T.C. Memo. 2008-128
UNITED STATES TAX COURT
JANE Z. ASTLEFORD, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 4342-06. Filed May 5, 2008.
Sue Ann Nelson and Robert J. Stuart, for petitioner.
Trent D. Usitalo and David Zoss, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
SWIFT, Judge: Respondent determined deficiencies of
$127,619 and $3,997,288 in petitioner’s 1996 and 1997 respective
Federal gift taxes.
After settlement by the parties of the valuation of a number
of properties, in order to calculate the fair market value of
limited partnership interests petitioner transferred as gifts in
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1996 and 1997, we must determine the fair market value of 1,187
acres of Minnesota farmland, whether a particular interest in a
general partnership should be valued as a partnership interest or
as an assignee interest, and the lack of control and lack of
marketability discounts that should apply to the limited and to
the general partnership interests.
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the 2 years in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
FINDINGS OF FACT
Many of the facts have been stipulated and are so found.
At the time the petition was filed, petitioner resided in
Minnesota.
Petitioner’s husband, M.G. Astleford (MG), was a successful
real estate businessman who over the course of years acquired
individually, jointly with petitioner, and through various trusts
and limited and general partnerships significant interests in
real estate located primarily in Minnesota. Below, we briefly
describe the interests in real estate MG and petitioner owned and
that petitioner transferred to a family limited partnership and
the gifts of interests in the family limited partnership that
petitioner in 1996 and in 1997 made to her children.
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In 1970, MG and Richard T. Burger formed Pine Bend
Development Co. (Pine Bend) as a Minnesota general partnership.
MG and Mr. Burger were each 50-percent general partners in Pine
Bend. Under provisions of the Pine Bend general partnership
agreement, consent of each partner was required with respect to
the management, conduct, and operation of the partnership
business in all respects and in all matters. The Pine Bend
general partnership agreement did not contain any provisions
relating to the transfers of interests in Pine Bend and whether
such transferred interests would be general partnership or
assignee interests.
In 1970, Pine Bend purchased 3,000 acres of land near St.
Paul, Minnesota, of which 1,187 acres consisted of agricultural
farmland in Rosemount, Minnesota (the Rosemount property). Pine
Bend leased 944 acres of the Rosemount property to farmers and
leased out the remaining acreage for use as a commercial
paintball field.
The Rosemount property was located near an industrial area
and an oil refinery and approximately 6 miles from the nearest
residential neighborhood. The Rosemount property was not
connected to municipal sewer or water.
On or about February 20, 1992, MG and petitioner each
created separate revocable trusts, and they each transferred to
their separate trusts various interests in real estate.
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On April 1, 1995, MG passed away. As of the date of his
death, MG owned directly (or indirectly through various
partnerships and his above revocable trust) interests in 41 real
properties located in Minnesota and California. All of MG’s real
estate interests passed under MG’s last will and testament to the
M.G. Astleford Marital Trust (the marital trust), which on MG’s
death came into existence under MG’s will for the benefit of
petitioner.
After MG’s death in 1995, petitioner owned (indirectly
through the marital trust) all of the interests in the various
real properties that MG had acquired over the years, and
petitioner continued to own all of the real estate interests she
separately had acquired.
On August 1, 1996, petitioner formed the Astleford Family
Limited Partnership (AFLP) as a Minnesota limited partnership to
facilitate the continued ownership, development, and management
of the various real estate investments and partnership interests
petitioner then owned and to facilitate the gifts which
petitioner intended to give to her three adult children.
Under provisions of the AFLP agreement, AFLP‘s net cashflow
was to be distributed annually among the partners. The limited
partners were not entitled to vote on matters relating to
management of AFLP, no outside party could become a partner in
AFLP without consent of petitioner as general partner, a limited
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partner could not sell or transfer any part of his or her AFLP
limited partnership interest without consent of petitioner, and
no real property interest held by AFLP could be partitioned
without consent of petitioner.
On August 1, 1996, petitioner funded AFLP by transferring
her ownership interest in an elder-care assisted living facility
with a stipulated value of $870,904.
Also on August 1, 1996, petitioner gave each of her three
children a 30-percent limited partnership interest in AFLP,
retaining for herself a 10-percent AFLP general partnership
interest.
A November 2, 1997, partnership resolution of AFLP referred
to an impending transfer to AFLP of petitioner’s 50-percent Pine
Bend interest as a transfer of petitioner’s “entire right and
interest” in Pine Bend.
