                        United States Court of Appeals
                            FOR THE EIGHTH CIRCUIT

                                   ___________

                                   No. 96-3462
                                   ___________

Estate of Verdon Gavin,                 *
                                        *
           Appellant,                   *
                                        * Appeal from the United States
     v.                                 * District Court for the
                                        * Northern District of Iowa.
United States of America,               *
                                        *
           Appellee.                    *
                                   ___________

                   Submitted:      March 13, 1997

                          Filed:   May 8, 1997
                                   ___________

Before MAGILL and MURPHY, Circuit Judges, and GOLDBERG,1 Judge.
                               ___________

MAGILL, Circuit Judge.


     The Estate of Verdon Gavin (the Gavin estate) brought this tax refund
suit against the government, alleging that the Gavin estate is entitled to
(1) value certain farmland under the special use valuation provisions of
Internal Revenue Code (I.R.C.) § 2032A (1988 & Supp. II 1990) and (2) use
a stepped-up basis under I.R.C. § 1014 (1988 & Supp. II 1990) to calculate
taxable income from the sale of grain and livestock.     The district court
granted summary judgment to the government on both claims.     We affirm in
part and reverse in part.




     1
     THE HONORABLE RICHARD W. GOLDBERG, Judge, United States
Court of International Trade, sitting by designation.
                                     I.


     The facts of this case are not in dispute.   Verdon Gavin was a farmer
who owned two parcels of farmland (Parcel One and Parcel Two) in Jones
County, Iowa.   Parcel One was approximately 200 acres, and Parcel Two was
approximately 275 acres.    During Verdon’s active farming years, he farmed
the land with his son, Gary Gavin.


     In 1978, Verdon entered into a crop share agreement with Gary for
Parcels One and Two.   According to the terms of this agreement, Gary Gavin
was to pay his father “one-half (½) the proceeds from all sales of
livestock and crops” as well as “[o]ne-half (½) the proceeds obtained
through participation in government programs designed for crop production
or price control[.]”       Farm Lease (May 17, 1978) at ¶ 2, reprinted in
Appellant’s App. at 51.    Since entering into the agreement and during all
times relevant to this appeal, Gary Gavin has actively farmed both Parcels
One and Two.


     Shortly after entering into the 1978 crop share agreement, Verdon
Gavin retired from active farming, leaving Gary to run the family farm.
On his federal income tax returns filed thereafter, Verdon Gavin reported
as ordinary income the crop and livestock sale proceeds that he received
from Gary.


     On January 4, 1990, Verdon and Gary Gavin signed a new lease for each
of the parcels.    With respect to Parcel One, Gary agreed “to pay as rent
. . . the sum of $10,000.00 for the year commencing March 1, 1990, and
ending March 1, 1991, or to crop share said property on a 50/50 basis.”
Lease with Option to Purchase Parcel One (Jan. 4, 1990) at ¶ 1, reprinted
in Appellant’s App. at 53.     As the government concedes, it is undisputed
that, under this




                                    - 2 -
provision, Gary “had the option to rent the land for a 50 percent share of
the crops or $10,000 per year . . . .”               Appellee’s Br. at 2.          Under the new
arrangement, Gary also had the option to purchase Parcel One for $800 per
acre.       See Lease with Option to Purchase Parcel One at ¶ 3(a), reprinted
in Appellant’s App. at 53.           With respect to Parcel Two, Gary agreed to pay
his father a fixed cash rent of $10,000 for the one-year period from March
1, 1990, to March 1, 1991, and then $15,000 per year for each year
thereafter.       See Lease with Option to Purchase Parcel Two (Jan. 4, 1990)
at ¶ 1, reprinted in Appellant’s App. at 56.                    Under the new arrangement,
Gary also had the option to purchase Parcel Two for $1000 per acre.                             Id.
at ¶ 3(a), reprinted in Appellant’s App. at 56.


