871 / What is an interest in a closely held business for purposes of the IRC Section 6166 estate tax deferral?

The term "interest in a closely held business" means (with regard to a stockholder interest) "stock in a corporation carrying on a trade or business." "Business," for purposes of IRC Section 6166, according to the IRS, refers to a business such as manufacturing, mercantile or service enterprise, as distinguished from management of investment assets.¹ According to the IRS, the level of activity is the factor that distinguishes an "active business" from mere passive ownership and management of income producing assets. In several rulings since 1961, the Service has tried to make the distinction in various fact situations:

Revenue Ruling 61-55:² The ownership, exploration, development, and operation of oil and gas properties is a "trade or business" within the meaning of IRC Section 6166, but the mere ownership of royalty interests in oil properties is not.

Revenue Ruling 75-366:³ Farms operated by tenant farmers under agreements that the decedent would pay 40 percent of the expenses and receive 40 percent of the crops, and in which the decedent had actively participated in the important management decisions, constitute an interest in a closely held business for purposes of IRC Section 6166.

Revenue Ruling 75-367:⁴ A decedent's ownership of an electing small business corporation engaged in home construction on the decedent's land, a sole proprietorship that developed the land and sold the homes, and a business office and warehouse shared with the corporation, constitute an interest in a closely held business for purposes of IRC Section 6166.

Letter Ruling 8524037: Commercial rental property as to which the decedent maintained a business office, hired a janitor/maintenance man, plumber, carpenter, electrician, contracted out larger jobs, ordered and supervised work done by employees, qualifies as an interest in a closely held business for purposes of IRC Section 6166.

Letter Ruling 8529026: Commercial warehouse, as to which the decedent owned the land on which it stood and negotiated leases with the tenants; carried out routine inspections of the property to determine necessary maintenance; carried out all maintenance and repair work; hired others to carry out additional maintenance; dealt with bankruptcy proceedings of two tenants and with subsequent lawsuits over a sublease; negotiated with tenants, attorneys, architects, and contractors with respect to modifications to the warehouse to suit tenants' needs; maintained an office in his home from which he performed all bookkeeping, paid monthly expenses, and maintained all correspondence concerning the warehouse; decedent's sons helped him with all aspects of the warehouse business. Held that the decedent's activity was not sufficient to qualify as an interest in a closely held business for purposes of IRC Section 6166.

Technical Advice Memorandum (TAM) 8601005: Interest in a general partnership leasing ranchland on a net-lease basis to a limited partnership actively engaged in ranching and in which the decedent was a limited partner. The Service said the land was not held simply as a passive income producing investment, but rather was used as an integral part of the trade or business of ranching. Accordingly, it was held that the decedent's interest in the general partnership was an interest in the business enterprise and not simply a passive investment.

Revenue Ruling 2006-34⁵ provides that, for purposes of determining whether a decedent's interest in real estate is an interest in an asset used in an active trade or business, the Service will consider all facts and circumstances, including the activities of agents and employees, the activities of management companies or other third parties, and the decedent's ownership interest in any management company or other third party. The Service will consider the following nonexclusive list of factors (no single factor is dispositive):

• The amount of time the decedent devoted to the trade or business;


• Whether an office was maintained from which the activities of the decedent were conducted or coordinated, and whether the decedent maintained regular business hours for that purpose;


• The extent to which the decedent was actively involved in finding new tenants and negotiating and executing leases;


• The extent to which the decedent provided landscaping, grounds care, or other services beyond the mere furnishing of leased premises;


• The extent to which the decedent personally made, arranged for, performed, or supervised repairs and maintenance to the property; and


• The extent to which the decedent handled tenant repair requests and complaints;

For purposes of this list of factors, the term decedent generally includes agents and employees of the decedent, partnership, LLC, or corporation.