### THE HONORABLE RICHARD W. GOLDBERG, Judge, United States 1 

### Court of International Trade, sitting by designation. United States Court of Appeals FOR THE EIGHTH CIRCUIT

___________ No. 96-3462

___________ Estate of Verdon Gavin, * * Appellant, * * Appeal from the United States v. * District Court for the * Northern District of Iowa. United States of America, * * Appellee. *

___________ Submitted: March 13, 1997 Filed: May 8, 1997

___________ Before MAGILL and MURPHY, Circuit Judges, and GOLDBERG, Judge. 1

___________ MAGILL, Circuit Judge.
The Estate of Verdon Gavin (the Gavin estate) brought this tax refund suit against the government, alleging that the G avin estate is entitled to (1) value certain farmland under the special use valuation provisions of Internal Revenue Code (I.R.C.) § 2032A (1988 & Supp. II 1990) and (2) use a stepped-up basis under I.R.C. § 1014 (1988 & S upp. II 1990) to calculate taxable income from the sale of grain and livestock. The district court granted summary judgment to the government on both claims. We affirm in part and reverse in part.

### - 2 - I.
The facts of this case are not in dispute. Verdon Gavin was a farmer who owned two parcels of farmland (Parcel One and Parcel Two) in Jone s County, Iowa. Parcel One was approximately 200 acres, and Parcel Two was approximately 275 acr es. During Verdon’s active farming years, he farmed the land with his son, Gary Gavin.

In 1978, Verdon entered into a crop share agreement with Gary fo r Parcels One and Two. According to the terms of this agreement, Gary Gavin
was to pay his father “one-half (1⁄2) the proceeds from all sales o f livesto ck and crops” as well as “[o]ne-half (1⁄2) the proceeds obtaine d through participationin government programs designed for crop production
or price c ontrol[.]” Farm Lease (May 17, 1978) at ¶ 2, reprinted i n Appellant’s App. at 5 1. Since entering into the agreement and during all times relevant to this appeal, Gary Gavin has ac tively farmed both Parcels One and Two.

Shortlyafter entering into the 1978 crop share agreement, Verdo n Gavin retired from active farming, leaving Gary to run the family farm

. On his federal income tax returns filed thereafter, Verdon Gavin reported
as ordinary income the crop and livestock sale proceeds that he received from Gary.
On January 4, 1990, Verdon and Gary Gavin signed a new lease fo r each of the parcels. With respect to Parcel One, Gary agreed “to pay as rent

. . . the sum of $10,000.00 for the year commencing March 1, 1990, an d ending March 1, 1991, or to crop share said property on a 50/50 basis. ” Lease with Option to Purchase Parcel One (Jan. 4, 1990) at ¶ 1, reprinted in Appellant’s App. at 53. As the government concedes, it is undisputed that, under this

### Because the issue is not relevant to this appeal, we do not decide whether Gary Gavin 2 

### had the option to purchase Parcel One for $800 per acre as specified under the lease or $1000 per acre as specified under the will. For purposes of this appeal, it is only important that Gary had the option to purchase Parcel One.
- 3 - provision, Gary “had the option to rent the landfor a 50 percent share of the crops or $10,000 per year . . . .” Appellee’s Br. at 2. Under the ne w arrangement, Gary als o had the option to purchase Parcel One for $800 per
acre. See Lease with Option to Purchase Parcel One at ¶ 3(a), reprinted inAppellant’s App. at 53. With respect to Parc el Two, Gary agreed to pay his father a fixed cash rent of $10,000 for the one-year period from March 1, 1990, to March 1, 1991, and then $15,000 per year for each yea r thereafter. See Lease with Option to Purchase Parcel Two (Jan. 4, 1990) at ¶ 1, reprinted in Appellant’s App. at 56. Under the new arrangement, Garyalso had the option to purchase Parcel Two for $1000 per acre. Id. at ¶ 3(a), reprinted in Appellant’s App. at 56.

