783 F.2d 694 (7th Cir. 1986), 84-2651, Schuneman v. United States

Docket Nº:84-2651, 84-2888.
Citation:783 F.2d 694
Party Name:Merle SCHUNEMAN and Robert Doty, Trustees under Trust Agreement dated April 10, 1977, with Kathryn M. Keefe, as Settlor, Plaintiffs-Appellants, v. UNITED STATES of America, Defendant-Appellee.
Case Date:February 10, 1986
Court:United States Courts of Appeals, Court of Appeals for the Seventh Circuit

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783 F.2d 694 (7th Cir. 1986)

Merle SCHUNEMAN and Robert Doty, Trustees under Trust

Agreement dated April 10, 1977, with Kathryn M.

Keefe, as Settlor, Plaintiffs-Appellants,


UNITED STATES of America, Defendant-Appellee.

Nos. 84-2651, 84-2888.

United States Court of Appeals, Seventh Circuit

February 10, 1986

Argued Sept. 10, 1985.

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B. Douglas Stephens, Jr., Van Derkamp, Cleaver & Stojan, P.C., Rock Island, Ill., for plaintiffs-appellants.

Michael J. Paup, Chief Appellate Section, Asst. Atty. Gen., Tax Div., U.S. Dept. of Justice, Washington, D.C., for defendant-appellee.

Before WOOD and ESCHBACH, Circuit Judges, and SWYGERT, Senior Circuit Judge.

ESCHBACH, Circuit Judge.

Merle Schuneman and Robert Doty ("taxpayers"), as trustees of a trust established by Kathryn Keefe, appeal from the district court's order, 570 F.Supp. 1327, denying special use valuation under 26 U.S.C. (I.R.C.) Sec. 2032A of approximately 330 acres of farmland. The government cross-appeals from an order requiring it to refund approximately $8,000 of interest that taxpayers paid as a result of the initial disallowance of a state death tax credit. We will reverse and remand in the appeal, and vacate the district court's order and remand for a recalculation of the refund in the cross-appeal. We hold that taxpayers are entitled to special use valuation under I.R.C. Sec. 2032A because the income derived from the lease of the farmland was substantially dependent upon production. 1


The farmland in question, which is located in Whiteside County, Illinois, has been owned by the Keefe family since 1895. Kathryn Keefe lived on the farm her entire life, from her birth in 1897 until her death in 1977. The farm was operated by Kathryn's parents, and, following their deaths, by Kathryn and her brothers Jerold, Cecil and Harry. Jerold and Cecil predeceased Kathryn in 1956 and 1961 respectively, and she inherited their shares. She also acquired 40 acres from another party, bringing her total farm ownership to approximately 330 acres.

From 1956 through 1968, Kathryn Keefe ("Keefe") personally operated the farm, hiring neighboring farmers to use their machinery to plant and to harvest the crops according to her directions. In 1969, Keefe first entered into an oral crop-share arrangement with a neighboring farmer, Arthur Wetzell. She continued this for each year thereafter through 1975.

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Under the terms of the oral crop-share arrangement, Keefe and Wetzell jointly decided what crops would be planted, how many acres would be planted in each crop, and what crop rotation would be used. Each winter Wetzell would propose a plan for the amount and location of each crop to be planted; however, Keefe and Wetzell continued the crop rotation pattern Keefe had developed earlier. Keefe consulted with Wetzell generally two or three times a week during the planting and harvesting seasons, and usually at least once a week during the remainder of the year. Each year Wetzell paid 50 percent of the cost of fertilizer, seeds, and supplies, and 100 percent of the fuel. Keefe paid 50 percent of the production costs and 100 percent of the utilities. She kept her own records and dealt directly with suppliers.

Keefe and Wetzell agreed in late 1975 and early 1976 to continue the crop-share arrangement for the 1976 crop year. They planned the necessary purchases, bought supplies, and decided on the crops to be planted. In early 1976, however, Keefe's health began to deteriorate. As a result, in February and March of 1976, Kathryn's nephew Edward Keefe discussed with Wetzell the possibility of entering into a cash lease so that Keefe would not have to participate actively in the operation of the farm. Keefe and Wetzell executed a new written lease for the 1976 season sometime between March and May of 1976.

The 1976 lease provided that Wetzell would pay a fixed cash rent of $80 per acre for a total annual rent of $26,240. Although Wetzell as lessee assumed sole responsibility for the operation of the farm, he ran the farm according to the plans for the 1976 season that Keefe and he had already jointly made. Moreover, he continued to consult with Keefe about the management of the farm at least two or three times a month. Throughout 1976, Keefe continued to inspect the farm regularly. She made repairs to the farm buildings, including reroofing the barn and repaving the driveway to the grainery. Also in 1976, she sold her share of the 1975 crop.

In November 1976, Keefe and Wetzell signed a lease for the 1977 crop year. The 1977 lease provided that Wetzell would pay a cash rent of $32,600 if certain grain production and price levels were met. If the 1977 crop yields and prices were as low as the 1976 yields and prices, however, Wetzell would not have been able to pay rent in the amount of $32,600 without suffering a loss. He therefore desired protection against the possibility of poor production and low prices. Thus, Wetzell proposed and Keefe accepted a rent-adjustment clause that stated:

It is a condition of this lease that if at the time of actual harvest, and providing that harvest is completed by December 31, 1977, the gross income derivable to tenant under this lease if sale were made at the time of harvest shall, without any neglect on the part of the tenant, be shown by tenant to be less than an amount equal to an average production of 70 bushels per acre of corn times a price of $2.25 per bushel per number 2 corn, then the annual rent shall be adjusted to $26,080.

1977 Lease p 16. Thus, if Wetzell's gross income from the lease of Keefe's farmland fell below $51,660, which is the amount that would be realized by the sale of the crops grown on the 328 acres under cultivation, assuming a yield of 70 bushels of corn per acre and a price of $2.25 per bushel, then the annual rent would be adjusted downward 20 percent from $32,600 to $26,080.

Keefe died on April 23, 1977. Shortly before her death, on April 10, 1977, she had transferred all of her property, including the 330 acres of farmland, into a trust for the benefit of herself and her nieces and nephews. On January 24, 1978, taxpayers, as trustees of the trust, timely filed a federal estate tax return. They elected to value the land at its special use valuation under I.R.C. Sec. 2032A. Although the land's fair market value is $686,000, its special use valuation if it qualifies under Sec. 2032A is $191,259. Upon an audit of the return, however, the IRS denied the special use

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valuation on the ground that the farmland was not being used for a "qualified use" on the date of Keefe's death. It also disallowed the state death tax credit. Taxpayers paid an additional assessment of $182,822 allocated as follows:

Item disallowed Assessment Interest

Special Use Valuation $114,224 $30,668

State Death Tax Credit $ 29,902 $ 8,028

The government later conceded that taxpayers were entitled to a credit for the state death taxes. Nevertheless, it denied a refund for the $8,028 of interest paid as a result of the initial disallowance of the state death tax credit.

Taxpayers filed this action for recovery of the $114,224 plus interest paid after denial of the special use valuation, and for a refund of the $8,028 paid as interest due to the initial disallowance of the state death tax credit. With regard to the special use valuation, the government conceded that Keefe had satisfied all of the elements of Sec. 2032A other than the qualified use requirement...

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