In 2007, heirs sold a conservation easement on inherited farmland for $910,000, in 2013, they got a shock from US Tax Court

Two siblings who inherited part of a family ranch in California lost a tax dispute after the US Tax Court rejected their attempt to use a higher property value to reduce capital gains from the sale of a conservation easement.

In Van Alen v. Commissioner, decided on October 21, 2013, the court ruled in favour of the Internal Revenue Service (IRS). The dispute involved $910,000 received by a family trust from the sale of an easement on the ranch. The court also upheld accuracy-related penalties against the taxpayers.

The case centered on a tax benefit claimed when the ranch was inherited and whether the family could later use a higher valuation to calculate the taxable profit from the easement sale.

Who inherited the family ranch?

Shana Tomlinson and Brett Van Alen were siblings who inherited an interest in the Preuschoff Ranch through a trust established after their father, Joseph Van Alen, died in 1994.

The ranch covered 2,345 acres in Madera County, California. Their father had owned a 13/16 interest in the property, which became part of his estate.

The estate used a special tax provision that allows qualifying farmland to be valued according to its agricultural use rather than its potential market value for development. This can reduce the estate tax payable when a property passes to heirs who agree to continue its qualified use.

The ranch interest was valued at $1.963 million in an appraisal. But the estate reported it at $427,500 on its tax return. It then used a special provision in Section 2032A of the US tax code to bring the value down further to $144,823.

Following an IRS review and other adjustments, the accepted special-use value was lower still, at around $98, 735.

The estate reported an estate tax liability of about $100,000, which later increased to nearly $120,000 after the IRS made adjustments.

The special valuation came with conditions. The heirs had to agree to certain tax consequences if the property was sold or stopper being used for the qualifying agricultural purpose.

In May 2007, the California Rangeland Trust bought a conservation easement on the ranch for $1.12 million. The family trust received $910,000.

The trust initially reported a basis of about $100,000 for the easement sale. The sale generated capital gains that passed through to the siblings.

The siblings argued that the basis should instead reflect the much higher appraisal of the ranch interest.

What did the US Tax Court decide?

The court rejected the siblings' argument. It ruled that the special-use value reported for estate tax purposes determined the basis used to calculate the gain from the easement sale.

The court also found that the taxpayers had received tax documents showing substantial capital gains but failed to report those gains on their individual returns. It upheld the accuracy-related penalties imposed by the IRS.