On Ja nuary 17, 1990, less than two weeks after signing the ne w leases, Verdon Gavin died testate. He left Parcels One and Two to hi s child ren and grandchildren. Under the will, Gary Gavin received a 1/ 7 interest in each of t he parcels of farm land. Verdon’s will also granted Gary the option to buy Parcels One and Two from the Gavin estate for $1000 per acre and provided that, if Gary exercised the option, he would have on e year to obtain financing for the purchase. See Last Will and Testament of Verdon Ga vin (Oct. 23, 1987) at § III, reprinted in Appellant’s App. a t 60. 2

Between Verdon’s death and February 28, 1990, Gary paid crop shar e to t he Gavin estate in the amount of 50% of the cash proceeds from al l livestock and crop sales. On March 1, 1990, Gary began

### - 4 -

paying cash rent to the Gavin estate in the amou nt of $10,000 per year for Parcel One and $10,000 per year for Parcel Two.
On December 12, 1990, Gary signed a notice of intent to exercise his option to purchase Parcel Two. On October 1, 1991, less than two year s after Verdon’s death, Gary bought Parcel Two. On February 4, 1992, just over two years after Verdon’s death, Gary signeda notice of his intent to exercise his option to purchase Parcel One. Gary continued to pay cas h rent to the Gavin est ate until February 29, 1992. On March 2, 1992, Gary made a down payment on Parcel One.

The execu tor of the Gavin estate filed a timely 1990 federal estate tax return on which the executor elected to value Parcels One and Two unde r the specia l use valuation provisions of I.R.C. § 2032A. The Interna l Revenue Service (IRS) accepted the special use valuation of Parcel Two, bu t denied the special use valuation of Parcel One. The IRS consequentl y assessed an additional tax of $11,040 against the Gavin estate.

In addi tion to the 1990 estate tax return, the executor also file d
a timely 1990 federal income tax return for the Gavin estate. On thi s form, the executor claimed, pursuant to I.R.C. § 1014(a), a stepped-u p basis in the amount of $94,296 for the grain andlivestock received by the Gavin estate as rental payment from Gary Gavin. Consistent with this clai m to a stepped-up basis, the executor reported a g ain of only $7990 from the sale of the grain and livestock. The IRS rejected the Gavin estate’s claim to a stepped-up basis . The IRS determined that the Gavin estate was not entitled to a stepped-up basi s because the crop and livestock sale proceeds con stituted income in respect of a decedent pursuant to I.R.C.

### - 5 -

§ 691 (1988) and § 10 14(c). The IRS instead required the Gavin estate to
use Verdon Gavin’s basis in the grain and livestock to calculate th e taxable income from the sale proceeds. As a result, based on Verdon’ s lower cost basis, the IRS assessed an additional tax of $23,432 against th e estate from the sale of the grain and livestock.
After paying the asserted deficiencies, the Gavin estate filed claims for ref unds with the IRS. The IRS denied the Gavin estate’s claims fo r refunds. After exhausting all administrative remedies, the Gavin estate filed suit in the district court.

The Gavi n estate and the government each moved for partial summar y judgm ent on the special use valuation claim, and then each party late r moved for summary judgment on the stepped-up basis claim. The distric t court granted summary judgment to the government on both claims. The Gavi n estate appeals.

II. The Gavin estate argues that it is entitled to value Parcel One under the speci al use valuation provisions of I.R.C. § 2032A and that the IR S therefore incorrectly assessed an additional tax of $11,040. We agree.

On appeal , we review the district court’s grant of summary judgment to the government de novo. See McCormack v. Cit ibank, N.A. , 100 F.3d 532, 537 (8th Cir. 1996). Summary judgment is appropriate only if the record, viewe d in the light most favorable to the nonmoving party, presents n o genuine i ssues of material fact and the moving party is entitled t o judgment as a matter of law. Id. ; see also Fed. R. Civ. P. 56(c).