        On January 17, 1990, less than two weeks after signing the new
leases, Verdon Gavin died testate.                  He left Parcels One and Two to his
children and grandchildren.              Under the will, Gary Gavin received a 1/7
interest in each of the parcels of farm land.                   Verdon’s will also granted
Gary the option to buy Parcels One and Two from the Gavin estate for $1000
per acre and provided that, if Gary exercised the option, he would have one
year to obtain financing for the purchase.                 See Last Will and Testament of
Verdon Gavin (Oct. 23, 1987) at § III, reprinted in Appellant’s App. at
60.2


        Between Verdon’s death and February 28, 1990, Gary paid crop share
to the Gavin estate in the amount of 50% of the cash proceeds from all
livestock and crop sales.            On March 1, 1990, Gary began




        2
         Because the issue is not relevant to this appeal, we do not decide whether Gary Gavin
had the option to purchase Parcel One for $800 per acre as specified under the lease or $1000 per
acre as specified under the will. For purposes of this appeal, it is only important that Gary had the
option to purchase Parcel One.

                                              - 3 -
paying cash rent to the Gavin estate in the amount of $10,000 per year for
Parcel One and $10,000 per year for Parcel Two.


     On December 12, 1990, Gary signed a notice of intent to exercise his
option to purchase Parcel Two.     On October 1, 1991, less than two years
after Verdon’s death, Gary bought Parcel Two.      On February 4, 1992, just
over two years after Verdon’s death, Gary signed a notice of his intent to
exercise his option to purchase Parcel One.       Gary continued to pay cash
rent to the Gavin estate until February 29, 1992.     On March 2, 1992, Gary
made a down payment on Parcel One.


     The executor of the Gavin estate filed a timely 1990 federal estate
tax return on which the executor elected to value Parcels One and Two under
the special use valuation provisions of I.R.C. § 2032A.         The Internal
Revenue Service (IRS) accepted the special use valuation of Parcel Two, but
denied the special use valuation of Parcel One.        The IRS consequently
assessed an additional tax of $11,040 against the Gavin estate.


     In addition to the 1990 estate tax return, the executor also filed
a timely 1990 federal income tax return for the Gavin estate.        On this
form, the executor claimed, pursuant to I.R.C. § 1014(a), a stepped-up
basis in the amount of $94,296 for the grain and livestock received by the
Gavin estate as rental payment from Gary Gavin.    Consistent with this claim
to a stepped-up basis, the executor reported a gain of only $7990 from the
sale of the grain and livestock.
     The IRS rejected the Gavin estate’s claim to a stepped-up basis.    The
IRS determined that the Gavin estate was not entitled to a stepped-up basis
because the crop and livestock sale proceeds constituted income in respect
of a decedent pursuant to I.R.C.




                                   - 4 -
§ 691 (1988) and § 1014(c).    The IRS instead required the Gavin estate to
use Verdon Gavin’s basis in the grain and livestock to calculate the
taxable income from the sale proceeds.      As a result, based on Verdon’s
lower cost basis, the IRS assessed an additional tax of $23,432 against the
estate from the sale of the grain and livestock.


     After paying the asserted deficiencies, the Gavin estate filed claims
for refunds with the IRS.     The IRS denied the Gavin estate’s claims for
refunds.   After exhausting all administrative remedies, the Gavin estate
filed suit in the district court.


     The Gavin estate and the government each moved for partial summary
judgment on the special use valuation claim, and then each party later
moved for summary judgment on the stepped-up basis claim.      The district
court granted summary judgment to the government on both claims.    The Gavin
estate appeals.


                                     II.
     The Gavin estate argues that it is entitled to value Parcel One under
the special use valuation provisions of I.R.C. § 2032A and that the IRS
therefore incorrectly assessed an additional tax of $11,040.       We agree.


     On appeal, we review the district court’s grant of summary judgment
to the government de novo.    See McCormack v. Citibank, N.A., 100 F.3d 532,
537 (8th Cir. 1996).   Summary judgment is appropriate only if the record,
viewed in the light most favorable to the nonmoving party, presents no
genuine issues of material fact and the moving party is entitled to
judgment as a matter of law.     Id.; see also Fed. R. Civ. P. 56(c).




