Rarely is bankruptcy filing contemplated when a special use valuation election of farmland is filed.1 However, financial adversity can overtake a qualified heir or heirs who are responsible for paying the recapture tax either because of reduced farm or ranch income from production or a major catastrophe which results in a filing in bankruptcy.2 Several possible issues may arise, including the effect of bankruptcy on personal liability for the tax benefits from the special use valuation filing.

Harl, Neil E

Peiffer, Joseph A

English

Rarely is bankruptcy filing contemplated when a special use valuation election of farmland is filed.1 However, financial adversity can overtake a qualified heir or heirs who are responsible for paying the recapture tax either because of reduced farm or ranch income from production or a major catastrophe which results in a filing in bankruptcy.2 Several possible issues may arise, including the effect of bankruptcy on personal liability for the tax benefits from the special use valuation filing.3</p

Harl, Neil

Peiffer, Joseph

Digital Repository @ Iowa State University (ISU)

Agricultural Law PressPublisher/EditorRobert P. Achenbach, Jr.Contributing EditorDr. Neil E. Harl, Esq.*   *   *   *Issue ContentsBankruptcy General  Exemptions   Homestead 75   IRA 75 Chapter 12  Estate property 75 Federal taxation  Discharge 75Federal Farm Programs Brucellosis 75Federal Estate and Gift Taxation Alternate valuation date 75 Disclaimers 76 Gifts 76Federal Income Taxation Alimony 76 Business expenses 76 Corporations  Accounting method 76 Disaster losses 76 Domestic Production Deduction 77 Health savings accounts 77 Hobby farm 77 Interest rate 77 Partnerships  Check-the box election 77  Election to adjust basis 77 Prepaid expenses 77 S Corporations  Passive investment income 78  Shareholders 78  Trusts 78 Safe harbor interest rates  June 2011 78	 Social	security	benefits	78 Timber 78 Travel expenses 78 Withholding taxes 79 Vineyards 79Secured Transactions Agricultural supplier lien 79Bankruptcy Filing After Special Use Valuation Election-by Neil E. Harl*  and Joseph A. Peiffer**	 Rarely	 is	 bankruptcy	 filing	 contemplated	when	 a	 special	 use	 valuation	 election	 of	farmland	is	filed.1		However,	financial	adversity	can	overtake	a	qualified	heir	or	heirs	who	are responsible for paying the recapture tax either because of reduced farm or ranch income from	production	or	a	major	catastrophe	which	results	in	a	filing	in	bankruptcy.2 Several possible issues may arise, including the effect of bankruptcy on personal liability for the tax	benefits	from	the	special	use	valuation	filing.3The effects of bankruptcy filing if special use land is not transferred from the bankruptcy estate during bankruptcy The	Internal	Revenue	Code	is	clear	as	to	the	effects	of	bankruptcy	filing	for	individuals4 who	are	Chapter	7	and	11	filers.5 In general, the transfer of assets to the bankruptcy estate is not treated as a disposition for purposes “. . . of any provision of this title.”6 The term “this title”	refers	to	Title	26	of	the	United	States	Code	which	includes	federal	income	tax,7  federal estate tax,8 federal generation skipping transfer tax9 and federal gift tax.10 The bankruptcy estate	is	treated	as	the	debtor	would	have	been	treated.11	Thus,	it	is	clear	that	the	mere	filing	of	bankruptcy	does	not	trigger	recapture	of	the	tax	benefits	from	the	special	use	valuation	election.12	 Likewise,	it	is	clear	that,	if	the	farmland	subject	to	the	special	use	valuation	election	is	retained	by	the	bankruptcy	estate	in	a	Chapter	7	or	11	filing	by	an	individual,	later		transfer	of the assets from the bankruptcy estate to the debtor on termination of the bankruptcy estate is not treated as a disposition for purposes “. . . of this title” and the debtor is treated as the bankruptcy	estate	would	have	been	treated13 and there should be no recapture.14 	 Chapter	12	bankruptcy	filers	are	not	eligible	for	a	separate	tax	entity	which	is	available	for	Chapter	7	and	11	filers	as	individuals.15	However,	a	2005	amendment		allows	a	Chapter	12	debtor	to	treat	amounts	arising	out	of	“.	.	.		claims	owed	to	a	governmental	unit”	as	a	result of “sale, transfer, exchange, or other disposition of any farm asset used in the debtor’s farming operation” to be treated as an unsecured claim that is not entitled to priority under Section	507(a)	of	 the	Bankruptcy	Code,	provided	the	debtor	obtains	a	discharge.16 That provision has been upheld by the Eighth Circuit Court of Appeals17Effects of transfer of special use land during bankruptcy If real property under a special use valuation election is transferred by the bankruptcy ______________________________________________________________________ * Charles F. Curtiss Distinguished Professor in Agriculture and Emeritus Professor of Economics, Iowa	State	University;	member	of	the	Iowa	Bar.** Day	Rettig	Peiffer,	P.C.,	Cedar	Rapids,	Iowa.Agricultural    Law	DigestVolume	22,	No.	10	 May	27,	2011		 																		ISSN	1051-2780Agricultural Law Digest	is	published	by	the	Agricultural	Law	Press,	127	Young	Rd.,	Kelso,	WA	98626	(ph	360-200-5666),	bimonthly	except	June	and	December.		