Other Valuation

Other Valuation and Compliance Matters

Undivided (Partial) Interests in Real Estate, Real Estate Trusts, Working Interests

Estate of Ellie B. Williams v. Commissioner, T.C. Memo 1998-59. Court allowed a combined discount of 44%, 20% for lack of marketability and 30% minority interest, despite the fact the taxpayer could not point to a single comparable sale of such a fractional interest in property. The Court said the absence of evidence of a history of comparable sales of partial interests was evidence that interests were not marketable. A real estate attorney testified that the costs of partitioning the property would be high because of the irregularities of the properties. Second, a bank executive testified that financial institutions will not generally lend funds to an owner of an undivided interest in property without the consent of the other tenants in common.

Sels Estate v. Commissioner, T.C. Memo 1986-501, 52 T.C.M. 731 (1986). Tax Court recognized a discount of 60%. This case is cited by Braswell as an illustration of what often happens in the Tax Court when the government refuses to acknowledge discounts and fails to put on evidence of a proper discount percentage. The estate’s expert witness testified that a partition action is generally a lengthy and expensive process. The Court determined value from the record as a whole and particularly in view of the unanimity of testimony of all the experts, including the government’s experts, that a minority discount was proper.

The Tax Court may disregard the testimony of expert witnesses. In Mooneyham v. Commissioner, T.C. Memo 1991-178 (1991), the Tax Court held that the testimony of the experts, although weak, was some evidence that the fair market value of a fractional interest in real property cannot be derived by multiplying an owner’s percentage interest by the value of the property as a whole. The Court noted that the taxpayer’s arguments were logical and supported by numerous precedents, namely Propstra (15%), Campanari (12.5%), Henry (10%), Stewart (15%) and Estate of Youle (12.5%), Bright (15%), and Minahan, 88 T.C. 492 (1987), sanction applied against IRS. The Minahan decision cites: William R. Stewart, 31 B.T.A. 881 (1934), nonacq., undivided interest, real estate, 15% discount on the basis that the only material evidence showed that fractional interests are ordinarily sold at a discount; Estate of Nina M. Campanari, 5 T.C. 488 (1945), acq., undivided interest in real estate, 12.5% discount; Estate of Charles S. Herter, 13 T.C.M. 298 (1954), undivided ownership interest in real estate, 15% discount; Estate of Louis Whitehead, 33 T.C.M. 253 (1974), undivided interest in real estate, 14.25% discount; Propstra v. United States, 82-2 USTC ¶13,475 (9th Cir. 1982), undivided community property ½ interest in real property, 15% discount; Estate of Youle, 56 T.C.M. 1594 (1989), 12.59% discount; Estate of Henry, 4 T.C. 423 (1944), 10% discount. As to other property, see, Bright v. United States, 81-2 USTC ¶13,359 (5th Cir. 1980), undivided community property ½ interest in a corporation.

Pillsbury Estate v. Commissioner, T.C. Memo 1992-425, 64 T.C.M. 284 (1992). Tax Court agreed with the government’s criticism of the expert’s reliance upon court decisions, and therefore disregarded the expert’s testimony to the extent that he relied on those decisions. The Court held, however, that the expert’s testimony did provide support for the conclusion that there should be a discount. The IRS presented no evidence to the contrary. The Court held that the 15% discount claimed on the estate tax return was an admission of the amount of the maximum discount, which the estate cannot overcome without cogent proof that it is wrong. Based on the record, the Tax Court concluded that a 15% discount was appropriate.