On December 1, 1997, as an additional capital contribution
to AFLP, petitioner transferred to AFLP her 50-percent Pine Bend
interest and her ownership interest in 14 other real estate
properties located in the Minneapolis-St. Paul metropolitan area
(the other properties).
As a result of the December 1, 1997, transfer to AFLP of
petitioner’s 50-percent Pine Bend interest and of the other
properties, petitioner’s general partnership interest in AFLP
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increased significantly, and petitioner’s children’s respective
limited partnership interests in AFLP decreased significantly.
However, also on December 1, 1997, and simultaneously with
petitioner’s above transfer of property to AFLP, petitioner gave
each of her three children additional limited partnership
interests in AFLP having the effect of reducing petitioner’s AFLP
general partnership interest back down to approximately 10
percent and increasing petitioner’s children’s AFLP limited
partnership interests back up to approximately 30 percent apiece.
In 1996 and in 1997, petitioner’s three children did not
make any contributions to the capital of AFLP.
On audit, as compared to the values and discounts used by
petitioner in calculating and reporting on her 1996 and 1997
Federal gift tax returns the value of the gifts of AFLP limited
partnership interests to her three children, respondent increased
the fair market values of a number of the properties that were
transferred to AFLP and the fair market value of AFLP’s net asset
value (NAV). Respondent decreased the lack of control and lack
of marketability discounts applicable to the valuation of the
gifted AFLP limited partnership interests. The schedule below
reflects the total value of petitioner’s taxable gifts and gift
tax liabilities for 1996 and 1997, as reported on petitioner’s
Federal gift tax returns and as determined by respondent on
audit:
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Petitioner’s Respondent’s Audit
Gift Tax Returns Determinations
Taxable Gift Tax Taxable Gift Tax
Year Gifts Liability Gifts Liability
1996 $ 277,441 $ 79,581 $ 626,898 $ 127,619
1997 3,954,506 2,005,689 10,937,268 3,997,288
OPINION
Under section 2501(a)(1) the transfer of property by gift is
subject to Federal gift taxes. The amount of the gift is equal
to the fair market value of the gifted property, defined as the
price at which, on the date of the gift, the property would
change hands between a willing buyer and a willing seller,
neither being under any compulsion to buy or sell and both having
reasonable knowledge of relevant facts. Sec. 2512(a); sec.
25.2512-1, Gift Tax Regs.; see also Rev. Rul. 59-60, 1959-1 C.B.
237.
A willing buyer and a willing seller are hypothetical
persons, rather than specific individuals or entities, and their
characteristics are not necessarily the same as those of the
donor and the donee of the property in question. Estate of
Bright v. United States, 658 F.2d 999, 1006 (5th Cir. 1981);
Estate of Newhouse v. Commissioner, 94 T.C. 193, 218 (1990).
The valuation of property is a question of fact, and all
relevant facts and circumstances are to be considered. Polack v.
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Commissioner, 366 F.3d 608, 613 (8th Cir. 2004), affg. T.C. Memo.
2002-145.
In deciding valuation issues, courts often receive into
evidence and consider the opinions of expert witnesses.
Helvering v. Natl. Grocery Co., 304 U.S. 282, 295 (1938). We may
largely accept the opinion of one expert over the opinion of
another expert, see Buffalo Tool & Die Mfg. Co., Inc. v.
Commissioner, 74 T.C. 441, 452 (1980), and we may be selective in
determining which portion of an expert’s opinion to accept,
Parker v. Commissioner, 86 T.C.547, 562 (1986).
The fair market values of the Rosemount property, the 50-
percent Pine Bend interest, and the other properties--that
petitioner on August 1, 1996, and on December 1, 1997, directly
or indirectly transferred as additional capital contributions to
AFLP--obviously increased the fair market value of the three AFLP
limited partnership interests that petitioner simultaneously
transferred to her children. As stated, of these underlying
properties transferred to AFLP, the parties herein dispute only
the value of the Rosemount property, whether the 50-percent Pine
Bend interest should be valued as a general partnership interest
or as an assignee interest, and the lack of control and lack of
marketability discounts that should apply to the 50-percent Pine
Bend interest and to the gifted AFLP limited partnership
interests.