                                    - 5 -
        Federal estate taxes are “generally based on the fair market value
of the taxable property transferred, valued at its highest and best use.”
LeFever v. Commissioner, 100 F.3d 778, 782 (10th Cir. 1996).         Section
2032A, however, provides an exception to this general rule.           If the
requirements of § 2032A are met, real property acquired from a decedent is
valued at its actual use, rather than at its highest and best use.        See
I.R.C. § 2032A(a)(1).    Valuing real property at its actual use will often
substantially reduce an estate’s tax burden.


        Congress intended that § 2032A would “protect the heirs of family
farms and small family businesses from being forced to sell the farms or
businesses to pay federal estate taxes.”      LeFever, 100 F.3d at 782.    As
explained in the 1976 House Report that accompanied the enactment of §
2032A, Congress feared that:
        In some cases, the greater estate tax burden [from highest and
        best use valuation] makes continuation of farming . . . not
        feasible because the income potential from these activities is
        insufficient to service extended tax payments or loans obtained
        to pay the tax. Thus, the heirs may be forced to sell the land
        for development purposes. Also, where the valuation of land
        reflects speculation to such a degree that the price of the
        land does not bear a reasonable relationship to its earning
        capacity . . . it [is] unreasonable to require that this
        “speculative value” be included in an estate with respect to
        land devoted to farming . . . .

H.R. Rep. No. 94-1380, at 22 (1976), reprinted in 1976 U.S.C.C.A.N. 3356,
3376.    In short, Congress intended to provide a measure of federal estate
tax relief to the heirs of small family farmers so that, when their parents
died, the heirs would not have to sell the family farm.


        At the same time, however, Congress included § 2032A(c) “to foreclose
abuse of the privilege by taxpayers who would engage in




                                    - 6 -
family farming only long enough to reap the estate tax benefits and then
would convert the property to a more lucrative commercial use.”   Williamson
v. Commissioner, 974 F.2d 1525, 1527 (9th Cir. 1992).     Specifically, as
relevant here, § 2032A(c)(1) provides that “[i]f, within 10 years after the
decedent’s death and before the death of the qualified heir . . . (B) the
qualified heir ceases to use for the qualified use the qualified real
property . . . then, there is hereby imposed an additional estate tax.”
I.R.C. § 2032A(c)(1).


     The parties agree that Gary Gavin as well as the several children and
grandchildren who inherited the proceeds of the Gavin estate were each
“qualified heirs,” see I.R.C. § 2032A(e) (defining “qualified heir”), and
that Parcel One was a “qualified real property,” see I.R.C. § 2032A(b)
(defining “qualified real property”).     Moreover, the government concedes
that Gary’s 1/7 interest in Parcel One never became subject to the
additional tax imposed by § 2032A(c)(1) and that, until February 28, 1990,
when Gary stopped paying crop share and began to pay cash rent for Parcel
One, Parcel One was put to a qualified use with respect to all the
qualified heirs.


     The government, however, argues that the heirs, other than Gary,
“cease[d] to use for the qualified use the qualified real property,” I.R.C.
§ 2032A(c)(1)(B), on March 1, 1991, when Gary stopped paying crop share and
began paying cash rent to the Gavin estate.    According to the government,
once Gary started making cash rent payments, the heirs, with the exception
of Gary, were no longer subject to the financial risks of farming as
required by § 2032A, and consequently “cease[d] to use for the qualified
use the qualified real property . . . .”    Id.




                                  - 7 -
     In Minter v. United States, 19 F.3d 426 (8th Cir. 1994), this Court
recognized that the receipt of cash rent from a farming operation is
ordinarily not a qualified use for purposes of § 2032A(c)(1).            Minter, 19
F.3d at 429.    Nevertheless, we made clear in Minter that a qualified heir
who receives rental income does not automatically lose the benefits of
special use valuation.         We explained that:
     [W]hen a decedent’s children enter into a fixed cash rent
     arrangement with another farmer who assumes the financial risks
     of farming, the children’s rent income is not linked to the
     contingencies of production and the children are mere landlords
     collecting a fixed rent.     Because this kind of arrangement
     takes the children out of the family farming business, it also
     puts them outside the scope of § 2032A. On the other hand, .
     . . when a decedent’s children enter into a leasing arrangement
     in which their rent income is substantially dependent on
     production, the children have accepted the financial risks of
     family farming and thus retain § 2032A’s benefits.

