SCOTUS Reports

Tag: Material Participation

  • Frank Aragona Trust v. Commissioner, 142 T.C. 165 (2014): Application of Section 469(c)(7) Exception to Trusts

    Frank Aragona Trust v. Commissioner, 142 T. C. 165 (U. S. Tax Court 2014)

    The U. S. Tax Court ruled in favor of the Frank Aragona Trust, clarifying that trusts can qualify for the exception under Section 469(c)(7) of the Internal Revenue Code. This decision allows trusts to treat rental real estate activities as non-passive if they meet specific participation criteria, impacting how trusts manage their real estate investments and report losses for tax purposes.

    Parties

    The petitioner was the Frank Aragona Trust, with Paul Aragona as the executive trustee. The respondent was the Commissioner of Internal Revenue.

    Facts

    The Frank Aragona Trust, established in 1979 by Frank Aragona, owned rental real estate and engaged in other real estate activities. Upon Frank Aragona’s death in 1981, the trust was managed by six trustees, including his five children and an independent trustee. The trust operated through various entities, including Holiday Enterprises, LLC, a wholly owned subsidiary that managed most of the trust’s rental properties. The trust incurred losses from its rental activities in 2005 and 2006, which it reported as non-passive, enabling it to carry back net operating losses to 2003 and 2004. The IRS challenged the trust’s classification of these activities as non-passive, asserting that the trust’s rental real estate activities should be treated as passive under Section 469(c)(2), unless an exception applied.

    Procedural History

    The IRS issued a notice of deficiency to the trust for the tax years 2003, 2004, 2006, and 2007, asserting deficiencies in federal income tax and penalties. The trust filed a petition with the U. S. Tax Court contesting the IRS’s determinations. The court’s jurisdiction was based on Section 6214(a), allowing it to redetermine the deficiencies and penalties. After the IRS conceded the penalties for the relevant years, the court focused on whether the trust qualified for the Section 469(c)(7) exception and the proper characterization of trustee fees as expenses.

    Issue(s)

    Whether the Section 469(c)(7) exception, which allows certain taxpayers to treat rental real estate activities as non-passive, applies to a trust?

    Rule(s) of Law

    Section 469(c)(7) of the Internal Revenue Code provides an exception to the general rule that rental activities are treated as passive under Section 469(c)(2). The exception applies if more than one-half of the taxpayer’s personal services in trades or businesses are performed in real property trades or businesses in which the taxpayer materially participates and if the taxpayer performs more than 750 hours of services in such businesses annually. The statute does not explicitly exclude trusts from this exception.

    Holding

    The U. S. Tax Court held that a trust can qualify for the Section 469(c)(7) exception. Services performed by the trust’s individual trustees can be considered personal services performed by the trust, enabling the trust to meet the criteria for the exception. The court further held that the Frank Aragona Trust materially participated in its real property trades or businesses, thus qualifying for the exception.

    Reasoning

    The court’s reasoning included several key points:

    – The court rejected the IRS’s argument that trusts cannot perform “personal services” as defined by Section 1. 469-9(b)(4) of the regulations, which specifies “any work performed by an individual in connection with a trade or business. ” The court reasoned that work performed by individual trustees on behalf of the trust can be considered personal services performed by the trust itself.

    – The court noted that the statute’s use of the term “taxpayer” in Section 469(c)(7), as opposed to “natural person” used in other parts of the Code, suggested that Congress did not intend to exclude trusts from the exception.

    – The court considered the legislative history of Section 469(c)(7) but found it did not explicitly limit the exception to individuals and closely held C corporations.

    – Regarding material participation, the court determined that the activities of all six trustees, including their work as employees of Holiday Enterprises, LLC, should be considered in assessing whether the trust materially participated in its real estate operations. The trust’s extensive involvement in real estate, managed primarily by three full-time trustees, supported the finding of material participation.

    – The court did not need to decide the proper characterization of trustee fees as expenses of the trust’s rental real estate activities, as the trust’s qualification under Section 469(c)(7) meant its rental activities were not passive.