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The Rosemount Property
On the basis of the average size of a farm in Minnesota
(namely 160 acres or a one quarter section), petitioner’s expert1
treated the 1,187-acre Rosemount property owned by Pine Bend as
extraordinarily large and unique and used the market data
approach in his valuation, with a downward adjustment for an
absorption discount.
Petitioner’s expert identified as comparables to the
Rosemount property 18 farm properties that had been sold. He
adjusted the 18 properties for differences from the Rosemount
property based on date of sale, location, and size, and he
calculated an initial value for the Rosemount property of $3,100
per acre, or a total of $3,681,000. Petitioner’s expert’s
absorption discount decreased the value to $1,817 per acre, or a
total fair market value of $2,160,000.
Petitioner’s expert’s absorption discount was based on his
opinion that a sale of the entire Rosemount property would flood
the local market for farmland and would reduce the per-acre price
at which the Rosemount property could be sold. Believing that
the Rosemount property would sell over the course of 4 years and
would appreciate 7 percent each year, petitioner’s expert
1
At trial, petitioner had four experts, and respondent had
two experts. Throughout our opinion, we simply reference
“petitioner’s expert” and “respondent’s expert” without further
identification.
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performed a cashflow analysis using a present value discount rate
of 25 percent.2
Respondent’s expert, in valuing the Rosemount property, also
used the market data approach and reviewed the sale of
approximately 125 Minnesota farmland properties. He personally
viewed and visited 12 of the properties. Ultimately,
respondent’s expert chose two of the properties he considered
comparable to the Rosemount property, and he made adjustments to
his two comparables based on date of sale, and he arrived at a
per-acre value for the Rosemount property of $3,500, or a total
fair market value of $4,156,000.
Respondent’s expert did not believe other adjustments and
discounts were necessary because of the similarity of his two
comparables to the Rosemount property. Respondent’s expert also
concluded that because in 1970 3,000 acres of land (including the
Rosemount property) had been purchased by Pine Bend in a single
transaction, the entire Rosemount property likely could be sold
in a single year without an absorption discount. Respondent’s
expert also concluded that even if an absorption discount was
appropriate, petitioner’s 25-percent present value discount rate
was excessive. Respondent argued that the present value discount
rate should track the rate of return on equity which farmers in
2
Petitioner’s expert also reduced projected annual cashflow
by estimated sales expenses and costs of 7.25 percent and by
property taxes of approximately .6 percent.
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Dakota County, Minnesota, actually earned, and respondent’s
expert referenced a report of the Southeastern Minnesota Farm
Business Management Association indicating that in 1997 the
average rate of return on equity for farmers in southeastern
Minnesota was 9.2 percent.
Respondent’s expert was particularly credible and highly
experienced and possessed a unique knowledge of property located
throughout Dakota County and the surrounding area, and we
conclude that respondent’s expert’s initial value of $3,500 per
acre for the Rosemount property is correct. However, we believe
that due to the size of the Rosemount property in relation to the
number of acres sold each year in Dakota County, it is unlikely
that all 1,187 acres of the Rosemount property would be sold in a
single year without a price discount.
In other valuation cases we have allowed a market absorption
discount based on the understanding that a sale of a large parcel
of real estate over a short period of time tends to reduce the
price for which real estate otherwise would sell. See Estate of
Rodgers v. Commissioner, T.C. Memo. 1999-129; Carr v.
Commissioner, T.C. Memo. 1985-19; Estate of Grootemaat v.
Commissioner, T.C. Memo. 1979-49.
We, however, regard petitioner’s present value discount rate
of 25 percent as unreasonably high because it relies on
statistics relating to developers of real estate who expect
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greater returns given greater risks. A present value discount
rate is a function of the riskiness of a project, and the
hypothetical project herein is not land development but the sale
of farmland over 4 years.
Over 75 percent of the Rosemount property was leased to
farmers providing a source of future income to a prospective
purchaser. Given the low level of risk, a rate of return that
likely would induce a purchase of the Rosemount property would be
more akin to the return on equity which farmers in the area were
actually earning--namely, 9.2 percent. See IT&S of Iowa, Inc. v.
Commissioner, 97 T.C. 496, 531 (1991) (rate of return on equity
used as an appropriate present value discount rate).
Given the minimal risk involved in selling the Rosemount
property over 4 years, the fact that most of the acreage was
already leased, and the 9.2-percent return on equity earned by
southeastern Minnesota farmers in 1997, we conclude that the
appropriate present value discount rate to apply to the projected
cashflow from the Rosemount property over 4 years is 10 percent.