Id.; see also Schuneman v. United States, 783 F.2d 694, 698 (7th Cir. 1986)
(“[T]he qualified use requirement of § 2032A(b)(1) is satisfied if the
income   from    rental   of   the   property   is   substantially   dependent   upon
production.”).    Thus, to determine if the heirs ceased using Parcel One for
a qualified use under § 2032A(c)(1)(B), we must determine if the receipt
of cash rent took Verdon Gavin’s children “out of the family farming
business” and made them into “mere landlords collecting a fixed rent.”
Minter, 19 F.3d at 429.


     In the present action, the qualified heirs did not enter a cash rent
arrangement with just “another farmer.”         Id.    Instead, they leased Parcel
One to Gary, the qualified heir whom Verdon Gavin had groomed for many
years to take over the family farm.        Although not dispositive, we conclude
that the identity of the




                                        - 8 -
farmer is relevant to determining whether a decedent’s heirs were “mere
landlords collecting a fixed rent,” id., or qualified heirs engaging in a
qualified use.     The weight of case law and legislative history interpreting
§ 2032A lends support to this distinction.            Cf. LeFever, 100 F.3d at 783
(“Cash rental of the property to a nonfamily member is not a qualifying
use.” (emphasis added)); Brockman v. Commissioner, 903 F.2d 518, 521 (7th
Cir. 1990) (“The case law and the legislative history of Section 2032A both
make clear that the qualified use requirement is not satisfied if a
decedent’s financial stake or other involvement in land is merely that of
a landlord who collects a fixed rent from an unrelated tenant.” (emphasis
added));    H.R.    Rep.   No.   94-1380    (1976),   at   23,   reprinted   in   1976
U.S.C.C.A.N. at 3377 (“The mere passive rental of property will not
qualify.   However, where a related party leases the property and conducts
farming or other business activities on the property, the real property may
qualify for special use valuation.         For example, if A, the decedent, owned
real property which he leased for use as a farm to the ABC partnership in
which he and his sons B and C each had a one-third interest in profits and
capital, the real property could qualify for special use valuation.”
(emphasis added)); but see Williamson, 974 F.2d at 1531 (“The legislative
history accompanying section 2032A and its amendments reconfirms the
statute’s plain language insisting that Williamson as the qualified heir
must personally use the property in its qualified use.             Cash rental to a
relative will not suffice.”).
     In addition to keeping the family farm within the family, Verdon’s
heirs “accepted the financial risks of family farming.”             Minter, 19 F.3d
at 429.    During the one-year period from March 1, 1990, to March 1, 1991,
Gary had the option, under the lease then in effect, “to pay as rent for
[Parcel One] the sum of $10,000 . . . or to crop share [Parcel One] on a
50/50 basis.”      Lease With




                                       - 9 -
Option to Purchase Parcel One at ¶ 1 (emphasis added), reprinted in
Appellant’s App. at 53.   Because it was Gary’s choice, by simply choosing
to pay cash rent in the amount of $10,000, Gary did not reduce the
financial risk faced by the other heirs.         Had Parcel One’s crop or
livestock sales suffered because of weather, disease, or fluctuating prices
to such an extent that the value of 50% of the sale proceeds dropped to
less than $10,000, Gary could and reasonably would have exercised his
option to pay crop share rather than cash rent.      As a result, the other
heirs shared the risk of farming because they were not guaranteed to
receive $10,000 in cash rent.    Instead, depending on weather, disease, and
fluctuating prices, they might have earned something less than $10,000, or
nothing at all.


