I. FRACTIONAL INTERESTS IN GENERAL 1 II. CONTROL/DECONTROL DISCOUNTING 6 A. Unity of Ownership Squelched Rev. Rul. 93-12 and its Progeny 6 B. Aggregation of Various Interests in Same Property 11 C. Stock Valuation Varies for Gross Estate and Marital/ Charitable Deduction Purposes 20 D. Control Premium 24 E. Transfers to Remove Control 28 F. Partnership Amendment after Cancer Diagnosed Allowed 38 III. FAMILY PARTNERSHIPS/RESTRICTIONS 38 A. Restrictions Outside of Chapter 14 38 B. Chapter 14 Restrictions 45 IV. BUY/SELL AGREEMENT RECOGNITION 48 V. VALUATION DISCOUNTS/IMPORTS OF POST TRANSACTION EVENTS 61 M. Built In Capital Gains Tax Relevance 72 Z. Attacks On Family Partnerships 93 NN-PP Tax Court Behavioral Presumptions Rejected 148 VI. BEST USE 183 VII. ACTUARIAL TABLES APPLICATION 187 VIII. SPECIAL FORMULAS 204 IX. APPLICATION OF PENALTIES FOR UNDERVALUATION 209 X. THE COURT'S ATTITUDE RE APPRAISAL EXPERTS 212 A. Taxpayer's Appraiser Followed In Part--Had Significant Impact on Holding 212 B. Appraiser "Carried the Day" 213 C. Taxpayer's Appraiser Ignored 214 D. Incompetent Appraiser Overlooked -- Bailed Out by New Appraiser in Tax Court 220
E. Not Appraising Second Element Up Front: Entity Securities-Hurt Taxpayer 221 F. IRS Burned by Poor Appraisal Expert 221 G. Neither IRS Nor Taxpayer's Appraiser(s) Acceptable 221 XI. IRS EXAMINATION ATTITUDES/NEW FORM 709 REPORTING 222 ALI-ABA PLANNING TECHNIQUES FOR LARGE ESTATES IS VALUATION THE BEST PLANNING GAME REMAINING? Byrle M. Abbin Arthur Andersen Washington, D.C. I. FRACTIONAL INTERESTS IN GENERAL A. Twenty percent fractional interest discount for 50% farm and homestead tenancy in common interest Decedent had a 50% interest (the balance was owned as an undivided 25% interest by each of his two children) of a farm and homestead. A considerable amount of the farm was suitable only for ranching, a significant portion was floodplain and only a portion had direct access to a paved road. His estate claimed a 25% fractional interest discount. IRS disallowed the entire discount. Its expert claimed that the farm was "ripe" for a partition and that a forced sale proceeds would result in no discount to the homestead. The Tax Court concluded that a 20% fractional interest discount should be applied to both segments of realty, disagreeing with taxpayer that partition was impossible. Rather, it concluded that partition would be difficult and would entail substantial legal costs, appraisal fees, and delay that resulted in the propriety of a 20% fractional interest discount. Estate of Cerbin v. Comm., T.C. Memo 14-550 B. Gift value reflected bad economy no appreciation expectation; fractional interest discount, not partnership, controlled LeFrak owned numerous rental properties in New York. In 1976, he contributed 7.5% interests to each of four children (6.5% in others) in most of the properties, then he pooled his 70% with his children
2001 Byrle M. Abbin. in two straight up partnerships, each one for a separate real estate parcel. All properties were heavily mortgaged; in advance of transfers, donor contributed cash so no property's value was less than the mortgage on it. The buildings, subject to over $25 million in debt, were valued at $255,000 and the gifts at $59,925 (30% or $76,500) less a minority discount. IRS asserted FMV of the buildings was $34.8 million and the gifts value $2.6 million (30% of the buildings' value $34.8 million less mortgage of $25+ million or under $9.8 million). The Tax Court determined that LeFrak gave his children fractional interests in real estate, rather than partnership interests as the LeFraks contended. Although both parties' experts agreed that the buildings should be valued based on their income-generating capacities, it rejected, however, IRS's assumption that the net income from the buildings and their value would increase in the future, relying instead on the taxpayers' evidence on the downward trend in the New York City economy and the city's rent stabilization laws. In addition, the court found that IRS's estimation of the expenses a willing buyer would expect to pay was too low. With respect to the discount for minority interests, the court pointed out that a holder of a fractional interest in real estate has the power to compel partition of the property, which adds cost and delay. It rejected IRS's argument that no minority discount is appropriate when all the owners are members of the same family. The court concluded that a 20% minority discount was appropriate. Finally, the court determined that an additional 10% discount for lack of marketability was also proper, accepting the estimation of the IRS expert. LeFrak, et ux, v. Comm., T.C. Memo 13-526 C. Discount for undivided interest in real estate is cost of partition. LTR 9336002 D. Real estate fractional discount allowed; hazardous waste discount denied A decedent's estate was entitled to a 15% discount in the valuation of its undivided fractional interests in certain parcels of real estate, but was not entitled to a discount for a potential hazardous waste problem associated with one of the properties. In addition, the estate was not entitled to a discount with respect to the valuation of its fractional interest in certain personal property because it did not present any evidence in support of the discount.