Annual	subscription	$120	($90	by	e-mail).		Copyright	2011	by		Robert	P.	Achenbach,	Jr.	and	Neil	E.	Harl.		No	part	of	this	newsletter	may	be	reproduced	or	transmitted	in	any	form	or	by	any	means,	electronic	or	mechanical,	including	photocopying,	recording	or	by	any	information	storage	or	retrieval	system,	without	prior	permission	in	writing	from	the	publisher.		http://www.agrilawpress.com		Printed		on	recycled	paper.73contingent liability of the debtor for payment of the recapture tax survives bankruptcy and subjects the debtor to liability for the recapture tax in question.   ENDNOTES 1	I.R.C.,	§	2032A.	See	generally	5	Harl,	Agricultural Law §	43.03[2]	(2011);	Harl,	Agricultural Law Manual	§	5.03[2]	(2011).	See	also	Harl,	“Recapture	Under	Special	Use	Valuation	on Sale of Non-Elected property?” 22 Agric. L. Dig.	41	(2011);	Harl, “Claiming Entity Discounts in Addition to Special Use Valuation,” 20 Agric. L. Dig.	41	(2009). 2	See	13	Harl,	Agricultural Law	Ch.	120	(2011). 3	I.R.C.	§	2032A(c). 4	I.R.C.	§	1398(a). 5	I.R.C.	§	1398(f)(1). 6	I.R.C.	§	1398(f)(1). 7	I.R.C.	§§	1-1563. 8 I.R.C. §§  2001-2210. 9 I.R.C. §§  2601-2664. 10	I.R.C.	§§	2501-2524.	 11	I.R.C.	§	1398(f)(1). 12		5	Harl,	Agricultural Law	§	43.03[2][g][i][C]	(2011). 13	I.R.C.	§	1398(f)(2). 14	See	5	Harl,	Agricultural Law	§	43.03[2][g][i][C][I]. 15	I.R.C.	§	1398. 16		11	U.S.C.	§	1222(a)(2). 17	Knudsen	v.	Internal	Revenue	Service,	581	F.3d	696	(8th	Cir.	2009).	But	see	United	States	v.	Hall,	617	F.3d	1161	(9th	Cir.	2010),	on	appeal	to	the	U.S.	Supreme	Court. 18	I.R.C.	§	2032A(c)(1)(A). 19	See	5	Harl,	Agricultural Law	§	43.03[2][g][i][C][I]	(2011). 20	See	I.R.C.	§	2032A(c)(1)(A). 21	I.R.C.	§	2032A(c)(1)(B). 22	I.R.C.	§	503(b)(1)(B). 23		581	F.3d	696	(8th	Cir.	2009). 24	11	U.S.C.	§§	724,	507(a). 25	11	U.S.C.	§	545. 26	I.R.C.	§	2032A(c)(1). 27	581	F.3d	696	(8th	Cir.	2009).trustee to an eligible transferee, such as a member of the debtor’s family,18	there	should	be	no	recapture	of	the	tax	benefits	from	the special use valuation election.19	However,	if	the	property	is	transferred	to	an	individual	or	entity	who	is	not a member of the	qualified	heir’s	family,	and	thus	is	not an eligible transferee for purposes of special use valuation recapture,20 recapture occurs. 	 If		the	recapture	tax,	which	is	an	“additional	estate	tax,”21 is triggered	by	the	bankruptcy	estate,	the	recapture	amount	would	presumably be paid by the bankruptcy estate if the bankruptcy estate has sufficient funds available to pay the recapture tax. The additional estate tax appears to be an “excise tax” as a tax levied	upon	the	transfer	of	a	person’s	property	at	death	and	would	be paid as an administrative expense of the bankruptcy estate.22 For	Chapter	12	filers,	with	no	separate	tax	entity,	the	tax	would	likely not be an administrative expense unless the Eighth Circuit Court of Appeals case, Knudsen v. Internal Revenue Service23 is	followed.	 Because the special use valuation recapture tax is secured by a lien, payment of the tax is subject to a special priority payment system. Because the lien is not avoidable by the bankruptcy trustee or debtor in possession, the bankruptcy estate	special	use	valuation	property	 	which	 is	subject	 to	 the	tax	lien	is	distributed	first	to	satisfy	any	other	allowed	secured	claims	 	against	 the	property	and	all	unsecured	claims	with	a	higher priority than pre-petition tax claims.24 The tax lien is not avoidable because the lien arose prior to, and not because of, the	filing	for	bankruptcy.25 Any special use valuation recapture tax	that	remains	unpaid	would	be	an	unsecured	claim,	and	if	the	bankruptcy	estate	does	not	have	sufficient	assets	to	pay	the	remaining	tax,	the	question	is	whether	the	debtor	remains	liable	for the tax if it is not dischargeable. What about the debtor’s personal liability for the recapture tax?	 A	qualified	heir,	who	is	a	debtor	in	bankruptcy	has	personal	liability for federal estate tax recaptured  as a result of disposal of	 the	 property	 outside	 of	 the	 qualified	heir’s	 family	within	10-years	after	the	decedent’s	death	(15-years	for	deaths	before	1982).26	As	an	excise	tax,	if	personal	liability	was	incurred	prior	to	three	years	before	filing	for	bankruptcy,	the	amount	of	the	claim for recaptured federal estate tax should be dischargeable in	bankruptcy.	For	Chapter	12	filers,	 the	Eighth	Circuit	case	of Knudsen v. Internal Revenue Service27 could provide relief even if three years had not elapsed from the time of disposition provided all of the other requirements  for Chapter 12 bankruptcy have been met. 	 The	 key	 issue	 is	whether	 the	 debtor’s	 contingent	 liability	to pay the recapture tax survives the transfer of property to the bankruptcy estate. If it does, the liability is arguably not dischargeable in bankruptcy because the claim did not arise prior	to	the	filing	of	bankruptcy.		 To	 date,	 there	 is	 no	 definitive	 authority	 on	whether	 the	74	 Agricultural	Law	Digest

Bankruptcy Filing After Special Use Valuation Election

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Bankruptcy Filing After Special Use Valuation Election

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