     Indeed, Gary’s option to pay cash rent decreased the return that the
other heirs could expect.       The option to pay cash rent for Parcel One
effectively capped the heirs’ income from Parcel One at $10,000, without
in any way reducing the downside potential faced by the heirs in the event
that the crop and livestock sales suffered.   If a 50% crop share were worth
more than $10,000, Gary could and reasonably would have paid $10,000 in
cash rent, thereby preventing the heirs from participating in the upside
potential of an extremely profitable year.    As a result, the terms of the
lease forced the heirs to accept all the downside potential of bad years
without enjoying the upside potential of good years--an arrangement
inconsistent with the heirs being “mere landlords collecting a fixed rent.”
Minter, 19 F.3d at 429.
     At the conclusion of the one-year period from March 1, 1990, to March
1, 1991, the lease provided that the rent on Parcel One “for the period of
March 1, 1991, and each year thereafter shall be $10,000.00 or a crop share
lease on a 50/50 basis at the election of Verdon Gavin.”   Lease With Option
to Purchase Parcel One at ¶ 1,




                                    - 10 -
reprinted in Appellant’s App. at 53.     Accordingly, because the Gavin estate
had the option to demand either a cash rent or a crop share, the heirs’
rent income was still dependent on production.         In profitable years, the
heirs would likely request that Gavin pay them half of the sale proceeds
whereas in difficult years the heirs would likely ask for $10,000 in rent.
While this level of dependency on production is not in and of itself
sufficient to have kept the heirs in the “family farming business,” Minter,
19 F.3d at 429, it nevertheless indicates that the qualified heirs were
more than “mere landlords collecting a fixed rent.”         Id.


     The qualified heirs had an additional link to the financial fortunes
of the family farm.    According to the terms of Verdon Gavin’s will, Gary
had an outstanding option to buy Parcel One for $1000 per acre, which he
did not exercise until February 4, 1992.        Furthermore, Verdon Gavin’s will
provided that, if Gary exercised his option to purchase Parcel One, Gary
had an additional year to obtain financing to carry out the purchase.             As
a result, prior to the expiration of Gary’s option to buy and prior to the
expiration of the one-year financing period, it would have been difficult
for the Gavin estate to sell Parcel One or do anything with that parcel
other than allow Gary to farm it.          Consequently, the terms of Verdon
Gavin’s will locked the heirs into an arrangement that was dependent on
Gary’s decision to purchase the family farm.        Gary’s decision in turn was
at least partially dependent on the revenue he could earn from farming.
Again, while this factor is not in and of itself sufficient to have kept
the heirs in the “family farming business,” Minter, 19 F.3d at 429, it
nonetheless indicates that the qualified heirs were more than “mere
landlords . . . .”    Id.
     Considering     the   particular   facts   presented   in   this   appeal,   we
conclude that the combination of the foregoing factors demonstrates that
the interests held by the Gavin estate heirs were




                                    - 11 -
substantially dependent on production such that the qualified heirs did not
“cease[] to use for the qualified use the qualified real property . . . .”
I.R.C. § 2032A(c)(1)(B).            Section 2032A was designed to protect family
farmers such as the Gavins.           The heirs of the Gavin estate did not remove
themselves from the family farming business and did not seek to abuse the
benefits offered by § 2032A.           Cf. Schuneman, 783 F.2d at 699-701 (holding
that income was substantially dependent on production where the production
history of the farmland in question indicated it was likely that a rent-
adjustment clause in a lease could cause a 20 percent increase or decrease
in taxpayer’s income).             Instead, they chose to allow Gary, the heir
designated by Verdon Gavin to run the family farm, to continue his ongoing
farming operations until he could eventually buy out the interests of the
other heirs in Parcel One.
        Once he bought out the other heirs, Gary Gavin became the sole
qualified heir, and because he continued to actively farm Parcel One,
Parcel One has been continuously put to a qualified use by a qualified
heir.       Thus, the qualified heirs of Verdon Gavin have never ceased to use
Parcel One for the qualified use of farming, and consequently the Gavin
estate has not run afoul of § 2032A(c)(1).3
                                              III.