    Disposition

    The court decided to enter a decision under Tax Court Rule 155, reflecting that the trust’s rental real estate activities were not passive due to the application of the Section 469(c)(7) exception.

    Significance/Impact

    This case is significant as it clarifies the application of the Section 469(c)(7) exception to trusts, potentially affecting how trusts structure their real estate investments and report losses. The ruling provides trusts with an opportunity to treat rental real estate activities as non-passive, thereby increasing their flexibility in managing tax liabilities. It also highlights the need for clear regulations regarding the material participation of trusts in passive activities, as noted by various commentators. The decision may influence future IRS guidance and court interpretations concerning trusts and passive activity rules.

  • Frank Aragona Trust v. Commissioner, 142 T.C. No. 9 (2014): Application of Section 469(c)(7) Exception to Trusts

    Frank Aragona Trust v. Commissioner, 142 T. C. No. 9 (2014)

    In Frank Aragona Trust v. Commissioner, the U. S. Tax Court ruled that trusts can qualify for the section 469(c)(7) exception, which allows certain real estate professionals to treat their rental real estate activities as non-passive. The court found that services performed by individual trustees on behalf of the trust can be considered personal services performed by the trust itself. This decision expands the scope of the exception beyond individuals and closely held C corporations, potentially affecting how trusts report income and losses from rental real estate activities.

    Parties

    The petitioner, Frank Aragona Trust, was represented by Paul Aragona, its executive trustee, against the respondent, the Commissioner of Internal Revenue. The case was heard in the United States Tax Court.

    Facts

    The Frank Aragona Trust, a complex residuary trust, was established in 1979 by Frank Aragona with his five children as beneficiaries. After Frank’s death in 1981, six trustees, including the five children and an independent trustee, managed the trust. The trust’s primary activities included owning and managing rental real estate properties and engaging in other real estate businesses. The trust paid annual fees to its trustees, which were reported as expenses on its tax returns. The trust claimed losses from its rental real estate activities as non-passive, which allowed it to offset these losses against other income, resulting in net operating losses carried back to previous years.

    Procedural History

    The Commissioner issued a notice of deficiency determining that the trust’s rental real estate activities were passive, which would disallow the offsetting of losses against other income. The trust petitioned the Tax Court to redetermine the deficiencies. The IRS conceded on the issue of accuracy-related penalties but maintained that the trust’s rental activities were passive. The trust argued that it qualified for the section 469(c)(7) exception, which would treat its rental activities as non-passive.

    Issue(s)

    Whether a trust can qualify for the section 469(c)(7) exception, which requires that more than half of the personal services performed by the taxpayer in trades or businesses are in real property trades or businesses in which the taxpayer materially participates, and that the taxpayer performs more than 750 hours of services in such businesses?

    Rule(s) of Law

    Section 469 of the Internal Revenue Code generally disallows passive activity losses for certain taxpayers, including trusts. However, section 469(c)(7) provides an exception for rental real estate activities if the taxpayer meets specific criteria. The regulation at section 1. 469-9(b)(4) defines “personal services” as “any work performed by an individual in connection with a trade or business. “

    Holding

    The Tax Court held that a trust can qualify for the section 469(c)(7) exception. The court determined that services performed by individual trustees on behalf of the trust can be considered personal services performed by the trust, thus satisfying the statutory requirements for the exception.

    Reasoning

    The court rejected the IRS’s argument that a trust cannot perform personal services because the regulation defines personal services as work performed by an individual. The court reasoned that trustees, as individuals, can perform work on behalf of the trust in connection with a trade or business, thus fulfilling the statutory requirement. The court also noted that the legislative history did not explicitly exclude trusts from the exception, unlike other sections of the code that specifically limit applicability to “natural persons. ” The court further held that the trust materially participated in real property trades or businesses based on the activities of all six trustees, including their roles as employees of a wholly-owned entity, Holiday Enterprises, LLC. The IRS did not challenge whether the trust met the specific hour and service requirements of the exception, so the court did not address those issues.

