Value of decedent's unfinished residence, not completed value, was includible in gross estate.

• Author: Fiore, Nicholas J.

In October 1991, B'S house was completely destroyed in a fire in California. Under her insurance policy with C, she was entitled to receive replacement cost, limited to 50% of the policy's coverage limits. After its adjusters examined the property, C paid B the maximum amount under the policy (almost $500,000).

Within six months after the fire, the California insurance industry (including C) unilaterally agreed, in connection with this fire, to disregard the 50% charges and pay the actual cost of replacement, even if that cost exceeded the policy limits.

B then invited bids for construction of a replacement residence. Ultimately, C agreed to pay her $1.3 million for this work. C also paid B for living expenses while the residence was being rebuilt.

B died in 1994. After her death, the co-executors of her estate decided to complete the reconstruction of the residence. B'S estate tax return reflected the value of the partially (57%) finished home as its fair market value (FMV). Also included was an amount that the estate estimated would be due from C for future reimbursement on completion of the restoration; excluded was the amount that would be due the contractor. In effect, this resulted in a net reduction in B's gross estate.

The IRS determined that the completed value of the residence should be included, thereby increasing B's gross estate. The estate challenged this increase. In a memorandum opinion, the Tax Court holds for B's estate. No amount representing any possible future payment from C is includible in B's estate; at the same time, the estate is not entitled to deduct the possibility of future payments to the contractor.

For Federal estate tax purposes, assets are includible in a decedent's gross estate at FMV determined at the date of death. FMV is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts. FMV is tested on an objective basis, using a hypothetical buyer and seller, and not on the basis of the particular entities or individuals involved.

First, the asset in question was incomplete and under construction at the time of death. More significantly, the residence was to be restored to its prefire specifications. The cost of restoring the destroyed residence to its original vintage condition was substantially greater than the per-square-foot cost of constructing a...