LeFrak v. Commissioner, T.C. Memo 1993-526. A gift tax case. Samuel J. LeFrak, a New York real estate developer, conveyed undivided interests in 22 buildings to trusts for his three children in December of 1976. Mr. LeFrak and the trusts formed 22 partnerships to hold the buildings one month later, in January of 1977. Mr. LeFrak owned 70% of each partnership and the trusts owned 30% in each partnership. Mrs. LeFrak consented to the transfer so that, for gift tax purposes, the gift was made by both spouses. The partnership agreements gave Mr. LeFrak management rights and the right to transfer and manage the properties without the consent of the other partners. The partnership agreements also contained substantial restrictions on the voting, liquidation, and transfer rights of the partners. The Tax Court (Judge Whalen) ignored the restrictions. The trusts had received undivided interests in real estate before the partnership was created. The value of the fractional interests in real estate, not the partnership, was considered to be relevant. The Tax Court recognized an overall 30% reduction in the value of the property. The Court concluded that a discount of 20% would be appropriate considering the minority owner’s lack of control over the property and other factors because a holder of a fractional interest in real property has the power to compel partition. There is an implication in the opinion that a larger discount might be appropriate in valuing the partnership interests because the partnership agreements did not permit partition. The Court recognized another 10% discount for lack of marketability. “We believe, based on the record in the instant case, that some discount for lack of marketability is warranted in valuing the interests transferred by petitioner. We will accordingly allow a discount of 10 percent from the full value of each gift to each donee to be taken into account in valuing such gifts. . . . In summary, in the instant case, we will allow a combined discount of 30 percent for minority or fractional interest and lack of marketability in valuing the buildings.”

Debt Obligations, Claims

A business appraiser is required to depart from fair market value standards and standard methodology to accommodate exceptions imposed by law-makers, regulatory agencies, and the courts. The exceptions to fair market value, imposed by law and regulations, and that cause a departure from the recognized determination of fair market value, are called for the purpose of this study and report “tax value.” We count eleven exceptions in which tax value must prevail over fair market value. These include:

(1) The imputed interest requirements under Internal Revenue Code sections 483, 1274, and 7872. The valuation rules of Section 7872 apply to “gift loans.”

(2) The valuation of term interests, life interests, remainder interests as recognized by Estate of Fabric, 83 TC 932 (1984); McLendon v. Commissioner, 77 F. 3rd 477 (5th Circuit 1995), McLendon v. Commissioner, 135 F. 3rd 1017 (5th Circuit 1998); Wheeler v. United States, 116 F.3d 749 (5th Cir. Tex. 1997). D’Ambrosio v. Commissioner, 101 F.3d 309 1996 (3rd Cir. 1996), cert. denied, 1997 WL 134397 (U.S.) (May 19, 1997), reversing the Tax Court in 105 TC 252 (1995).

(3) The zero valuation rules of Code Section 2701, in which the business appraiser must ignore the value of certain put, call, conversion and liquidation rights.

(4) Disregard for compliance purposes of voting and non-voting rights under the “same class” rules Code Section 2701.

(5) Disregard on real restrictions on transfer of property, valid and enforceable under state law, pursuant to Code Section 2702, if restrictions do not technically comply with the term limits and payment requirements under Code Section 2702.

(6) Disregard of buy/sell requirements and restrictions, otherwise enforceable under state law, pursuant to Code Section 2703.

(7) Disregard of contractual liquidation (or anti-liquidation) requirements enforceable under state law because the appraiser must consider instead the default requirements of state law.

(8) The business appraiser must ignore swing vote attribution. Victor Minahan v. Commissioner, 88 TC 492 (1987); Ward v. Commissioner, 87 TC 78 (1986), citing Estate of Bright v. United States, 658 F.2d 999 (5th Cir. 1981) (en banc); Harwood v. Commissioner, 82 TC 239 (1984), affd. without published opinion 786 F.2d 1174 (9th Cir. 1986); Estate of Andrews v. Commissioner, 79 TC 938, 940 (1982); Estate of Zaiger v. Commissioner, 64 TC 927 (1975); Estate of deGuebriant v. Commissioner, 14 TC 611 (1950), revd. on other grounds sub nom.; Claflin v. Commissioner, 186 F.2d 307 (2d Cir. 1951); Hooper v. Commissioner, 41 B.T.A. 114, 129 (1940); Sundquist v. United States, an unreported case (E.D. Wash. 1974, 34 AFTR 2d 74-6337, 74-2 USTC par. 13,035); Obermer v. United States, 238 F. Supp. 29 (D. Hawaii 1964); Drybrough v. United States, 208 F. Supp. 279 (W.D. Ky. 1962). The minority discount is recognized because the holder of a minority interest lacks control over corporate policy, cannot direct the payment of dividends, and cannot compel a liquidation of corporate assets. See Harwood v. Commissioner, 82 TC at 267; Estate of Andrews v. Commissioner, 79 TC at 953; Drybrough v. United States, 208 F. Supp. at 287-288; Carr v. Commissioner, TC Memo. 1985-19; Estate of Kirkpatrick v. Commissioner, TC Memo. 1975-344.