Using an initial per-acre value of $3,500, and substituting a
present value discount rate of 10 percent, the fair market value
of the Rosemount property, taking into account market absorption
over 4 years, is $2,786.14 per acre or a total fair market value
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of $3,308,575.3 In the summary schedule below (using rounded
numbers), we compare the parties’ calculations with our
calculation for the fair market value of the Rosemount property:
Petitioner’s Respondent’s Our
Rosemount Property* Expert Expert Calculation
Per acre value before
absorption discount $ 3,100 $ 3,500 $ 3,500
Value of 1,187.51 acres
before absorption
discount 3,681,000 4,156,000 4,156,000
Per acre value after
absorption discount 1,817 3,500 2,786.14
Total value of 1,187.51
acres after absorption
discount 2,160,000 4,156,000 3,308,575
* We use actual acreage for the Rosemount property of
1,187.51 acres.
Treatment of 50-Percent Pine Bend Interest
The valuation dispute relating to Pine Bend involves the
treatment or the nature, for gift tax valuation purposes, of the
50-percent Pine Bend interest that petitioner transferred to AFLP
(i.e., whether it should be treated as a general partnership
interest or merely as an assignee interest) and the lack of
control and lack of marketability discounts that should apply to
the 50-percent Pine Bend interest.
3
Like petitioner’s expert, we assume 7-percent annual
appreciation and reduce projected cashflow by estimated sales
expenses and property taxes of 7.25 percent and .6 percent,
respectively.
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Petitioner treats the 50-percent Pine Bend interest
transferred to AFLP as an assignee interest and discounts that
interest by 5 percent because under Minnesota law a holder of an
assignee interest would have an interest only in the profits of
Pine Bend and would have no influence on management. See Minn.
Stat. sec. 323.26 (1996), repealed by Minn. Stat. ch. 323A
(enacted 1997 and renumbered Supp. 2008).
Petitioner’s argument that under Minnesota law the 50-
percent Pine Bend interest should be treated as an assignee
interest is based primarily on Minnesota law and trial evidence
suggesting that Mr. Burger, the other 50-percent Pine Bend
general partner, did not consent to petitioner’s December 1,
1997, transfer to AFLP of petitioner’s Pine Bend interest. See
Minn. Stat. sec. 323.26.
Respondent argues that the substance over form doctrine
should apply and that thereunder the Pine Bend interest
petitioner transferred to AFLP should be treated as a general
partnership interest. We agree with respondent and so hold.4
4
Alternatively, respondent argues that if the 50-percent
Pine Bend interest is to be treated as an assignee interest,
petitioner’s voting and liquidation rights in the transferred
Pine Bend interest would have lapsed on the date of petitioner’s
transfer thereof, and under sec. 2704(a) the lapse would trigger
an additional deemed taxable gift by petitioner of those rights--
effectively recapturing for Federal gift tax purposes the value
of the voting and liquidation rights (i.e., the difference in
value between a Pine Bend general partnership interest and a Pine
Bend assignee interest). Because of our resolution as to the
substance of the transferred 50-percent Pine Bend interest, we
(continued...)
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The Federal tax effect of a particular transaction is
governed by the substance of the transaction rather than by its
form. In Frank Lyon Co. v. United States, 435 U.S. 561, 573
(1978), the Supreme Court explained this substance over form
doctrine as follows:
In applying this doctrine of substance over form, the
Court has looked to the objective economic realities of
a transaction rather than to the particular form the
parties employed. The Court has never regarded “the
simple expedient of drawing up papers,” Commissioner v.
Tower, 327 U.S. 280, 291 (1946), as controlling for tax
purposes when the objective economic realities are to
the contrary. “In the field of taxation, administrators
of the laws, and the courts, are concerned with
substance and realities, and formal written documents
are not rigidly binding.” Helvering v. Lazarus & Co.,
308 U.S. [252, 255 (1939).] * * *
The substance over form doctrine has been applied to Federal
gift and estate taxes. See Heyen v. United States, 945 F.2d 359,
363 (10th Cir. 1991); Estate of Murphy v. Commissioner, T.C.
Memo. 1990-472. In particular, we have applied the substance
over form doctrine in valuation cases to treat transfers of
alleged assignee interests as, in substance, transfers of
partnership interests. See Kerr v. Commissioner, 113 T.C. 449,
464-68 (1999), affd. on another issue 292 F.3d 490 (5th Cir.