### - 6 - Federal estate taxes are “generally based on the fair market valu e of the taxable proper ty transferred, valued at its highest and best use.” LeFever v. Commissioner , 100 F.3d 778, 782 (10th Cir. 1996). Sectio n 2032A, ho wever, provides an exception to this general rule. If th e requirements of § 2032A are met, real property a cquired from a decedent is value d at its actual use, rather than at its highest and best use. Se e I.R.C. § 2032A(a)(1). Valuing real property at its actual use will often substantially reduce an estate’s tax burden.

Congr ess intended that § 2032A would “protect the heirs of famil y farms and small family businesses from being forced to sell the farms or busines ses to pay federal estate taxes.” LeFever , 100 F.3d at 782. A s expla ined in the 1976 House Report that accompanied the enactment of § 2032A, Congress feared that: In some cases, the great er estate tax burden [from highest and best us e valuation] makes continuation of farming . . . no t feasible because the inc ome potential from these activities is insufficient to service extended tax payments or lo ans obtained to pay the tax. Thus, the heirs may be forced to s ell the land for development purposes. Also, where the valuation of lan d reflect s speculation to such a degree that the price of th e lan d does not bear a reasonable relationship to its earnin g capacity . . . it [is] unreasonable to require that thi s “sp eculative value” be included in an estate with respect t o land devoted to farming . . . . H.R. Rep. No. 94-1380 , at 22 (1976), reprinted in 1976 U.S.C.C.A.N. 3356, 3376. In short, Cong ress intended to provide a measure of federal estate tax relief to the heirs of small family farmers so that, when their parent s died, the heirs would not have to sell the family farm.
At the same time, however, Congress included § 2032A(c) “to for eclose abuse of the privilege by taxpayers who would engage in

### - 7 -

family farming only long enough to reap the estate tax benefits and then would convert the property to a more lucrative commercial use.” Williamso n
v. Commissioner , 974 F.2d 1525, 1527 (9th Cir. 1992). Specifically, a s relevant here, § 2032A(c)(1) provides that “[i]f, within 10 years after th e decedent’s death and before the death of the qualified heir . . . (B) the qualified heir ceases to use for the qualified use the qualified rea l property . . . then, there is hereby imposed an additional estate tax. ” I.R.C. § 2032A(c)(1).
The parties agree that Gary Gavin as well as the several childr en and grandchildren who inherited the proceeds of the Gavin estate were eac h “qualified heirs,” se e I.R.C. § 2032A(e) (defining “qualified heir”), and that Parcel One was a “qualified real property,” see I.R.C. § 2032A(b ) (defining “qualified real property”). Moreover, the government concedes tha t Gary’s 1/7 interest in Parcel One never became subject to th e additional tax imposed by § 2032A(c)(1) and that , until February 28, 1990, when Gary stopped pay ing crop share and began to pay cash rent for Parcel One, Parcel One was put to a qualified use with respect to all th e qualified heirs.

The government, however, argues that the heirs, other than Gary , “cease[d] to use for the qualified use the qualified real property,” I.R.C

. § 2032A(c)(1)(B), on March 1, 1991, when Gary stopped paying crop share an d began paying cash ren t to the Gavin estate. According to the government, once Gary started making cash rent payments, the heirs, with the exception of Gar y, were no longer subject to the financial risks of farming a s required by § 2032A, and consequently “cease[d] to use for the qualified use the qualified real property . . . .” Id.

### - 8 - In Minter v. United States , 19 F.3d 426 (8th Cir. 1994), this Court
reco gnized that the receipt of cash rent from a farming operation i s ordinarily not a qual ified use for purposes of § 2032A(c)(1). Minter , 19 F.3d at 429. Neverth eless, we made clear in Minter that a qualified heir who receives rental income does not automatically lose the benefits o f special use valuation. We explained that: [W] hen a decedent’s children enter into a fixed cash ren t arrangement with another farmer who assumes the fin ancial risks of farm ing, the children’s rent income is not linked to th e contingencies of production and the children are me re landlords col lecting a fixed rent. Because this kind of arrangemen t takes the children out o f the family farming business, it also puts them outside the scope of § 2032A. On the other hand, . . . when a decedent’s children enter into a leasing arrangement in which their rent income is substantially dependent o n production, the children have accepted the financial risks of family farming and thus retain § 2032A’s benefits.