    Disposition

    The Tax Court ruled in favor of the trust, holding that its rental real estate activities were not passive due to its qualification for the section 469(c)(7) exception. The case was set for further proceedings under Tax Court Rule 155 to determine the final tax liabilities.

    Significance/Impact

    This decision expands the application of the section 469(c)(7) exception to include trusts, potentially allowing them to treat their rental real estate activities as non-passive and offset losses against other income. This ruling may influence how trusts structure their real estate activities and report income and losses on their tax returns. The decision also highlights the need for clearer regulatory guidance on how trusts can satisfy the material participation requirements under section 469.

  • Garnett v. Commissioner, 132 T.C. 368 (2009): Application of Passive Activity Loss Rules to Limited Liability Entities

    Garnett v. Commissioner, 132 T. C. 368 (U. S. Tax Court 2009)

    In Garnett v. Commissioner, the U. S. Tax Court ruled that interests in limited liability partnerships (LLPs) and limited liability companies (LLCs) are not automatically subject to the passive activity loss limitations applicable to limited partners under IRC § 469(h)(2). The decision clarified that LLP and LLC members are not presumptively passive and must be evaluated under general material participation tests, impacting how losses from such entities are treated for tax purposes.

    Parties

    Paul D. Garnett and Alicia Garnett, Petitioners, filed a petition against the Commissioner of Internal Revenue, Respondent, in the U. S. Tax Court. They were represented by Jeffrey D. Toberer and Donald P. Dworak, while J. Anthony Hoefer represented the Respondent.

    Facts

    Paul and Alicia Garnett owned interests in seven limited liability partnerships (LLPs), two limited liability companies (LLCs), and two tenancies in common, primarily engaged in agribusiness operations. The Garnetts held most of their interests indirectly through five separate holding LLCs. The LLPs and LLCs reported income and losses on Forms 1065, and on Schedules K-1, they identified the Garnetts or the holding LLCs as limited partners or LLC members. The LLP agreements generally allowed partners to participate actively in management, while the LLC agreements provided for management by a manager selected by majority vote of the members. The tenancies in common were reported as partnerships for tax purposes, with one identified as a general partner and the other as a limited partner on Schedules K-1.

    Procedural History

    The Garnetts filed a motion for partial summary judgment, seeking a ruling that their interests in the LLPs, LLCs, and tenancies in common were not subject to the passive activity loss limitations under IRC § 469(h)(2). The Commissioner filed a cross-motion for partial summary judgment, arguing that the Garnetts’ interests should be treated as limited partnership interests under the temporary regulations. The Tax Court granted the Garnetts’ motion and denied the Commissioner’s motion, holding that the interests were not subject to the special rule of IRC § 469(h)(2).

    Issue(s)

    Whether the Garnetts’ interests in the LLPs, LLCs, and tenancies in common should be treated as interests in a limited partnership as a limited partner under IRC § 469(h)(2), thereby subjecting them to the passive activity loss limitations?

    Rule(s) of Law

    IRC § 469(h)(2) provides that “no interest in a limited partnership as a limited partner shall be treated as an interest with respect to which a taxpayer materially participates,” except as provided in regulations. Temporary regulations under § 1. 469-5T(e) define a “limited partnership interest” and provide exceptions, including that an interest shall not be treated as a limited partnership interest if the individual is a general partner at all times during the partnership’s taxable year.

    Holding

    The Tax Court held that the Garnetts’ interests in the LLPs and LLCs were not subject to the passive activity loss limitations under IRC § 469(h)(2) because they did not hold their interests as limited partners. The court further held that the Garnetts’ interests in the tenancies in common were also not subject to the rule, as they were not interests in limited partnerships.