2002).
4
(...continued)
need not address respondent’s alternative argument under sec.
2704(a).
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The facts in this case establish that in substance the Pine
Bend interest transferred by petitioner to AFLP should be treated
as a general partnership interest, not as a Pine Bend assignee
interest. Because petitioner was AFLP’s sole general partner,
petitioner was essentially in the same management position
relative to the 50-percent Pine Bend interest whether she is to
be viewed as having transferred to AFLP a Pine Bend assignee
interest (and thereby retaining Pine Bend management rights) or
as having transferred those management rights to AFLP via the
transfer of a Pine Bend general partnership interest (in which
case she reacquired those same management rights as sole general
partner of AFLP). Either way, after December 1, 1997, petitioner
continued to have and to control the management rights associated
with the 50-percent Pine Bend general partnership interest.
We note that the November 2, 1997, AFLP partnership
resolution treats petitioner’s Pine Bend transfer as a transfer
of all of petitioner’s rights and interests in Pine Bend,
suggesting the transfer of a general partnership interest, not
the transfer of an assignee interest. See Estate of Jones v.
Commissioner, 116 T.C. 121, 133 (2001) (interests not assignee
interests where documents referred to interests as “partnership”
interests); Kerr v. Commissioner, supra at 466-467 (interests not
assignee interests where language used to document transfers
demonstrated “partnership” interests were transferred); Estate of
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Dailey v. Commissioner, T.C. Memo. 2001-263 (interests not
assignee interests where documents referred to “partnership”
interests); cf. Estate of Nowell v. Commissioner, T.C. Memo.
1999-15 (interests assignee interests where documents did not
indicate partnership interests were transferred).
Discounts Applicable to Pine Bend and to AFLP Interests
For purposes of calculating lack of control and lack of
marketability discounts that should apply to the 50-percent Pine
Bend general partnership interest petitioner transferred to AFLP
on December 1, 1997, and to the AFLP limited partnership
interests petitioner gave to her children on August 1, 1996, and
December 1, 1997, petitioner’s expert relied on comparability
data from sales of registered real estate limited partnerships or
RELPs. Respondent’s expert relied on comparability data from
sales of publicly traded real estate investment trusts or REITs.
We decline to declare either RELP or REIT data generally
superior to the other. We note that courts have accepted expert
valuations using both RELP and REIT data. For example, RELP data
were used in Estate of Weinberg v. Commissioner, T.C. Memo. 2000-
51, and Temple v. United States, 423 F. Supp. 2d 605, 619 (E.D.
Tex. 2006); REIT data were used in Lappo v. Commissioner, T.C.
Memo. 2003-258, and Estate of McCormick v. Commissioner, T.C.
Memo. 1995-371.
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We believe that when considering the size, marketability,
management, distribution requirements, and taxation of RELPs and
REITs, RELPs more closely resemble AFLP and Pine Bend, and we
believe that the low trading volume on the RELP secondary market
is not so low as to render available RELP data unreliable.
We also believe, however, that the large number of REIT
sales transactions tends to produce more reliable data compared
to the limited number of RELP sales transactions. We believe
further that differences between REITS, on the one hand, and Pine
Bend and AFLP, on the other, may be minimized given the large
number of REITs from which to choose comparables.
With regard to the lack of control and lack of marketability
discounts applicable to the 50-percent Pine Bend general
partnership interest which petitioner on December 1, 1997,
transferred to AFLP, petitioner’s expert identified trading
discounts (i.e., differences between unit or share trading prices
and unit or share NAVs) observed in 17 RELP comparables trading
on the RELP secondary market, and he equated those trading
discounts with a combined discount for lack of control and lack
of marketability. Petitioner’s expert derived therefrom what he
believed should be the lower and upper limits to his combined
discount–-a floor of 22 percent and a ceiling of 46 percent--but
he then abruptly concluded that a combined 40-percent discount
for lack of control and lack of marketability should apply
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without explaining further how he picked 40 percent as opposed to
22 or 46 percent, or some other number within his range.