Id. ; see also Schuneman v. United States , 783 F.2d 694, 698 (7th Cir. 1986 ) (“[T]he qualified use requirement of § 2032A(b)(1) is satisfied if th e income from rental of the property is substantially dependent upo n production.”). Thus, to determine if the heirs ceased using Parcel One fo r
a qualified use under § 2032A(c)(1)(B), we must determine if the receipt of c ash rent took Verdon Gavin’s children “out of the family farmin g business” and made them into “mere landlords collecting a fixed rent. ” Minter , 19 F.3d at 429.
In the present action, the qualifiedheirs did not enter a cash rent arrangement with just “another farmer.” Id. Instead, they leased Parcel One to Gary, the qualified heir whom Verdon Gavin had groomed for man y years to take over the family farm. Although no t dispositive, we conclude that the identity of the

### - 9 -

far mer is relevant to determining whether a decedent’s heirs were “mer e landlords collecting a fixed rent,” id. , or qualified heirs engaging in a qualified use. The weight of case law and legislative history interpretin g § 2032A lends support to this distinction. Cf. LeFever , 100 F.3d at 783 (“Cash re ntal of the property to a nonfamily member is not a qualifyin g use.” (emphasis added )); Brockman v. Commissioner , 903 F.2d 518, 521 (7th Cir. 1990) (“The case law and the legislative history of Section 2032A bot h make clea r that the qualified use requirement is not satisfied if a decedent’s financial stake or other involvement in land is merely that of a landlord who collec ts a fixed rent from an unrelated tenant .” (emphasis added)); H.R. Rep. No. 94-1380 (1976), at 23, reprinted in 197 6 U.S.C.C.A.N. at 3377 (“The mere passive rental of property will no t qualify. However, wh ere a related partyleases the property and conducts farming or other business activities on the property, the real property ma y qualify for special use valuation. For example, if A, the decedent, owned real property which h e leased for use as a farm to the ABC partnership in which he and his sons B and C each had a one-thi rd interest in profits and capita l, the real property could qualify for special use valuation. ” (emphasis added)); bu t see Williamson , 974 F.2d at 1531 (“The legislative hi story accompanying section 2032A and its amendments reconfirms th e statute’s plain language insisting that Williamson as the qualified heir must personally use the property in its qualified use. Cash rental to a relative will not suffice.”). In addit ion to keeping the family farm within the family, Verdon’ s heirs “accepted the financial risks of family farming.” Minter , 19 F.3d at 429. During the o ne-year period from March 1, 1990, to March 1, 1991, Garyhad the option, under the lease then in effect, “to pay as rent for [Parcel One] the sum of $10,000

