What Is a Recapture Agreement for Estate Tax?
Understand how a recapture agreement enables special use valuation to lower estate tax on qualified property and the long-term commitments required of heirs.
A recapture agreement for estate tax is a binding contract with the IRS, allowing an estate to value specific real property, like a farm or closely held business, at its current use value instead of its typically higher fair market value. This special use valuation, under Internal Revenue Code Section 2032A, can reduce the federal estate tax owed. The agreement is a condition for receiving this tax benefit, ensuring that the heirs who inherit the property will adhere to specific use requirements for a set period. It formalizes the heirs’ consent to be personally liable for an additional estate tax if they fail to meet these obligations.
Required Information and Parties for the Agreement
A recapture agreement requires consent from all individuals with a legal interest in the specially valued property, including direct heirs and anyone with a present, future, or contingent interest. Every person whose rights could affect the property’s disposition must sign the agreement. This includes trustees and holders of remainder interests. The agreement is formally executed using Part 3 of Schedule A-1, an attachment to the U.S. Estate Tax Return, Form 706.
The agreement must contain specific information, including the decedent’s name and taxpayer identification number, a legal description of the property, and its fair market value alongside its special use value. The document also requires the designation of a single agent authorized to act on behalf of all parties in future dealings with the IRS. This agent serves as the primary point of contact for all communications.
The estate’s executor must gather all necessary data, including the valuation figures and the names and addresses of all parties in interest. The form guides the executor to list each party, their relationship to the decedent, and the specific interest they hold in the property. Proper completion and attachment of this agreement is a prerequisite for the IRS to accept the election.
Post-Death Qualified Use Obligations
By signing the recapture agreement, heirs personally commit to fulfilling specific obligations for a 10-year period following the decedent’s death. This ‘recapture period’ is the timeframe during which the property must be continuously used for its intended purpose. The primary obligation is maintaining the ‘qualified use’ of the property, meaning it must be operated as a farm for farming purposes or used in the trade or business for which it was valued. For example, a farm must be actively farmed and not converted into a residential subdivision.
The qualified use obligation includes a ‘material participation’ requirement, meaning a qualified heir or a member of their family must be actively involved in the operation of the farm or business. The IRS assesses material participation by looking at factors such as involvement in management decisions, performance of physical work, and financial responsibility for the operation. The heir must have a tangible role in its business activities, not just passive ownership.
The 10-year recapture period begins on the date of the decedent’s death, but the law provides a two-year grace period for the qualified heir to commence the qualified use. If an heir uses this grace period, the 10-year recapture timeline is extended by the amount of time taken. For instance, if an heir takes one year to begin farming the inherited land, the recapture period will end 11 years after the decedent’s death.
Events Triggering the Recapture Tax
Two primary events trigger the ‘recapture tax’ within the 10-year post-death period: the disposition of the property or the cessation of its qualified use. If the qualified heir sells, gifts, or otherwise transfers the property to someone who is not a member of their family, an additional estate tax becomes due.
Cessation of the qualified use occurs if the heir stops using the property for its designated purpose or fails to meet material participation standards. For example, if an heir leases the farm to a non-family third party and ceases all involvement in its management and physical work, they would no longer be materially participating, which triggers the tax.
If a triggering event occurs, an additional estate tax is imposed. The amount is the lesser of the estate tax saved at the time of death or the excess of the amount realized on the disposition over the special use value. The qualified heir who received the property is personally liable for paying this tax.
Filing Procedures for the Agreement and Recapture Tax
If a recapture event happens, the qualified heir is personally responsible for reporting the event and paying the resulting tax. This is done by filing Form 706-A, the U.S. Additional Estate Tax Return. Each qualified heir involved in a taxable event must file a separate Form 706-A.
The qualified heir must file Form 706-A and pay the additional tax within six months of the disposition or cessation of qualified use. An extension to file can be requested using Form 4768, Application for Extension of Time To File a Return and/or Pay U.S. Estate Taxes.