As part of the omnibus tax bill, HF 848, passed by the Minnesota legislature over the weekend, the legislature has directed the commissioner of revenue to review the estate tax’s definition of qualified farm property and its linkage to the property tax classification of the property during the three-year period following the death of the decedent. The commissioner is to issue a report to the legislature by February 1, 2017.
Specifically, the commissioner is to report on “alternative methods of ensuring that the use of the property by qualified heirs during the three-year period after the decedent’s death is consistent with the purpose of limiting the subtraction to properties where its use continues that of the decedent without any material change in its use by the qualified heirs and its ownership is consistent with maintaining family ownership of the farm” (emphasis added).
This estate tax review was prompted by the estate tax definition of “qualified farm property” and its limiting affect on traditional estate planning for farmers, specifically trusts. Minnesota’s estate tax code allows a deduction for qualified farm property, which can result in huge estate tax savings for Minnesota farmers. One of the requirements of qualifying the farm property is that it must be agricultural homestead in the year of death. However, some county assessors have interpreted the agricultural homestead linkage law so that estate and succession planning for farmers can result in farm land losing agricultural homestead. This interpretation arises from the requirement that property must be owned by the exact same ownership entity to maintain agricultural homestead.
Take this common scenario: Husband John and Wife Daisy decide it is time to do estate tax planning. They own a few hundred acres of quality farm land in Southeastern Minnesota. In order to avoid probate and to give them some flexibility in estate tax planning, they form revocable trusts to hold their farm land. They put half of the land in John’s trust and half in Dorothy’s trust. (This scenario would also apply in the event of the death of a spouse, where an interest in farm land is placed into a trust to use the estate tax credit of the deceased spouse.) In either case, the titling of the farm land in the trusts would split ownership of their farm land and it would no longer be owned by the exact same ownership entity. Moving the farmland into revocable trusts for estate planning reasons is of little use if it will cost thousands of dollars in increased property taxes year after year. (You can read about this example here and added to my firm’s blog here.)
Instead of looking at whether trust-owned properties can be linked together to preserve agricultural homestead, the new tax bill is aimed at the recapture tax under the qualified farm property deduction. The recapture tax basically imposes a tax on deducted property if the property does not meet the post-death requirements.
The tax bill includes this mandate regarding the recapture tax:
Prior to June 1, 2017, the commissioner of revenue shall not assess recapture tax under Minnesota Statutes, section 291.03, subdivision 11, for a change in the property tax classification of agricultural homestead property if the following conditions are satisfied:
(1) the property is held in a trust of which the surviving spouse is a beneficiary; and
(2) the property receives partial homestead classification because a beneficiary of the trust is the owner of another agricultural homestead.
Upon reading this instruction to the commissioner to not impose recapture tax for a change in the agricultural homestead classification of the property, one would think that continuing to be classified as agricultural homestead is a post-death requirement of the qualified farm property deduction. It is not, at least as the law is written. The recapture tax provision of the qualified farm property deduction imposes a tax if, within three years after the decedent’s death, the property fails to be classified as class 2a property under section 273.13, subd. 23. Class 2a property is basically farm land as most people think of it (see the statute for complete definition), but it is not necessarily agricultural homestead! Thus, the mandate directs the commissioner to not impose a recapture tax in a scenario that would not have triggered a recapture tax in the first place. This change creates potential uncertainty in the law and its application.
As noted above, commissioner is to report on alternative methods of ensuring that the use of the property by qualified heirs following the decedent’s death is consistent with the purpose of limiting the subtraction to properties where its use continues that of the decedent without any material change in its use by the qualified heirs. The 2011 version of the qualified farm property law required qualified heirs continuously use the property in the operation of the trade or business for three years following the death of the decedent. It also imposed a recapture tax if the family member ceased to use the qualified property. However, this was later amended to remove the use requirement from the law. As the law is written now, qualified heirs are not required to continue the use of the farm. The new omnibus tax seems resurrect the use requirement through its instruction to the commissioner.
This estate tax review was absolutely added with the best intentions to give farmers more flexibility in their estate planning. Estate planning attorneys throughout Minnesota have been working on this issue for months for the benefit of their clients, and a review of the agricultural homestead linkage rules is needed. Unfortunately, in my view, the tax bill got the relationship between the taxes turned around and missed the mark. It remains to be seen if Governor Dayton will sign the omnibus tax bill into law, but further legislative fixes will be needed if it is. The focus for future legislation should be on allowing spouses to link farm land owned by their trusts and limited liability entities for agricultural homestead purposes and not homestead classification of farm land during the three-year period following the date of death. Allowing spouses to link farm land owned by their trusts and limited liability entities will in turn give farmers more flexibility for their estate plans in relation to the qualified farm property deduction.