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Estate of Walter F. Klosterman v. Commissioner Internal Revenue Service

filed*fn*: July 5, 1994.


Appeal from a Decision of the United States Tax Court. Tax Ct. No. 27652-89.

Before: Charles Wiggins and David R. Thompson, Circuit Judges, and David A. Ezra, District Judge.*fn** Opinion by Judge Thompson.

Author: Thompson

THOMPSON, Circuit Judge:

The Estate of Walter F. Klosterman, deceased, elected to use the formula prescribed by 26 U.S.C. § 2032A(e)(7)(A) to value farmland for estate tax purposes. This section permits a taxpayer to value farmland by dividing the excess of the "average annual gross cash rental" received for comparable land over the "State and local real estate taxes" imposed upon such land, by the applicable Federal Land Bank interest rate. In applying this formula, the estate excluded from the average annual gross cash rental the average annual amounts of irrigation assessments tenants of such land pay to their landlords. The estate contends these payments are not payments of rent for land and thus are not includable in the valuation formula as "gross cash rental for comparable land," or, if includable in such gross rental, the assessments may be deducted as local real estate taxes under § 2032A(e)(7)(A)(i) and 26 U.S.C. § 164.

The tax court, in a published decision, Estate of Klosterman v. Commissioner I.R.S., 99 T.C. 313 (1992), rejected the estate's arguments, concluded the estate had misapplied the formula, and determined the estate's tax deficiency to be $15,232. The estate appeals.

We have jurisdiction under 26 U.S.C. § 7482 and we affirm. We conclude that in applying the valuation formula of § 2032A(e)(7)(A), irrigation assessments paid by farm tenants to landlords of comparable land as part of the rent are includable as "gross cash rental," and are not deductible as "local real estate taxes."

The farmland involved in this case consists of 369 acres of irrigable land in the high desert of Idaho, an area where farming is impossible without irrigation. The Minidoka and A & B Irrigation Districts, quasi-municipal Idaho corporations, supply water to irrigate farmlands in this area. The Irrigation Districts levy operation and maintenance (O & M) assessments on all irrigable land within their districts without regard to whether water is actually supplied to the assessed land.

Failure to pay an O & M assessment results in an Irrigation District denying the property irrigation water. To ensure that the assessments are paid, the common practice is for landlords to pay the assessments and collect them from their tenant farmers as part of the rent. For the applicable time period, the average annual gross rental for farmland comparable to the estate's 369 acres was $98.73 per acre, and the average annual assessment was $23.00 per acre.

Under § 2032A(e)(7)(A), the value of farmland is determined according to the following formula:

The value of a farm for farming purposes shall be determined by dividing (i) the excess of the average annual gross cash rental for comparable land used for farming purposes and located in the locality of such farm over the average annual State and local real estate taxes for such comparable land, by (ii) the average annual effective rate for all new Federal Land loans.

26 U.S.C. § 2032(A)(e)(7)(A).

In arguing that the assessments landlords collect from their tenants are not "rent," the estate contends these payments are nothing more than a security deposit to ensure payment of the O & M assessments, a simple pass-through of a tenant expense from the tenant through the landlord to the Irrigation District; because § 2032A(e)(7)(A)(i) refers to rental for comparable land, and the "security deposits" are not rent for land, the assessments should be excluded when computing the average annual gross cash rental.

We reject this argument. The statute refers to gross cash rental. The meaning of the term "gross" in this context is plain. It means an amount unreduced by any deductions. This point is driven home by the fact Congress expressly listed only one kind of expense which can be used to reduce gross rental: "State and local real estate taxes." Id.

The fact that the landowners pass the economic cost of the O & M assessments on to their tenants in the form of higher rent does not mean these charges may be deducted from the gross rent to determine the "gross cash rental." Were it otherwise, any economic cost pertaining to the property and passed on to the tenant, such as casualty and liability insurance premiums, could be deducted from "gross cash rental" in applying the formula. The result would be that the meaning of the term "gross" would not be "gross" at all. It would be "net." Had the estate ...

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