In valuing the 50-percent Pine Bend general partnership
interest, respondent’s expert concluded that because the Pine
Bend partnership interest was simply an asset of AFLP, discounts
he applied at the AFLP level, see infra pp. 22-24, obviated the
need to apply an additional and separate discount at the Pine
Bend level.5
With regard to petitioner’s expert’s 17 RELP comparables we
eliminate 4 of the RELP comparables because their data was based
on information from 1999, not from 1997. Median and mean trading
discounts of approximately 30 and 36 percent were observed in the
5
We note that this Court, as well as respondent, has
applied two layers of lack of control and lack of marketability
discounts where a taxpayer held a minority interest in an entity
that in turn held a minority interest in another entity. See
Estate of Piper v. Commissioner, 72 T.C. 1062, 1085 (1979); Janda
v. Commissioner, T.C. Memo. 2001-24; Gow v. Commissioner, T.C.
Memo. 2000-93, affd. 19 Fed. Appx. 90 (4th Cir. 2001); Gallun v.
Commissioner, T.C. Memo. 1974-284. However, we also have
rejected multiple discounts to tiered entities where the lower
level interest constituted a significant portion of the parent
entity’s assets, see Martin v. Commissioner, T.C. Memo. 1985-424
(minority interests in subsidiaries comprised 75 percent of
parent entity’s assets), or where the lower level interest was
the parent entity’s “principal operating subsidiary”, see Estate
of O’Connell v. Commissioner, T.C. Memo. 1978-191, affd. on this
point, revd. on other issues 640 F.2d 249 (9th Cir. 1981).
The 50-percent Pine Bend interest constituted less than
16 percent of AFLP’s NAV and was only 1 of 15 real estate
investments that on Dec. 1, 1997, were held by AFLP, and lack of
control and lack of marketability discounts at both the Pine Bend
level and the AFLP parent level are appropriate.
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remaining RELP comparables. In light of these median and mean
trading discounts and in light of 28.7 percent and 30 percent
median and mean trading discounts observed in a total sample of
130 RELPs in 1997, we conclude that a combined discount of 30
percent for lack of control and lack of marketability is
appropriate for the 50-percent Pine Bend interest that petitioner
on December 1, 1997, transferred to AFLP. We conclude that as of
December 1, 1997, the fair market value of the 50-percent Pine
Bend general partnership interest petitioner transferred to AFLP
is $1,299,107, computed as follows:
Pine Bend assets
Cash $ 213,159
Rosemount Property 3,308,575
Stipulated NAV of other property 190,000
Total NAV of Pine Bend $3,711,734
Less 30-percent combined
discount for lack of control
and marketability (1,113,520)
Total discounted Pine Bend NAV $2,598,214
12/1/1997 FMV of 50-percent Pine Bend
general partnership interest $1,299,107
To establish just the lack of control discount applicable to
the AFLP limited partnership interests as of the dates of
petitioner’s gifts thereof to her three children--August 1, 1996,
and December 1, 1997--petitioner’s expert used trading discounts
observed in RELP units traded in the RELP secondary market.
Taking into account AFLP’s financial situation, petitioner’s
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expert selected nine specific RELPs to serve as comparables to
AFLP.
Petitioner’s expert’s RELP comparables were significantly
more leveraged than AFLP (from 82 percent to 205 percent of debt
to NAV compared to AFLP’s more moderate leverage in 1997 of 52
percent of debt to NAV), and petitioner’s expert’s RELP
comparables had an average trading discount of 38 percent.
From his initial nine RELP comparables, petitioner’s expert
selected four RELP comparables he considered most comparable to
AFLP, which had trading discounts ranging from 40 percent to 47
percent, and petitioner’s expert chose a lack of control discount
for the gifted AFLP interests of 45 percent for 1996 and 40
percent for 1997.6
Of petitioner’s expert’s four specific RELP comparables, two
had NAVs approximately five times the NAV of AFLP and his other
two RELP comparables were even more leveraged. Where the
comparables are relatively few in number, we look for a greater
similarity between comparables and the subject property. Cf.
Estate of Heck v. Commissioner, T.C. Memo. 2002-34 (“As
similarity to * * * [a] company to be valued decreases, the
number of required comparables increases”).
6
For convenience, we occasionally reference “1996” and
“1997” without specifying the exact valuation dates--namely,
Aug. 1, 1996, and Dec. 1, 1997.
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Because AFLP held less debt and was, according to
petitioner’s expert, inherently less risky than his comparables,
we find it unlikely that the proper lack of control discount to
apply to AFLP should be as high as the 45-percent and 40-percent
discounts used by petitioner’s expert for the respective 1996 and
1997 gifted AFLP limited partnership interests.
