Rev. Rul. 86-99

1986-2 C.B. 159, 1986-33 I.R.B. 6.

SPECIAL USE VALUATION; FARM USED IN CONJUNCTION WITH GRAZING PERMIT

Published: August 18, 1986

Section 2032A.-Valuation of Certain Farmland, Etc., Real Property, 26 CFR

20.2032A-4: Method of valuing farm real property

(Also Sections 2031: 20.2031-1.)

  Special use valuation; farm used in conjunction with grazing permit. Two methods are described for valuing farmland for federal estate tax purposes where the farm is used in conjunction with a grazing permit on nearby federal land.

ISSUE

  For federal estate tax purposes, how is farmland valued if the farmland is used in conjunction with a grazing permit on nearby federal land?

FACTS

  SITUATION 1.

  A, a United States citizen, died in 1984. At the time of A's death, A had owned and operated a ranch for more than six years. The ranching operation consisted of two parcels of grazing land. One parcel was owned by A in the fee simple. The other parcel was owned by the Federal Government and was used by A under a federal grazing permit issued by a federal agency.

  The permit enables the owner of A's ranch to graze a specified number of animals on the federal parcel for five months of each year. The two parcels have been used as a single integrated ranching unit for many years. The grazing permit had been renewed periodically by the Federal Government, although the government retained the discretion to refuse to renew the permit. The grazing permit specifies the permissible uses of the grazing land and will remain in effect for A's heirs during the remaining term of the permit after A's death. Although the federal statutes that authorize grazing permits state that such permits do not create any right, title, or interest in federal lands, in many

cases grazing permits are continually renewed and remain a valuable asset that enhance the value of nearby farmland. When farmland is sold, the owner waives any grazing rights attributable to such farmland; however, the purchaser generally takes into consideration the existence of the grazing permit in determining the purchase price of the farmland, because a purchaser who otherwise qualifies generally will be able to obtain a new grazing permit.

  The annual fees paid to the Federal Government under the grazing permit as of A's death are less that the rates that would be paid for grazing rights on comparable land between unrelated individuals in an arm's length commercial transaction. Consequently, the grazing permit represents a valuable right to A and to A's heirs.

  As of A's death, the fair market value of the parcel of farmland owned by A was $800,000. This value represents the price at which the parcel would sell between a hypothetical willing buyer and seller in an arm's length transaction. The $800,000 price is based in part on the fact that buyer of A's parcel would expect to be able to obtain renewals of the grazing permit on the nearby federally owned parcel on the same basis that A had done for many years. If there had been no federal grazing permit on the nearby federal land, the fair market value of the parcel owned by A would have been only $600,000.

  The executor for A's estate will not make a special use valuation election on the estate tax return to be filed.

  SITUATION 2.

  The facts are the same as in Situation 1, except that A's executory plans to make a special use valuation election under section 2032A of the Internal Revenue Code. A's farmland satisfied the requirements described in section

2032A(b) relating to qualified real property. The excess of the average annual gross cash rentals over the average annual state and local real estate taxes for land located in the locality and comparable to the land owned by A is

$20,000. However, the excess of the average annual gross cash rentals over the average annual state and local real estate taxes for land located in the locality and comparable to A's land, and including a grazing permit on federal land comparable to the land subject to A's grazing permit, is $30,000. The average annual effective interest rate for Federal Land Bank loans for the region in which A's ranch is located is 11.93 percent.

LAW AND ANALYSIS

  Section 2031 of the Code provides in part that the value of the gross estate of a decedent shall be determined by including property in the gross estate on the basis of the fair market value of such property as of the date of the decedent's death, unless the executor elects the alternative valuation method under section 2032 of the Code. Section 20.2031-1(b) of the Estate Tax Regulations provides in part that the fair market value of property 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 sell and both having reasonable knowledge of relevant facts.

  Section 2032A of the Code provides that, under certain conditions, an executor may elect to value farm or business real property based upon its current use rather than its fair market value as determined under otherwise applicable estate tax valuation rules. For property to qualify for 'special use' valuation under section 2032A, the property must be 'qualified real property' described in section 2032A(b) of the Code.

  Section 2032A(e)(7)(A) of the Code provides, in general, that the value of a farm for farming purposes shall be determined by dividing (i) the excess of the average annual gross cash rental for comparable land used for farming purposes and located in the locality of such farm over the average annual state and local real estate taxes for such comparable land, by (ii) the average annual effective interest rate for all new Federal Land Bank loans. Further, each average annual computation shall be made on the basis of the five most recent calendar years ending before the date of the decedent's death.

  Although a grazing permit does not create any right, title, or interest in the federal land affected by the permit, it is a valuable component part of the nearby farmland and has been recognized as having value to the holder in several court decisions. See Estate of Cronin v. Cronin, 89 S.D. 632, 237 N.W.

2d 171 (1975); United States v. Jaramillo, 190 F.2d 300 (10th Cir. 1951). See also Board of Supervisors of County of Modoc v. Archer, 18 Cal. App.3d 717,

726, 96 Cal. Rptr. 379, 386 (1971), which held that a federal grazing permit was a possessory interest under California law, i.e., 'an interest in real property which exists as a result of possession, exclusive use, or a right to possession or exclusive use of land . . . unaccompanied by the ownership of a fee simple or life estate in the property'; and Ruelas v. Ruelas, 7 Ariz. App.

98, 436 P.2d 490, 493 (1968), which held that a federal grazing permit 'has an economic value which affects the value of the patented land to which the permit is an adjunct.' Accordingly, the federal grazing permit is a valuable asset attached to the land owned in fee by the decedent and is thus an element of the value of the land owned in fee.

  In Situation 1, the fair market value of the land owned in fee by the decedent should reflect the fair market value of the grazing permit, because the value of the grazing permit would be taken into consideration in determining the price at which the land owned in fee would change hands in a sale between a willing buyer and a willing seller. Therefore, for purposes of section 2031 of the Code, the value of A's farmland includible in the gross estate is $800,000. Moreover, these facts indicate that the grazing permit has no value independent of the ownership of A's farmland; thus, the grazing permit is not separately includible in A's gross estate.

  In Situation 2, the value of the grazing permit must be reported as part of the value of the land owned by the decedent in fee simple. In valuing the farmland under section 2032A(e)(7) of the Code, only land comparable to the land being valued under section 2032A may be used. Where the farmland to be valued under section 2032A is used in conjunction with a grazing permit on nearby federal land, an example of comparable farmland for purposes of section

2032A would be a parcel of farmland (similar to that owned by the decedent) that is used in conjunction with a second parcel (similar to that used under the decedent's federal permit) and that is rented as a combined unit to a third party.

  The special use value of A's farmland, computed with the formula provided in section 2332A(e)(7) of the Code, is $251,467 ($30,000 excess average annual rental value divided by 11.93 percent average annual interest rate).

HOLDINGS

  SITUATION 1.

  For federal estate tax purposes, the fair market value of A's farmland, which is used in conjunction with a grazing permit on nearby federal land, must reflect the value of the permit.

  SITUATION 2.

  Under section 2032A of the Code, the special use value of A's farmland is computed by taking into account the total rent that an owner receives for a parcel of land comparable to the decedent's farmland consisting of a fee simple parcel and a grazing permit over nearby federal land.

Rev. Rul. 86-99, 1986-2 C.B. 159, 1986-33 I.R.B. 6.