Taxation & Estate Planning

A METHODOLOGY FOR DISCOUNTING JOINT OWNERSHIP INTERESTS

By Charles Rubin

Federal transfer taxes are based on the value of the property transferred. When the property transferred is a joint interest in property, some reduction from the pro rata share of the full value of the property is appropriate since a willing buyer would not pay 100% of the pro rata share of the value due to restrictions on enjoyment of the property or freely liquidating the property.

All qualities of appraisals to quantify this discount are obtained by appraisers, ranging from detailed to valuations akin to estimates. In a recent case gift tax case, the Tax Court rejected the data and appraisals offered by both the IRS and the taxpayer. Instead, the Tax Court applied its own methodology. This well-thought-out methodology should be useful to appraisers and taxpayers alike.

The property interest involved was a 50% tenancy-in-common interest of residential real property situated in Hawaii.

FIRST, determine a value as if partition is not necessary to sell the property.

  A. Determine the pro rata share of the appraised value of the full parcel, projected 1 year into the future (the estimated time to complete the sale in the case).

  B. Reduce that value by an appropriate discount for the time period needed to sell.

  C. Reduce by the pro rata share of selling costs (e.g., broker fees).

  D. Reduce by estimated operating costs for the time period needed to sell.

SECOND, determine a value as if partition is necessary to sell the property.

  A. Determine the pro rata share of the appraised value of the full parcel, projected 2 years into the future (the estimated time to complete both the partition and the sale).

  B. Reduce that value by an appropriate discount for the time period needed to partition and sell.

  C. Reduce by pro rata share of selling costs (e.g., broker fees) and partition costs.

  D. Reduce by estimated operating costs for the time period needed to partition and sell.

Then, find a value in-between FIRST and SECOND, based on an expert opinion on the likely need of a partition (in the case, that was estimated at 10% likelihood of need for partition).

Andrew K. Ludwick, et ux.,, TC Memo 2010-104

Full post as published by Rubin on Tax on May 19, 2010 (boomark / email).