IRAs and Alternate Valuation Part I

IRAs and Alternate Valuation Part I

By: Martin M. Shenkman, CPA, MBA, JD

Introduction: AVD IRA Complexity

When a client dies, assets have to be valued for purposes of filing an estate tax return. Generally, assets are valued as of the date of death. However, if certain requirements are met, estate assets may be valued at the alternate valuation date (“AVD”), which is in general terms six months after the date of death. IRC Sec. 2032. The continued deterioration of the economy has made this occasionally used technique become common place. If values have declined subsequent to death, using lower values six months later may lower the estate tax and thus prevent the estate from having to pay tax with value it no longer has. But the growing use of AVD belies the complexity that affects application of the AVD rules. These difficulties are exacerbated by the recent issuance of controversial proposed regulations. Prop. Reg. Sec. 20.2032-1(f)(1). Overlaying these complexities on the rules governing individual retirement accounts (“IRA”s) post-death and uncertainty, confusion abounds. But the fun doesn’t stop there. The election to use AVD can, depending on the circumstances, have a varying impact on different beneficiaries. Considering that for many estates, IRAs are a major asset, the stakes are high. Further, an executor can be held personally liable if the alternate valuation could lower taxes and it is not elected. Re Lohm Est., 269 A.2d 451 (Pa. 1970). Finally, there seems to be little actual guidance on these potentially significant AVD/IRA issues. Likely the IRS will at some point issue official guidance to address these issues.

This article will summarize the basic requirements affecting the use of the AVD, then explore some of the issues unique to applying the AVD rules to IRAs.

AVD Overview

AVD can only be elected if the value of all estate assets has declined by the AVD, and there is a reduction on the estate/GST tax due. If this occurs, then the executor (or in some instances, a trustee under a revocable living trust) can make an election to use the AVD to value assets. IRC Sec. 2032. The AVD election is made by the executor on the estate tax return. The estate tax return must be filed within one year of the due date, including extensions for the election to be valid. IRC Sec. 2032(d)(2). The AVD election is irrevocable. IRC Sec. 2032(d)(1).

The six month period is measured in terms of months. If there is no day in the sixth month which corresponds numerically, e.g., the decedent died on the 31st,st but the sixth month only has 30 days, then the last day of the month his used. The election must apply to all estate assets, no partial application is permitted. Treas. Reg. Sec. 20.2032-1(b)(2).

Although the general rules is that assets are valued six months following death, if property distributed, sold, exchanged, or otherwise disposed of, prior to the six month date after the decedent's death, such property is valued as of the date of the distribution, sale, exchange, or other disposition. IRC Sec. 2032(a). A transaction, which is a mere change in form of the assets and not a sale, exchange or other disposition of those interests should be valued at the six month AVD. Treas. Reg. Sec. 20.2032-1(c). Applying these rules to IRAs is complicated and uncertain.

When is Property Distributed, Sold, Exchanged, or Otherwise Disposed Of

One of the keys to determining whether IRA assets are valued for AVD purposes six months after the decedent’s death or at some earlier date, is based on how the phrase “property distributed, sold, exchanged, or otherwise disposed of” is defined. If a particular one of the many events that can affect an IRA post-death (e.g., division into separate IRAs, sale of some but not all underlying assets, spousal rollover, etc.) is deemed to be equivalent to the IRA being “distributed, sold, exchanged, or otherwise disposed of,” the portion or all of the IRA is valued at that earlier date, rather than the six month date.

The Regulations provide that:

  • “…it does not include a transfer of assets to a corporation in exchange for its stock in a transaction with respect to which no gain or loss would be recognizable for income tax purposes under section 351.” Treas. Reg. Sec. 20.2032-1(c)(1). Some practitioners have argued that if no gain or loss occurs for income tax purposes, in any context, that should be as the litmus test for a 2032 “disposition.” Based on this criteria, a division of an IRA should not fix the valuation date for AVD purposes.
  • “…Property is considered as “distributed” upon the first to occur of the following: (i)The entry of an order or decree of distribution, if the order or decree subsequently becomes final; (ii) The segregation or separation of the property from the estate or trust, so that it becomes unqualifiedly subject to the demand or disposition of the distributee; or (iii) The actual paying over or delivery of the property to the distributee.” Treas. Reg. Sec. 20.2032-1(c)(2). These concepts don’t appear applicable to the mere division or separation of an IRA into separate accounts for each beneficiary.
  • “Property may be “sold, exchanged, or otherwise disposed of” by: (i) The executor; (ii) a trustee or other donee to whom the decedent during his lifetime transferred property included in his gross estate under sections 2035 through 2038, or section 2041; (iii) an heir or devisee to whom title to property passes directly under local law; (iv) a surviving joint tenant or tenant by the entirety; or (v) any other person.… Treas. Reg. Sec. 20.2032-1(c)(3). These provisions appear to indicate that any of these persons could sell, exchange…. The property, not that a transfer to them would automatically be deemed a sale, exchange,…
  • “If a binding contract for the sale, exchange, or other disposition of property is entered into, the property is considered as sold, exchanged, or otherwise disposed of on the effective date of the contract…” Treas. Reg. Sec. 20.2032-1(c)(3). Similarly, the division of an IRA does not appear analogous to a binding sale.

The Proposed Regulations provide:

  • “Post-death events. (i) In general. In order to eliminate changes in value due to post-death events other than market conditions, any interest or estate affected by post-death events other than market conditions is included in a decedent's gross estate under the alternate valuation method at its value as of the date of the decedent's death, with adjustment for any change in value that is due to market conditions.” Prop. Treas. Reg. Sec. 20.2032-1(f)(3)(i).

The breadth of this provision might be interpreted to negate some of the questions as to whether certain post-death IRA events should not be considered so that the IRA as of the date of death adjusted for market conditions to the AVD. A concept embodied in the proposed Regulations is that actions controlled by the executor, rather than the market, should not be considered. A consistent application of this should not have the valuation date for an IRA then accelerated, because the executor or beneficiaries of an IRA divide that IRA, re-title it as an inherited IRA, etc. It is unclear whether the Proposed Regulations will be finalized, if so how, and how they may be applied to IRAs.

Is the IRA a Single Asset or An Envelope Holding Underlying Assets

If an IRA account is deemed a single asset, then transactions in the securities held in the IRA will affect the value of the IRA, but it is the IRA as a unit that is valued and analyzed for AVD purposes. It would seem, however, that the approach of treating an IRA more like a brokerage account, a mere basket or envelope holding the assets inside, is more logical. Using the latter approach, if an asset is sold or distributed from the IRA then that particular asset, not the IRA as a whole, should be treated as having been “distributed, sold, exchanged, or otherwise disposed of.”

The IRS addressed the conceptual treatment of IRAs in Revenue Ruling 2008-5. If the IRA account holder sells stock at loss and then next day purchases same quantity of identical stock for his IRA or Roth IRA, loss is disallowed under Code Sec. 1091; and basis in IRA isn't increased under Code Sec. 1091(d). If the IRS looks through the IRA to evaluate an individual security holding for the loss sale rule, why would it not view an IRA as being comprised of individual security holdings for AVD purposes as well?

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