In Private Letter Ruling 201343004 (released Oct. 25, 2013), the estate asked the Internal Revenue Service to answer three questions:
1. Do the activities of one of the divisions (Division 5) of a decedent’s closely held corporation constitute the carrying on of a trade or business, such that an interest in that division qualifies as an interest in a closely held business for purposes of Internal Revenue Code Section 6166(a)(1)?
2. Do the activities of a different division (Division 1) constitute the carrying on of a trade or business such that an interest in that division qualifies as an interest in a closely held business for purposes of IRC Section 6166(a)(1)?
3. Does a company (in which a decedent’s closely held corporation owns stock), and the company’s two divisions, qualify as lending and finance businesses for purposes of the special election under IRC Section 6166(b)(10)?
The IRS answered all three questions in the affirmative. Here’s why.
Pursuant to Section 6166(a)(1), an estate may elect to pay all or part of an estate tax liability in two or more (but not more than 10) equal installments, if the value of a decedent’s interest in a closely held business exceeds 35 percent of the decedent’s adjusted gross estate. The maximum amount of tax that could be deferred is the percent of estate tax equal to the percent of the adjusted gross estate that’s comprised of the closely held business amount. If an estate makes an election under Section 6166(a)(1), the estate has up to five years from the due date to make the first installment payment.
Under Section 6166(b)(10), an asset used in a qualifying lending and finance business will be treated as an asset that’s used in carrying on a trade or business. If an estate elects treatment under this section, the five-year deferral available under Section 6166(a)(3) can’t be used, and an estate may only elect to pay its tax liability in up to five installments.
Active Trade or Business: Division 5
The estate asked the IRS to first determine whether the activities of one of the business divisions (Division 5) of the decedent’s closely held business constituted an active trade or business. Among other things, Division 5 was responsible for selling or leasing used equipment that was returned on the expiration of leases; provided marketing, management and support services to third-party lessors; had full-time employees; maintained extensive support capabilities, including computer and network specialists, analysts, lease administration office personnel and in-house counsel; and provided marketing and portfolio management services.
To ascertain whether Division 5 was engaged in a trade or business, the IRS looked to Revenue Ruling 2006-34 for guidance. That ruling contained a non-exclusive list of factors to consider when determining whether real property interests were interests in a closely held business for purposes of Section 6166. Although Division 5 managed personal property, not real estate, the IRS found the revenue ruling instructive. Because the employees of Division 5 actively negotiated leases, inspected equipment, shipped equipment, arranged repairs and monitored third-party contractors, the IRS found that those activities constituted an active trade or business under Section 6166.
Active Trade or Business: Division 1
A second division, Division 1, was a real estate business involved in the acquisition, development, leasing operation and management of commercial real properties. It had an in-house leasing department with full-time employees; was involved in the day-to-day operations, management and maintenance of properties; used a team of in-house professionals and engineers; and developed extensive procedures for hiring and overseeing third-party suppliers and vendors. Applying the list of non-exclusive factors from Rev. Rul. 2006-34, the IRS determined that the activities of Division 1 constituted the carrying on of a trade or business under Section 6166.
Qualified Lending and Finance Business
Under Section 6166(b)(10)(A), any asset used in a qualified lending and finance business is treated as an asset that’s used in carrying out an active trade or business. Section 6166(b)(10)(B)(ii) enumerates five activities that constitute a lending and finance business. These include: 1) making loans; 2) purchasing or discounting accounts receivables, notes or installment contracts; 3) engaging in rental/leasing of real/tangible personal property; 4) rendering services or making facilities available in the ordinary course of a lending or finance business; and 5) rendering services or making activities available in connection with the preceding activities carried on by the corporation rendering services or making facilities available, or another corporation that’s a member of the same affiliated group.
In this instance, the decedent’s closely held corporation (Company 1) owned a second company (Company 2). Company 2 included two operating divisions, Division 4 and Division 5, both of which focused their efforts in leasing capital equipment such as trains, airplanes, railcars and power plants. In at least three of the five taxable years prior to the decedent’s death, Company 2 had fulltime management employees and fulltime non-owner employees and had a revenue of over $5 million from its leasing activities. Company 2 satisfied at least three of the factors enumerated in Section 6166(b)(10)(B)(ii).
Division 3, which was a division of Company 1, also satisfied the factors enumerated in Section 6166(b)(10)(B)(ii). Division 3 employed fulltime, non-owner employees, as well as at least one fulltime management employee; had acquired a portfolio of multi-family real property in different locations; and leased and maintained rental properties and collected rent. These activities constituted substantial activities involving renting and leasing of real property and rendering services in connection with those activities. As such, Division 3 qualified for the special election under Section 6166(b)(10) for assets in a qualified lending and finance business.