    Reasoning

    The court reasoned that the legislative intent behind IRC § 469(h)(2) was to presume that limited partners do not materially participate in the business due to statutory restrictions on their involvement. However, members of LLPs and LLCs are not similarly restricted by state law, necessitating a factual inquiry into their participation under the general material participation tests. The court applied the temporary regulations and found that the Garnetts’ interests in the LLPs and LLCs should be treated as general partner interests, thus falling under the general partner exception in § 1. 469-5T(e)(3)(ii). The court also noted that the tenancies in common were not limited partnerships, and the Garnetts’ interests therein were not designated as limited partnership interests. The court rejected the Commissioner’s argument that the Garnetts’ limited liability status alone should determine their interests as limited partnership interests, emphasizing the need for a broader interpretation that aligns with the legislative purpose of § 469(h)(2).

    Disposition

    The Tax Court granted the Garnetts’ motion for partial summary judgment and denied the Commissioner’s cross-motion, holding that the Garnetts’ interests in the LLPs, LLCs, and tenancies in common were not subject to the passive activity loss limitations under IRC § 469(h)(2).

    Significance/Impact

    The decision in Garnett v. Commissioner has significant implications for the tax treatment of losses from LLPs and LLCs. It clarifies that members of such entities are not automatically subject to the passive activity loss limitations applicable to limited partners, requiring an analysis of their material participation under the general tests. This ruling may influence how taxpayers report and claim losses from similar entities and could lead to further scrutiny of the temporary regulations governing the application of IRC § 469(h)(2). The decision also underscores the need for the IRS to address the treatment of LLPs and LLCs in final regulations, given the evolving nature of business entities and their tax implications.

  • Krukowski v. Commissioner, 114 T.C. 366 (2000): Validity and Application of Passive Activity Recharacterization Rules

    Krukowski v. Commissioner, 114 T. C. 366 (2000)

    The IRS’s recharacterization rule for passive activity income is valid and applies to rental income from C corporations in which the taxpayer materially participates.

    Summary

    Thomas Krukowski, the sole shareholder of two C corporations, sought to offset a loss from renting a building to a health club with income from renting another building to a law firm in which he actively worked. The IRS disallowed this offset, applying the recharacterization rule that deems rental income from a business in which the taxpayer materially participates as nonpassive. The Tax Court upheld the rule’s validity, ruling it was within the IRS’s authority and not arbitrary or capricious. The court also found that the income from the law firm was not exempt under the written binding contract or transitional rules, as the 1991 lease renewal was considered a new contract post-dating the rule’s effective date.

    Facts

    Thomas Krukowski was the sole shareholder of a health club and a law firm, both operated as C corporations. He rented a building to the health club, incurring a loss of $69,100 in 1994, and another building to the law firm, earning income of $175,149. Krukowski reported both as passive activities on his 1994 tax return, offsetting the health club loss against the law firm income. The IRS recharacterized the law firm rental income as nonpassive under IRS regulations because Krukowski materially participated in the law firm’s activities. The initial lease with the law firm was signed in 1987 with options to renew, and a renewal was executed in 1991.

    Procedural History

    The IRS issued a notice of deficiency to Krukowski for $28,184 in 1994 taxes and a $5,637 accuracy-related penalty. Krukowski petitioned the Tax Court for redetermination. The IRS conceded the accuracy-related penalty. Both parties filed for summary judgment, and the case was decided on cross-motions for summary judgment in favor of the IRS.

    Issue(s)

    1. Whether the IRS’s recharacterization rule under Section 1. 469-2(f)(6) of the Income Tax Regulations is valid?
    2. Whether the recharacterization rule applies to Krukowski’s rental income from the law firm under the written binding contract exception?
    3. Whether the transitional rule in Section 1. 469-11(b)(1) of the Income Tax Regulations exempts Krukowski from the recharacterization rule?

    Holding

    1. Yes, because the rule is within the IRS’s statutory authority and is not arbitrary, capricious, or manifestly contrary to the statute.
    2. No, because the 1991 lease renewal with the law firm was considered a separate contract from the 1987 lease, not covered by the pre-1988 written binding contract exception.
    3. No, because the 1992 proposed regulations, applicable under the transitional rule, do not contain the exception that would exempt Krukowski from the recharacterization rule.