(9) Forced application of the family attribution rules with regard to the partial liquidation of an owner’s interest in a closely held company for federal income tax purposes.

(10) In the assessment of value based upon “best use,” a business appraiser is not required to assume that the company can be liquidated at any time because members of the same family own 67 percent of the outstanding equity. The facts of each case will control the question: “Is it likely that a company will liquidate its assets or will the company likely continue as a going concern?” See, Charles W. Ward v. Commissioner, 87 TC 78 (1986).

(11) The appraiser is to ignore the division of ownership in an entity produced as the result of a transferor’s death. For transfer tax purposes, the value of the security transferred is measured by what the assignee receives, not what the assignor gives up. In Ltr. Rul. 9449001 (IRS National Office Technical Advice Memorandum), a donor transferred all of the shares of stock in a closely-held corporation simultaneously to 11 family members. The value of the gift to each donee is determined by considering each gift separately and not by aggregating all of the donor’s holdings in the corporation immediately prior to the gift. The application of any discounts for lack of control or marketability would be determined in connection with each separate gift to each donee. The rule is different for estate tax purposes. All shares or units of a deceased owner are treated as single block for valuation purposes. Potential conflict in methodology, but not result. Jones II v. Commissioner, 116 T.C.11 (March 6, 2001).

Internal Revenue Code Section 7872 is of primary concern in our selection of the required valuation standard. In a “related party transaction,” must we (are we required to do so) value to collateral, even if there is no collateral, must we assume the buyer’s ability to service debt, even if the buyer has limited financial resources, and must we assume liquidity even though there is no market for a marginal, if not deficient, debt instrument? Our valuation guideline for income and transfer tax purposes is provided by Frazee v. Commissioner, 98 TC 554 (1992). Section 7872 applies to the classification of all or a part of a “loan” as a gift for gift tax purposes. The Court in Frazee held that a loan is not a gift loan if it prescribes the required minimum rate of interest as determined by the government for short-term, mid-term, long-term obligations.

The value of a partial interest in real estate by Iron Horse Business Valuation Group requires that the whole of the real estate be valued by a qualified real estate appraiser.

Life and Remainder Interests

We have been asked to value the term and remainder interests of charitable remainder trusts. In almost all cases, our services are not needed. The valuation of term and remainder interests is dictated by federal law. It is a matter of tax value, not fair market value. Anyone can do the math. It is tax value, not fair market value. A qualified valuation expert is needed to value an interest in a closely held company or partnership that is contributed to a charity or charitable trust

Fairness Opinions, Compliance Opinions, Technical Advice …… Examples:

In estate and transfer tax planning, we have been asked to determine the return premium for preferred equity or to confirm in a written opinion of an existing premium considering income coverage ratios, liquidation coverage ratios, prevailing preferred rates available in the public market, and probable premium or discount associated with current and reasonably prospective economic conditions.

In a reorganization of a Florida limited partnership with preferred equity to a limited liability company with one class of equity, we were asked to provide a detailed opinion that the transaction would be tax free and that conversion from preferred equity to common equity would not constitute a taxable gift.

In a Wyoming case, a taxpayer gave the remainder interest in his home to a public charity. The value of the real estate was determined by a qualified real estate appraiser. The value of the remainder interest was determined using tables prescribed by the Internal Revenue Service [tax value]. Several years later, the taxpayer’s son entered into negotiation with the charity to buy the remainder interest for fair market value. We were asked for an independent opinion as to the fair market value of the remainder interest, compliance (did the IRS tables apply to a subsequent sale of the remainder interest?), and that the transaction was not disqualified under Treas. Reg. Section 53.4958-3(b)(1) and Treas. Reg. Section 53.4958-3(e).

We have worked with legal counsel in requests for private letter rulings (applicable law, applicable procedure, and compliance) and in the defense of a request for technical advice by an agent of the Internal Revenue Service.

Gibbs has provided detailed opinions in cases alleging professional misconduct and damages. Gibbs also has worked with trial attorneys and their designated expert witnesses in preparation for depositions and trial.