Petitioner’s expert also stated that the higher an RELP’s
cash distribution rate the lower the investor risk should be,
which in turn would suggest a lower trading discount. Because
AFLP’s cash distribution rate of 10 percent was significantly
higher than the 6.7-percent average cash distribution rate
observed in his RELP comparables, under petitioner’s expert’s own
approach his recommended AFLP lack of control discounts should be
lower than the 38-percent average trading discount he observed in
his RELP comparables.
We conclude that the RELP comparables petitioner’s expert
used are too dissimilar to AFLP to warrant the amount of reliance
petitioner’s expert placed on them, and we conclude that
petitioner’s lack of control discounts for the gifted AFLP
limited partnership interests of 45 percent for 1996 and 40
percent for 1997 are excessive.
Rather than sifting through RELP data looking for more
appropriate RELPs to serve as comparables in an effort to
estimate lack of control discounts for the gifted AFLP limited
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partnership interests, we use REIT data used by respondent’s
expert with adjustments to his methodology.
From an investment advisory firm respondent’s expert
obtained trading prices and share NAVs for approximately 75
REITs. The REIT data showed that in 1996 in the public
marketplace REITs traded at a median .1-percent premium over per-
share NAV and in 1997 at a median 1.2-percent discount under per-
share NAV.
Because REITs allow investors to own a minority but at the
same time a liquid investment in an otherwise nonliquid asset
(i.e., real estate), investors in REITs are willing to pay a
liquidity premium (relative to per-share NAV) to invest in REIT
shares. As explained in McCord v. Commissioner, 120 T.C. 358,
385 (2003), revd. and remanded on other grounds 461 F.3d 614 (5th
Cir. 2006), this does not mean that a lack of control discount is
nonexistent but suggests that an REIT’s share price is in part
affected by two factors, one positive (the liquidity premium) and
one negative (lack of control). Thus, in analyzing REIT
comparables and their trading prices, it is appropriate to
identify and to quantify, and then to reverse out of the trading
prices, any liquidity premiums that are associated with REIT
comparability data, which calculation results in an REIT discount
for lack of control that can be applied to the subject property.
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On the basis of a regression analysis, respondent’s expert
concluded that for 1996 and 1997 REITs traded generally at a
liquidity premium of 7.79 percent over illiquid investments such
as closely held partnership interests.
To eliminate the effect of this 7.79-percent liquidity
premium on REIT trading share prices respondent’s expert made a
mathematical calculation that for 1996 combined this 7.79-percent
liquidity premium with the observed 1996 .1-percent REIT median
trading premium and the observed 1997 1.2-percent REIT median
trading discount, and he arrived at a lack of control discount to
apply to the gifted AFLP limited partnership interests of 7.14
percent for 19967 and 8.34 percent for 1997.8
We agree with respondent’s expert that in order to estimate
or quantify an appropriate lack of control discount from REIT
trading prices one should eliminate or reverse out the liquidity
premium inherent in REIT trading prices. However, respondent’s
expert’s 7.79-percent liquidity premium appears unreasonably low.
Our concern rests partly on the fact that other studies cited by
respondent’s expert suggest that liquidity premiums applicable to
publicly traded investments are nearly double that used by
respondent’s expert and partly on the fact that respondent’s
expert’s 7.79-percent liquidity premium resulted in a discount
7
1-[1+.001]/[1+.0779]=.0714.
8
1-[1-.012]/[1+.0779]=.0834.
- 25 -
for lack of control that, on its face, appears unreasonably low
(namely, his lack of control discounts of 7.14 percent for 1996
and 8.34 percent for 1997). See Lappo v. Commissioner, T.C.
Memo. 2003-258 (respondent’s expert’s calculation of a liquidity
premium rejected for similar reasons).
To combine or to calculate a liquidity premium (to use in
this case for 1996 and 1997 and to reverse out of REIT trading
prices to isolate or to quantify an appropriate lack of control
discount), we look simply to the difference in average discounts
observed in the private placements of registered and unregistered
stock based on the premise that the difference so observed
represents pure liquidity concerns, since a ready, public market
is available to owners of registered stock but is unavailable to
owners of unregistered stock. See McCord v. Commissioner, supra
at 385; Lappo v. Commissioner, supra. According to two studies
respondent’s expert cited, the difference was approximately 14
percentage points, which results in a general liquidity premium
inherent in publicly traded assets of 16.27 percent9 that would
also be applicable to publicly traded REITs.
