether the same interest rate should apply for purposes of both section 482 and section 483. The Treasury proposed differing rates and justified these on the grounds that section 482 may be avoided by proof that the rate actually used is more appropriate whereas section 483 may not be avoided in that manner. On the other hand, it is not clear that lending transactions subject to section 482 differ enough from those subject to section 483 to predict that in arm's

Under another proposed rule, section 482 would not apply to loans or advances, when the interest or principal amount is expressed in a foreign currency. This proposed change was not addressed by the Subcommittee's hearing announcement and is not described in this pamphlet.

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length transactions higher rates would be charged in section 482 transactions.

If different rates are set, a second issue arises which is whether section 482, section 483, or both will apply in a transaction subject to both provisions. Existing regulations under section 482 provide that the treatment of unreleated taxpayers should govern related taxpayers. This implies that section 483 should apply. However, the section 483 regulations contemplate the application of other provisions in addition to section 483.

An added difficulty arises from the fact that under section 482 a taxpayer may prove that a rate below the safe haven rate is appropriate but is not permitted to prove the appropriateness of a lower rate for section 483 purposes. How these various provisions might be applied probably would depend on the particular case in which the issue arose. For example, a transaction using a rate lower than the section 482 rate but higher than the section 483 rate would be more likely to survive scrutiny under section 482 than one in which no interest is charged.

A third issue raised by the Treasury in the notice of proposed rulemaking is whether some system for automatically adjusting interest rates under sections 482 and 483 should be adopted. The Treasury has the authority to adopt such a system without additional legislation. Related to this issue are the questions of how closely interest rates under sections 482 and 483 should reflect market rates of interest charged with respect to such instruments as mortgages, Treasury bills, and corporate bonds.

In 1965, when the first regulations under section 483 were issued, the test rate was set at 4 percent and the imputed rate at 5 percent. At that time, the prime rate was approximately 412 percent, mortgage rates were approximately 51/2 percent, and government and corporate bond rates were approximately 41/2 percent. In 1975, when the rates were last adjusted, the test rate was set at 6 percent and the imputed rate was set at 7 percent. At that time, the prime rate was at 7%8 percent and corporate bonds were yielding 812 to 9 percent.

II. CURRENT USE VALUATION (SECTION 2032A)

A. Legislative History and Background In the case of decedents dying before January 1, 1977, the value of all property included in the gross estate, for purposes of determining the Federal estate tax, was the fair market value of the property interest at the date of the decedent's death (or at the alternate valuation date, if elected). The fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts. The fair market value of property will depend upon the use to which it is, or may be, put.

If the fair market value of real property is subject to dispute, there are several valuation techniques which the courts tend to accept. These methods include the income-capitalization technique, the reproductioncost-minus-depreciation technique, and the comparative sales technique. Courts generally will use one of these methods, or a combination of these methods, in determining fair market value.

However, in the case of land, it is presumed that the price between a willing buyer and a willing seller will be based on the highest and best use" to which that land could be put, rather than the current use of the land at the time it is transferred.

As part of the Tax Reform Act of 1976, Congress enacted a new section (sec. 2032A) that permits an executor to elect to value real property on the basis of the property's value as a farm or in a closelyheld business rather than on the basis of its highest and best use. This election is available to estates of decedents dying after December 31, 1976.

The legislative history of the Tax Reform Act of 1976 stated that the Congress believed that, when land is actually used for farming purposes or in other closely-held businesses (both before and after the decedent's death), it is inappropriate to value the land on the basis of its full fair market value since it is desirable to encourage the continued use of property for farming and other small business purposes. In some cases, the greater estate tax burden from valuing property at its highest and best use could make continuation of farming, or the closely-held business activities, infeasible because the income potential from these activities is insufficient to service extended tax payments or loans obtained to pay the tax. Thus, the heirs may be forced to sell

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1 While the special valuation method provided by section 2032A is generally referred to in this pamphlet as "current use valuation method", it should be noted that, where the formula method (discussed below) is available, the value of real property under section 2032A may be (and often is) less than the current use value of the real estate.

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the land for development purposes. Also, when the valuation of land reflects speculation to such a degree that the price of the land does not bear a reasonable relationship to its current earning capacity, the Congress believed it unreasonable to require that this “speculative value” be included in an estate with respect to land devoted to farming or closely-held businesses.

To date, the current use valuation provision has been used almost exclusively for the valuation of real estate used in the trade or business of farming. When estates are eligible for current use valuation, the benefits have been substantial. Table 1, below, sets forth the results of a survey by the Internal Revenue Service indicating the average reduction in value (i.e., average discount) for farms eligible for current use valuation.

TABLE 1.–PERCENTAGE REDUCTION IN VALUATION OF FARM LAND UNDER CURRENT USE VALUATION IN DIFFERENT IRS REGIONS

Midwest Region
Percent Mid-Atlantic Region

Percent Springfield, Illinois62 Philadelphia, Pennsylvania.

76 Chicago, Illinois.61 Newark, New Jersey -

63 Des Moines, Iowa.-50 Baltimore, Maryland.

60 Fargo, North Dakota.

47 Richmond, Virginia. Milwaukee, Wisconsin. 62 Wilmington, Delaware

59 Omaha, Nebraska.

85

North Atlantic Region St. Louis, Missouri.-

49 Aberdeen, South Dakota-47 Albany, New York..

23 St. Paul, Minnesota--47 Boston, Massachusetts.

67 Brooklyn, New York.

42 Southwest Region

Buffalo, New York

46 Albuquerque, New Mexico. 65 Burlington, Vermont

68 Oklahoma City, Oklahoma. 64 Hartford, Connecticut.

70 Austin, Texas.-67 Manhattan, New York.

39 Dallas, Texas_

64 Portsmouth, New Hampshire.. 32 Wichita, Kansas--39 Providence, Rhode Island..

26 Cheyenne, Wyoming

71 Denver, Colorado.

63

Western Region Little Rock, Arkansas. 44 Boise, Idaho..

52 New Orleans, Louisiana.. 44 Helena, Montana.

47 Seattle, Washington.

40 Southeast Region

Portland, Oregon-

57 Greensboro, North Carolina

44 Fresno, California (IRS Service Jacksonville, Florida65 Center)

55 Nashville, Tennessee66 Salt Lake City, Utah.

46 Atlanta, Georgia--43 Los Angeles, California.

29 Birmingham, Alabama67 Phoenix, Arizona..

59 Columbia, South Carolina--57 San Francisco, California.

40 Central Region Cincinnati, Ohio--Cleveland, Ohio.--

49 Detroit, Michigan..

62 Indianapolis, Indiana.

51 Louisville, Kentucky

51 Parkersburg, West Virginia--- 46

Source: Treasury Department testimony of March 4, 1980, before the Subcommittee on Taxation and Debt Management of the Senate Finance Committee, based on IRS survey of November 1979 showing reduction in fair market value of property (as reported by executors) resulting from election of current use valuation.

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