    Court’s Reasoning

    The court upheld the validity of the recharacterization rule, stating it was a legislative regulation within the IRS’s authority under Section 469(l) of the Internal Revenue Code, designed to prevent the sheltering of active income through passive losses. The court rejected Krukowski’s argument that the rule conflicted with statutory text, affirming it was neither arbitrary nor capricious. The 1991 lease renewal was deemed a new contract under Wisconsin law, thus not qualifying for the written binding contract exception applicable to pre-1988 contracts. Regarding the transitional rule, the court found that the 1992 proposed regulations did not retain the exception from prior temporary regulations that would have excluded C corporation activities from a shareholder’s material participation. The court’s interpretation of the regulations’ silence on this matter did not support Krukowski’s position. The court emphasized the IRS’s authority to change its position, provided it is publicly announced, which was done with the 1994 final regulations.

    Practical Implications

    This decision clarifies that rental income from a business in which a taxpayer materially participates cannot be offset by losses from other passive activities. Taxpayers must carefully consider the material participation rules and the effect of lease renewals on their tax strategy. The ruling underscores the IRS’s authority to issue and modify regulations to prevent tax avoidance, impacting how taxpayers structure their business and leasing arrangements. Subsequent cases have followed this precedent, reinforcing the application of the recharacterization rule to C corporation shareholders. Tax practitioners should advise clients to review and potentially restructure lease agreements in light of this ruling to ensure compliance and optimize tax outcomes.

  • Estate of Heffley v. Commissioner, 89 T.C. 265 (1987): When Passive Rental Income Does Not Qualify for Special Use Valuation

    Estate of Opal P. Heffley, Deceased, Timothy S. Heffley, Executor v. Commissioner of Internal Revenue, 89 T. C. 265 (1987)

    Passive rental of farmland to non-family members does not qualify for special use valuation under IRC Section 2032A.

    Summary

    Opal Heffley’s estate sought to value her farmland under the special use valuation provisions of IRC Section 2032A. However, the farmland was leased to non-family members under fixed-rent agreements, with no material participation by Opal or her family in the farm’s operation. The Tax Court held that the farmland did not meet the qualified use requirement and that there was no material participation, thus disqualifying the estate from special use valuation. Additionally, the court declined jurisdiction over the estate’s claim for reduced interest rates on the tax deficiency.

    Facts

    Opal Heffley owned a 296. 37-acre farm in Indiana, which was leased to non-family members from 1976 until her death in 1981. The lease agreements provided for fixed rent, not contingent on crop production, and required no services or management from Opal or her family. After her husband’s death in 1972, Opal managed the farm for one year before leasing it out. Her son, Timothy, occasionally helped the lessees but was compensated directly by them. Opal’s health declined after a 1975 stroke, preventing her from participating in farm management. Timothy’s independent farming activities in 1981 were minimal, involving only 18 acres of the farm.

    Procedural History

    The estate filed a Federal estate tax return electing special use valuation under IRC Section 2032A. The Commissioner determined a deficiency and denied the special use valuation, asserting that the farm was not put to a qualified use and there was no material participation. The estate petitioned the Tax Court, which upheld the Commissioner’s determination and also declined jurisdiction over the estate’s claim for reduced interest rates on the deficiency.

    Issue(s)

    1. Whether the farm was put to a qualified use within the meaning of IRC Section 2032A(b)(2) during the relevant period.
    2. Whether Opal Heffley or a member of her family materially participated in the operation of the farm during the relevant period.
    3. Whether the Tax Court has jurisdiction to allow the estate to pay interest on its deficiency at the reduced rate provided by IRC Section 6601(j).

    Holding

    1. No, because the farm was leased to non-family members under fixed-rent agreements, which constituted passive rental and not an active trade or business as required by IRC Section 2032A.
    2. No, because neither Opal nor Timothy participated in the management decisions, performed physical work, or assumed financial responsibility for the farm’s operation.
    3. No, because the Tax Court’s jurisdiction is limited to determining the amount of a deficiency, and the estate did not make a timely election under IRC Section 6166 to pay the tax in installments.