        The Gavin estate argues that, pursuant to I.R.C. § 1014(a), it was
entitled to a stepped-up basis in the grain and livestock




        3
        The government also argues that, because Gary Gavin purchased Parcel One more than
two years after the death of his father, his purchase of Parcel One does not meet the requirements
of § 2032A(c)(7)(A)(i), a provision that offers a safe harbor from the additional tax burden
imposed by § 2032A(c)(1). Because we conclude that the qualified heirs did not cease using
Parcel One for a qualified purpose and therefore that the additional tax should never have been
imposed, we need not reach this issue.

                                            - 12 -
received from Gary Gavin in satisfaction of Gary’s crop share agreement
with Verdon Gavin.          The Gavin estate argues that the crop share was not
income in respect of a decedent under I.R.C. § 691 and that the Gavin
estate was therefore entitled to a stepped-up basis under § 1014(a).                            We
disagree.


        Section       1014(a)   provides     generally      for     a   stepped-up     basis   for
property transferred from a decedent.               However, under § 1014(c), a stepped-
up basis is not to be applied to “property which constitutes a right to
receive an item of income in respect of a decedent under section 691.”
I.R.C. § 1014(c).4


        Under I.R.C. § 61(a)(5), rent is income.                  I.R.C. § 61(a)(5) (1988 &
Supp. II 1990).         Regardless of whether rent is paid in cash or in crops and
livestock, it is still income in respect of the person who, in exchange for
the use of real property, receives the rent.                    See Tatum v. Commissioner,
400 F.2d 242, 247 (5th Cir. 1968) (“Crop shares representing payment by the
tenant for the use of the land are rental income assets no less than money
paid for the same purpose.”).             To determine whether income, such as rent,
is income in respect of a decedent, “[t]he focus is upon the decedent’s
right




        4
         Internal Revenue Code § 691, in relevant part, provides:

        The amount of all items of gross income in respect of a decedent which are not
        properly includible in respect of the taxable period in which falls the date of his
        death or a prior period (including the amount of all items of gross income in
        respect of a prior decedent, if the right to receive such amount was acquired by
        reason of the death of the prior decedent or by bequest, devise, or inheritance from
        the prior decedent) shall be included in the gross income, for the taxable year when
        received, of:

               (A) the estate of the decedent, if the right to receive the amount is
               acquired by the decedent’s estate from the decedent . . . .

I.R.C. § 691(a)(1).

                                             - 13 -
or entitlement to income at the time of death.”      Estate of Peterson v.
Commissioner, 667 F.2d 675, 679 (8th Cir. 1981) (emphasis in original).
Accordingly, income in respect of a decedent includes any income earned in
satisfaction of a right that is fully vested at the time of the decedent’s
death such that the decedent had no obligations left to perform to earn
that income, other than to wait to receive payment.    See id. at 679-81.


     Here, in exchange for leasing his property to Gary, Verdon had a
right to receive one-half of the proceeds from all crop and livestock
sales.   See Farm Lease (May 17, 1978) at ¶ 2(a), reprinted in Appellant’s
App. at 51.   Throughout his life, Verdon had reported these sale proceeds
as ordinary income.   At the time of his death, Verdon’s right to the rent
income had fully vested because, had he lived, Verdon would have only
needed to wait to receive his income.      Upon Verdon’s death, his fully-
vested right to receive the rent income from Gary passed to his estate.
Thus, the rent received by the Gavin estate was income in respect of a
decedent for purposes of §§ 691 and 1014(c).


                                    IV.
     For the foregoing reasons, we reverse the district court’s grant of
summary judgment denying the benefits of § 2032A to the Gavin estate with
respect to Parcel One.    We further direct the district court to enter an
order requiring the government to accord special use valuation treatment
to the Gavin estate with respect to Parcel One and issue a tax refund in
the appropriate amount.   Finally, we affirm the district court’s grant of
summary judgment to the government on the issue of whether the Gavin estate
is entitled to a stepped-up basis under § 1014(a).




                                  - 14 -
A true copy.


     Attest:


           CLERK, U.S. COURT OF APPEALS, EIGHTH CIRCUIT.




                           - 15 -