In applying the 15% discount, the court noted that the fair market value of a fractional interest in real estate could not be derived merely by applying the percentage of the interest in the whole property to the value of the whole property where evidence was presented in support of a discount. In addition, the court distinguished its decision in A. McMullen Est., 56 T.C. Memo 1988-500. In that case, a discount claimed in the valuation of a fractional interest in a trust was denied because the trust instrument required that the trust corpus (real property) be sold as an entire fee simple interest, whereas the trust agreement in the present case did not include such a requirement. Further, the court held that the 15% discount applied by the estate in valuing the property on the decedent's estate tax return was an admission as to the maximum discount. Therefore, the conclusion of the estate' expert at trial that a 20% discount was appropriate was rejected, absent proof that the 15% discount was wrong. In denying a discount with respect to a potential hazardous waste problem arising from underground storage tanks associated with one property, the court noted that neither the appraiser nor the estate believed that a problem existed on the alternate valuation date. Further, no evidence was presented that a hypothetical buyer would have had reason to believe that potential liability existed on the valuation date since the lessee of the property bore all costs regarding the tanks. Thus, the court concluded that the estate failed to satisfy its burden of proof as to any foreseeable liability associated with the underground tanks. E. Pillsbury Est. v. Comm., T.C. Memo 12-425 E. 44% Fractional Interest Discount Decedent's one half tenancy in common of timberland was afforded a 44% discount by the Tax Court representing 20% for lack of marketability and 30% of lack of control (a seriatim discount amounting to 44%). IRS had not through its expert referenced any fractional interest discount, but conceded a 5% amount at Tax Court. The Tax Court noted other fractional interest discounts were allowed, of 40% (Estate of Wildman v. Comm., T.C. Memo 1989-667) and 60% in Estate of Sels v. Comm., T.C. Memo 1986-50. Estate of Williams v. Comm., T. C. Memo 18-59. F. No Fractional Interest Discount for Joint Tenancy with Right of Survivorship "Under the scheme of section 2040(a), the amount includable in a
decedent's gross estate does not depend on a valuation of property rights actually transferred at death, or on a valuation of the actual interest held by the decedent (legal title); instead, decedent's gross estate includes the entire value of property held in a joint tenancy by him and any other person, except to the extent the consideration for the property was furnished by such other person. * * * Section 2040(a) provides an artificial inclusion of the joint tenancy property: the entire value of the property less any contribution by the surviving joint tenant. Except for the statutory exclusions in section 2040(a), there is no further allowance to account for the fact that less than the entire interest is being included. [Citation and fn. Ref. Omitted.)" Est. of Young v. Comm., 110 TC 297 (1988) cited as above for authority by Est. of Fratini v. Comm., T.C. Memo 18-308. G. 20% Fractional Interest Discount Allowed: IRS Cost to Partition Theory Rejected Decedent owed 100% of six small apartment buildings and 50% in three others, all located in the Marina District of San Francisco. 2 of the 3 in which decedent held a 50% tenancy in common interest were subject to a similar ownership interest of 50% by decedent's husband's estate.
Taxpayer's Form 706 filing based on expert's report: a. Discount for "blockage" (1) on 6 buildings 20% b. Discount for fractional interest on 50% ownership interest 20% Taxpayer's Tax Court Brief a. Discount for "blockage" 12.5% b. Discount for fractional interest 20.0% IRS Deficiency Notice a. Discount for blockage 1.92% b. Discount for fractional interest Cost to partition The Tax Court essentially accepted taxpayer's expert and rejected IRS' expert. It recognized that competition between the properties for buyers would result in a 6 months period to sell, but that taxpayer overstated the number of properties that would compete for sale. The court reduced the blockage discount for noncompeting properties but allowed the claimed 20% discount for fractional interest. Bracato v. Comm., T.C. Memo 19-424. H. Is IRS Retreating? It says cost of partition is one method to determine fractional interest discount in applying the willing seller-willing buyer concept. TAM 1943003 I. Court Establishes Fractional Interest Discount as Cost to Partition. Busch v. Comm., T.C. Memo 2000-3 (See V.AAA) J. 25% Fractional Interest Discount For One Half Interest in 3 Real Properties The Tax Court agreed with taxpayer's approach that evaluated 3 parcels of realty based on cost, market (comparables), and two income approaches direct capitalization and discounted cash flow. The main contention at Tax Court was the aspect of fractional interest discounts. IRS' expert essentially used cost to partition of 10% for 2 parcels and 20% for a third that was of small size.