    Court’s Reasoning

    The court applied the regulations under IRC Section 2032A, which require the property to be used in an active trade or business, not merely as a passive investment. The leases to non-family members were for fixed rent, not dependent on crop production, and did not require any services from Opal or her family. The court found that Opal’s health prevented her from participating in the farm’s operation, and Timothy’s activities were insufficient to establish material participation. The court cited Estate of Martin and Estate of Abell, where similar passive rental arrangements were held not to qualify for special use valuation. On the interest issue, the court noted its limited jurisdiction and the absence of a timely election under IRC Section 6166, thus declining to review the interest claim.

    Practical Implications

    This decision clarifies that passive rental of farmland to non-family members does not qualify for special use valuation under IRC Section 2032A. Estate planners and tax professionals must ensure active involvement in the farm’s operation by the decedent or family members to qualify for this tax benefit. The decision also highlights the importance of timely elections for installment payments under IRC Section 6166 to secure reduced interest rates on deficiencies. Subsequent cases have followed this precedent, reinforcing the need for active management and participation to qualify for special use valuation. Practitioners should advise clients on the necessity of maintaining detailed records of their involvement in the farm’s operation to support a special use valuation claim.

  • Estate of Ward v. Commissioner, 89 T.C. 54 (1987): Material Participation in Sharecropping Arrangements for Special Use Valuation

    Estate of Rebecca Ward, Deceased, Floral Emerson and Reba Harris, Cotrustees and Coexecutrices v. Commissioner of Internal Revenue, 89 T. C. 54, 1987 U. S. Tax Ct. LEXIS 95, 89 T. C. No. 6 (1987)

    A decedent’s estate may qualify for special use valuation if the decedent materially participated in the operation of a farm under a sharecropping arrangement.

    Summary

    In Estate of Ward, the U. S. Tax Court ruled that Rebecca Ward materially participated in her farm’s operation under a sharecropping arrangement, allowing her estate to elect special use valuation under IRC Section 2032A. The court found Ward’s regular consultation with the sharecropper, inspection of the farm, and independent decision-making in crop harvesting and marketing sufficient to meet the material participation requirement. This case clarifies that material participation can be established even in modern, mechanized farming operations where the decedent does not physically operate the machinery.

    Facts

    Rebecca Ward owned a 118-acre farm in Indiana, which she operated under an oral sharecropping arrangement with Milton Barrett. Ward provided the land, while Barrett provided equipment and labor. They shared equally in the expenses and income from the grain farming operation, which included corn, soybeans, and wheat. Ward lived on the farm, inspected the fields regularly, and made independent decisions regarding the timing of crop harvesting and marketing. She was financially responsible for certain farm expenses and maintained her own books, although she did not initially report or pay self-employment tax on her farm income.

    Procedural History

    The Commissioner of Internal Revenue determined a deficiency in Ward’s estate tax, denying the estate’s election of special use valuation under IRC Section 2032A due to lack of material participation. The estate petitioned the U. S. Tax Court, which held in favor of the estate, allowing the special use valuation election.

    Issue(s)

    1. Whether Rebecca Ward materially participated in the operation of her farm within the meaning of IRC Section 2032A(b)(1)(C)(ii), allowing her estate to elect special use valuation.

    Holding

    1. Yes, because Ward’s regular consultation with the sharecropper, inspection of the farm, and independent decision-making in crop harvesting and marketing constituted material participation under the applicable regulations.

    Court’s Reasoning

    The court applied the material participation requirements of IRC Section 2032A and the related regulations, which are similar to those for self-employment tax under Section 1402(a). The court considered Ward’s activities in light of the mechanized nature of the grain farming operation and the common use of sharecropping in the area. Key factors included Ward’s regular advice and consultation with Barrett, her regular inspection of the farm, her financial responsibility for certain expenses, and her independent decision-making in harvesting and marketing her share of the crops. The court distinguished this case from Estate of Coon, where the decedent did not live on the farm or make independent decisions. The court also noted that Ward’s lack of formal education in farming did not undermine her decades of practical experience.

