• Intrafamily mortgage upheld—In Property of Barbara Galli v. Commissioner, Docket Nos. 7003-20 and 7005-20 (March 5, 2025), the Tax Court docket held for the taxpayer that an intrafamily interest-only mortgage on the relevant federal charge (AFR) wasn’t a present. Barbara made a $2.3 million mortgage to her son Stephen in 2013, three years earlier than her dying, documented with a observe. The mortgage referred to as for annual curiosity funds on the midterm AFR of 1.01%. Stephen paid the curiosity every year, and Barbara reported it on her earnings tax return. No present tax return was filed. On the property tax return, the unpaid portion of the mortgage was included as an asset.
The Inside Income Service issued notices of deficiency asserting that there was a present as a result of the unsecured mortgage didn’t have phrases that might have made it enforceable within the industrial market. The IRS additionally acknowledged that Stephen had no intent or capacity to pay it and that Barbara didn’t anticipate reimbursement. The IRS utilized a reduction when figuring out the observe’s honest market worth (FMV) for present tax functions to account for the chance of nonpayment. Because of this, the IRS concluded that the mortgage’s principal quantity, much less the observe’s FMV, was a present. Alternatively, the IRS claimed that the property tax worth of the observe needs to be decided by discounting the worth of the longer term funds and making use of the present AFR charge, which might enhance the worth of the property by $544,000.
Nonetheless, the courtroom discovered that the IRS didn’t allege or present any info supporting its declare that Stephen didn’t have the flexibility or intent to repay the mortgage.
Additional, the courtroom held the mortgage can’t be recharacterized as a present if it was made utilizing the AFR as a result of below Inside Income Code Part 7872,
a mortgage bearing curiosity on the AFR isn’t a “below-market mortgage” to which IRC Part 7872 applies. In Frazee v. Comm’r, 98 T.C. 554, 588 (1992), the Tax Court docket held that Part 7872 supplies “complete remedy of below-market loans for earnings and present tax functions,” explaining that by enacting Part 7872, Congress supposed the discounting methodology to totally exchange the standard honest market methodology of valuation of below-market loans.
This case helps cement the place {that a} observe bearing curiosity at AFR, which the events respect and intend to pay/accumulate, can be valued on the quantity of excellent principal for present and property tax functions.
• Valuation of certified terminable curiosity property (QTIP) belief isn’t adjusted for legal responsibility—In Kalikow v. Comm’r, 135 A.F.T.R.2nd 2025-831 (March 4, 2025), the U.S. Court docket of Appeals for the Second Circuit upheld the Tax Court docket’s ruling on abstract judgment motions relating to the property tax remedy of a settlement cost owed by a QTIP marital belief to the property of the beneficiary widow.
Pearl Kalikow survived her husband, Sidney. Sidney’s will established a QTIP marital belief that held 10 properties. After Pearl’s dying, the trustees of the QTIP belief reorganized the ten properties right into a household restricted partnership. On Pearl’s dying, the QTIP belief belongings handed to her two kids.
In the meantime, Pearl’s property finally handed to charity. On her dying, her property made a declare in opposition to the QTIP belief, asserting that she hadn’t been correctly paid the online earnings from the QTIP belief, as required. The difficulty was settled, and the QTIP belief agreed to pay over $6 million to Pearl’s property to fulfill the declare.
The taxpayers argued that the worth of the QTIP belief needs to be decreased by the declare payable to Pearl’s property. Nonetheless, the courtroom defined that the QTIP belief belongings have been includible in Pearl’s property, not the QTIP belief entity itself. The belongings of the QTIP belief weren’t encumbered by the putative declare as of the date of dying. A hypothetical purchaser of the belongings of the QTIP belief wouldn’t scale back the acquisition value of these belongings by the QTIP belief’s obligation to again pay the online earnings. As a result of the legal responsibility didn’t have an effect on the worth of the underlying partnership proudly owning the ten properties, it wasn’t related to the valuation of the belongings included in Pearl’s property.
Within the various, the taxpayers argued that the estates ought to deduct the $6 million settlement cost as an administrative expense. Nonetheless, this argument wasn’t profitable. The courtroom held that, as to the property, the $6 million cost was an asset or receivable, not an expense.
So, no adjustment was made to the QTIP belief, valued at virtually $55 million, for property tax functions in Pearl’s property.
Had the property prevailed on this case, the QTIP belief would have been decreased by $6 million for property tax functions, and the $6 million obtained by Pearl’s property would have certified for the property tax charitable deduction.