To calculate the lack of control discount present in the
REIT comparables we must eliminate (from the .1-percent median
9
If an illiquid asset trades at a discount of 14 percent
relative to a liquid asset, the liquid asset is trading at a
premium of 16.27 percent from the illiquid asset (namely,
1/[1-.14]-1=.1627).
- 26 -
trading premium observed for the 1996 REIT comparables and the
1.2-percent median trading discount observed for the 1997 REIT
comparables) this 16.27-percent liquidity premium. For 1996, we
simply subtract .1 percent from the 16.27-percent liquidity
premium to arrive at a lack of control discount of 16.17
percent.10 For 1997, we simply add 1.2 percent to the 16.27-
percent liquidity premium to arrive at a lack of control discount
of 17.47 percent11.12
For a lack of marketability discount applicable to the three
30-percent AFLP limited partnership interests petitioner gave to
her children on August 1, 1996, petitioner’s expert estimated a
discount of 15 percent, and respondent’s expert estimated a
discount of 21.23 percent. We perceive no reason not to use
10
.1627-.001=.1617.
11
.1627+.012=.1747.
12
Without explanation, to arrive at his lack of control
discounts for 1996 and 1997, when combining his liquidity premium
with the REIT trading premium and/or discount, respondent’s
expert used a different mathematical calculation than the one he
used in McCord v. Commissioner, 120 T.C. 358, 385 (2003), revd.
and remanded on other grounds 461 F.3d 614 (5th Cir. 2006). We
use the calculation respondent’s expert used in McCord because of
its simplicity and intuitiveness. We note that use of the
particular mathematical calculation respondent’s expert used
herein would produce lack of control discounts of approximately
14 percent for 1996 (1-[1+.001]/[1+.1627]=.14) and 15 percent for
1997 (1-[1-.012]/[1+.1627]=.15), relatively close to our lack of
control discounts of 16.17 percent and 17.47 percent,
respectively.
- 27 -
respondent’s higher marketability discount of 21.23 percent
without further discussion, which we do.
For the three AFLP limited partnership interests petitioner
gave her children on December 1, 1997, because both parties
advocate a lack of marketability discount of approximately 22
percent, we apply a lack of marketability discount of 22 percent.
Conclusion
We conclude that the fair market value of each of the three
30-percent AFLP limited partnership interests petitioner gave on
August 1, 1996, was $172,525, (for total taxable gifts in 1996 of
$517,575) and that the fair market value of each of the three
AFLP limited partnership interests petitioner gave on December 1,
1997, was $2,188,405 (for total taxable gifts in 1997 of
$6,565,215), calculated as follows:
1996 Gifts
Total stipulated AFLP NAV of
elder-care facility as of 8/01/96 $870,904
Less Discounts for AFLP limited
partnership interests
16.17-percent lack of control (140,825)
$730,079
21.23-percent lack of marketability (154,996)
$575,083
FMV of each gifted 30-percent interest $172,525
Total value of gifted AFLP interests $517,575*
* 3 x $172,525 = $517,575.
- 28 -
1997 Gifts
12/1/1997 NAV of properties and
interests transferred to AFLP
50-percent Pine Bend interest $ 1,299,107
Stipulated NAV of other
properties 10,032,721
$11,331,828
Less Discounts for AFLP limited
partnership interests
17.47-percent lack of control (1,979,670)
$9,352,158
22-percent lack of marketability (2,057,475)
$7,294,683
FMV of each gifted 30-percent interest $2,188,405
Total value of gifted AFLP interests $6,565,215*
* 3 x $2,188,405 = $6,565,215.
This case is decided on the preponderance of the evidence
and is unaffected by section 7491. See Estate of Bongard v.
Commissioner, 124 T.C. 95, 111 (2005).13
To reflect the foregoing,
Decision will be entered
under Rule 155.
13
Because of the way AFLP’s capital accounts were
maintained, petitioner argues that on Dec. 1, 1997, she
transferred to each of her three children a 27.9-percent limited
partnership interest in AFLP. Regardless of the exact percentage
interest in AFLP which petitioner transferred to her children
(27.9 percent or 30 percent), the value of each of the three
gifted interests is equal to 30 percent of the NAV of the
properties and Pine Bend partnership interest petitioner
transferred to AFLP on Dec. 1, 1997.