    Practical Implications

    This decision clarifies that material participation for special use valuation can be established in modern farming operations, even when the decedent does not physically operate the machinery. It emphasizes the importance of regular consultation, inspection, and independent decision-making in sharecropping arrangements. Practitioners should consider these factors when advising clients on estate planning for family farms. The ruling may encourage more estates to elect special use valuation, potentially reducing estate tax liability and facilitating the continuation of family farming operations. Subsequent cases have applied this reasoning to similar sharecropping arrangements, while distinguishing cases where the decedent’s involvement was more limited.

  • Estate of Coon v. Commissioner, 81 T.C. 602 (1983): Requirements for Material Participation in Special Use Valuation for Farm Property

    Estate of Catherine E. Coon, Deceased, Frank J. Coon, Administrator, Petitioner v. Commissioner of Internal Revenue, Respondent, 81 T. C. 602, 1983 U. S. Tax Ct. LEXIS 32, 81 T. C. No. 32 (1983)

    Material participation in the operation of farm property by the decedent or a family member is required for special use valuation under IRC section 2032A.

    Summary

    In Estate of Coon v. Commissioner, the court disallowed the estate’s election for special use valuation of farm property under IRC section 2032A due to a lack of material participation by the decedent or her family. Catherine E. Coon’s brother, Frank J. Coon, managed the farmland as an agent but did not meet the criteria for material participation set by the regulations. The court emphasized the need for regular advice or consultation on operations, inspection of production activities, and significant financial involvement. This case highlights the stringent requirements for qualifying for special use valuation and its impact on estate planning for farm properties.

    Facts

    Catherine E. Coon died intestate in 1977, leaving a one-third interest in farmland operated under crop-share leases by tenants. Her brother, Frank J. Coon, managed the property as an attorney-in-fact since 1951. The farmland was divided into three farms, each leased to different tenants. Frank maintained financial records, discussed crop plans annually, and inspected the farms occasionally. However, he did not participate in day-to-day production decisions or provide significant machinery. The estate elected special use valuation under IRC section 2032A, but the Commissioner disallowed it, arguing a lack of material participation by the decedent or her family.

    Procedural History

    The Commissioner issued a statutory notice of deficiency in 1980, asserting a $98,916. 30 estate tax deficiency. The estate filed a petition with the United States Tax Court, contesting the disallowance of the special use valuation election. After concessions, the sole issue before the court was whether there was material participation in the farm’s operation as required by IRC section 2032A(e)(6).

    Issue(s)

    1. Whether during the 8-year period ending on the date of the decedent’s death, there were periods aggregating 5 or more years during which the decedent or a member of her family materially participated in the operation of the farm property within the meaning of IRC section 2032A(e)(6).

    Holding

    1. No, because neither the decedent nor a member of her family met the criteria for material participation set forth in the regulations under IRC section 2032A and section 1402(a)(1).

    Court’s Reasoning

    The court applied the regulations under IRC section 2032A, which require material participation similar to that under section 1402(a)(1). It evaluated Frank Coon’s involvement against factors such as regular advice or consultation on operations, inspection of production activities, financial responsibility, and provision of machinery. The court found that Frank’s activities did not meet these criteria: he did not regularly advise on operations, his inspections did not constitute inspection of production activities, and he provided minimal machinery. The court also considered the legislative history of amendments to section 2032A, which introduced a lesser standard of “active management” for certain heirs, underscoring the higher threshold of material participation required for the decedent’s estate. The court concluded that the estate did not qualify for special use valuation due to the lack of material participation.

    Practical Implications

    This decision underscores the strict criteria for material participation required for special use valuation under IRC section 2032A. Estate planners and attorneys must ensure that clients engaged in farming or similar businesses actively participate in the operation of their property to qualify for tax relief. This case may influence how estates are structured and managed to meet these requirements, potentially affecting estate planning strategies for farm properties. It also highlights the importance of documenting participation and understanding the distinction between active management and material participation, especially in light of subsequent legislative changes. Subsequent cases may reference Estate of Coon when interpreting and applying the material participation requirements of section 2032A.