. . . or to crop share [Parcel One] on a 50/50 basis.” Lease With

### - 10 -

Option to Purchase Parcel One at ¶ 1 (emphasis added), reprinted i n Appellant’s App. at 5 3. Because it was Gary’s choice, by simply choosing to pay cash rent in the amount of $10,000, Gary did not reduce th e financial risk faced by the other heirs. Had Parcel One’s crop o r livestock sales suffered because of weather, disease, or fluctuating price s to su ch an extent that the value of 50% of the sale proceeds dropped t o less th an $10,000, Gary could and reasonably would have exercised hi s optio n to pay crop share rather than cash rent. As a result, the othe r heir s shared the risk of farming because they were not guaranteed t o receive $10,000 in cash rent. Instead, dependin g on weather, disease, and fluctuating prices, they might have earned somet hing less than $10,000, or nothing at all.
Indeed, Gary’s option to pay cash re nt decreased the return that the other hei rs could expect. The option to pay cash rent for Parcel On e effectivelycapped the heirs’ income from Parcel One at $10,000, without in any way reducing the downside potential facedby the heirs in the event that the crop and livestock sales suffered. If a 50% crop share were wort h
more than $10,000, Gary could and reasonably would have paid $10,000 i n cash rent, thereby preventing the heirs from participating in the upside potential of an extre mely profitable year. As a result, the terms of the lease forced the heirs to accept all the downside potential of bad years witho ut enjoying the upside potential of good years--an arrangemen t inconsistent with the heirs being “mere landlords collecting a fixed rent. ” Minter , 19 F.3d at 429. At the conclusion of the one-year period from March 1, 1990, to March 1, 1991, the lease provided that the rent on Par cel One “for the period of March 1, 1991, and each year thereafter shall be $10,000.00 or a crop shar e lease on a 50/50 basis at the election of Verdon Gavin.” Lease With Optio n to Purchase Parcel One at ¶ 1,

### - 11 -

reprinted inAppellant’s App. at 53. Accordingly, because the Gavin estat e had t he option to demand either a cash rent or a crop share, the heirs ’ rent income was still dependent on production. In profitable years, the heirs would likely request that Gavin pay them half of the sale proceeds whereas in difficult years the heirs would likel y ask for $10,000 in rent. While this level of dependency on production is not in and of itsel f sufficient to have kept the heirs in the “family farming business,” Minter , 19 F.3d at 429, it nevertheless indicates that the qualified heirs wer e more than “mere landlords collecting a fixed rent.” Id.
The qualified heirs had an additiona l link to the financial fortunes of the family farm. According to the terms of Verdon Gavin’s will, Gary had an outstanding option to buy Parcel One for $1000 per acre, which he did not exercise until February 4, 1992. Furthe rmore, Verdon Gavin’s will provided that, if Gary exercised his option to purchase Parcel One, Gary had an additional yea r to obtain financing to carry out the purchase. As a result, prior to the expiration of Gary’s opti on to buy and prior to the expiration of the one -year financing period, it would have been difficult for the Gavin estate to sell Parcel One or do anything with that parce l other than allow Gary to farm it. Consequently, the terms of Verdo n Gavin’s will locked the heirs into an arrangement that was dependent o n Gary’s decision to pu rchase the family farm. Gary’s decision in turn was at least partially dependent on the revenue he could earn from farming

. Again, while this factor is not in and of itself sufficient to have kept the heirs in the “family farming business,” Minter , 19 F.3d at 429, i t noneth eless indicates that the qualified heirs were more than “mer e landlords . . . .” Id. Considering the particular facts presented in this appeal, w e conclude that the combination of the foregoing factors demonstrates that the interests held by the Gavin estate heirs were

### The government also argues that, because Gary Gavin purchased Parcel One more than 3 

### two years after the death of his father, his purchase of Parcel One does not meet the requirements of § 2032A(c)(7)(A)(i), a provision that offers a safe harbor from the additional tax burden imposed by § 2032A(c)(1). Because we conclude that the qualified heirs did not cease using Parcel One for a qualified purpose and therefore that the additional tax should never have been imposed, we need not reach this issue.
- 12 - substantially dependent on production such that the qualified heirs did no t “cease[] to use for the qualified use the qualif ied real property . . . .” I.R.C. § 2032A(c)(1)(B). Section 2032A was designed to protect famil y farmers such as the G avins. The heirs of the Gavin estate did not remove themselves from the f amily farming business and did not seek to abuse the benefits offered by § 2032A. Cf. Schuneman , 783 F.2d at 699-701 (holding that income was substantially dependent on produ ction where the production historyof the farmland in question indicated it was likely that a rentadjustment clause in a lease could cause a 20 pe rcent increase or decrease in taxpay er’s income). Instead, they chose to allow Gary, the hei r designated by Verdon Gavin to run the family far m, to continue his ongoing farming operations un til he could eventually buy out the interests of the other heirs in Parcel One. Once he bought out the other heirs, Gary Gavin became the sol e qualifi ed heir, and because he continued to actively farm Parcel One , Parcel One has been continuously put to a qualified use by a qualifie d heir. Thus, the qual ified heirs of Verdon Gavin have never ceased to use Parcel One for the qualified use of farming, and consequently the Gavi n estate has not run afoul of § 2032A(c)(1). 3 III.

