A previous blog discussed the Mitchell case, in which long-term leases substantially reduced the estate tax value of certain real property. A very significant issue did not have to be decided by the Court because the IRS stipulated that the property gifted by the decedent as well as the property still owned by the decedent at the time of his death would receive fractional interest discounts.
Six days before he died, Mr. Mitchell gave a 5% interest in his beachfront property and his ranch to a trust for his sons. The IRS stipulated before trial that the 5% gift of the beachfront property would receive a 32% fractional interest discount and the 5% gift of the ranch would receive a 40% discount.
The IRS also stipulated that the 95% interests in the beachfront property and the ranch that were owned by the decedent at the time of his death would receive fractional interest discounts of 19% and 35%, respectively. The combined fractional interest discounts saved more than $1 million of estate taxes.
Numerous court decisions have recognized significant fractional interest discounts. In my experience, discounts of 25% to 35% are typical. These court decisions influenced the decision by the IRS to concede the discounts in the Mitchell case.
The decedent’s revocable trust devised the 95% interest to the very same trust to which he had gifted a 5% interest just 6 days before his death. Therefore, the trust for the sons received a 100% ownership of the property. However, by dividing the transfer of the property to the sons’ trust into two separate portions, Mr. Mitchell significantly reduced his estate taxes.
Mr. Mitchell’s estate was fortunate to receive the discounts since he made the gift after he became very ill due to cancer. Some prior cases have disallowed otherwise valid discounts for deathbed gifts. Ideally, the gift should be made at least one year before death and certainly before a diagnosis of a terminal illness.
Whenever you plan to make a gift of real estate, you should consider giving part now and part later (or part to one donee and part to another donee). Further, if you are planning to devise real estate through your Will, you should consider giving a small percentage interest in your lifetime and the remainder through your Will. Now is an excellent time to make a gift due to depressed real estate values and the temporary $5 million federal gift tax exemption.