The Gav in estate argues that, pursuant to I.R.C. § 1014(a), it wa s entitled to a stepped-up basis in the grain and livestock

### Internal Revenue Code § 691, in relevant part, provides: 4 

### The amount of all items of gross income in respect of a decedent which are not properly includible in respect of the taxable period in which falls the date of his death or a prior period (including the amount of all items of gross income in respect of a prior decedent, if the right to receive such amount was acquired by reason of the death of the prior decedent or by bequest, devise, or inheritance from the prior decedent) shall be included in the gross income, for the taxable year when received, of: (A) the estate of the decedent, if the right to receive the amount is acquired by the decedent’s estate from the decedent . . . . I.R.C. § 691(a)(1).
- 13 - rec eived from Gary Gavin in satisfaction of Gary’s crop share agreemen t with Ve rdon Gavin. The Gavin estate argues that the crop share was no t income in respect of a decedent under I.R.C. § 691 and that the Gavi n estate was therefore entitled to a stepped-up basis under § 1014(a). We disagree.

Section 1014(a) provides generally for a stepped-up basis fo r property transferred from a decedent. However, under § 1014(c), a stepped

up basi s is not to be applied to “property which constitutes a right t o receive an item of income in respect of a decedent under section 691. ” I.R.C. § 1014(c). 4

Under I.R .C. § 61(a)(5), rent is income. I.R.C. § 61(a)(5) (1988 & Supp. II 1990). Regardless of whether rent is paid in cash or in crops an d livestock, it is still income in respect of the person who, in exchange fo r the use of real property, receives the rent. See Tatum v. Commissioner , 400 F.2d 242, 247 (5th Cir. 1968) (“Crop shares representing payment by th e tenant for the use of the land are rental income assets no less than money paid for the same pur pose . ”). To determine whether income, such as rent, is income in respect of a decedent, “[t]he focus is upon the decedent’ s right

### - 14 -

or entit lement to income at the time of death.” Estate of Peterson v

. Com missioner , 667 F.2d 675, 679 (8th Cir. 1981) (emphasis in original)

. Accordingly, income in respect of a decedent inc ludes any income earned in satisfaction of a right that is fully vested at the time of the decedent’s death suc h that the decedent had no obligations left to perform to ear n that income, other than to wait to receive payment. See id. at 679-81.

Here, in exchange for leasing his property to Gary, Verdon had a right to r eceive one-half of the proceeds from all crop and livestoc k sales. See Farm Leas e (May 17, 1978) at ¶ 2(a), reprinted in Appellant’s App. at 51. Througho ut his life, Verdon had reported these sale proceeds as ordinary income. At the time of his death, Verdon’s right to the rent income had fully vested because, had he lived, Verdon would have onl y needed to wait to receive his income. Upon Verdon’s death, his fully

vested ri ght to receive the rent income from Gary passed to his estate

. Thus, th e rent received by the Gavin estate was income in respect of a decedent for purposes of §§ 691 and 1014(c).

IV. For the f oregoing reasons, we reverse the district court’s grant of summary judgment deny ing the benefits of § 2032A to the Gavin estate with respect to Parcel One. We further direct the district court to enter an order requiring the government to accord special use valuation treatment to the Gavin estate with respect to Parcel One and issue a tax refund in the appropriate amoun t. Finally, we affirm the district court’s grant of summary judgment to the government on the issue of whether the Gavin estat e is entitled to a stepped-up basis under § 1014(a).

### - 15 - A true copy.

Attest:

CLERK, U.S. COURT OF APPEALS, EIGHTH CIRCUIT.