TrustLawyer

Playing the Estate Tax “Valuation Game”

An important part of estate planning is to assign an “estate tax value” to every asset, including interests in real estate and businesses. Assigning the proper value to assets is more complex than you might think. And, if you don’t take full advantage of certain value reducing techniques, you can wind up paying tens of thousands of dollars more in taxes than necessary. In this post, I discuss some of the factors in valuing assets.

What’s an Asset Worth?

Joe died owning a one half interest in a building worth $1 Million. His brother, Moe, owned the other half. What is the value of Joe’s share of the business for estate tax purposes?

A. $500,000

B. $400,000

C. $300,000 or less

D.  Any of the above

You might be surprised to learn that D is the correct answer. Let’s see why. Most people assume A is the correct answer because it is half of $1 million. But, for estate and gift tax purposes, assets may be worth less than what you might think. Which of the above answers is correct depends on the circumstances of the situation.

Real Estate Valuation: $500,000

In this valuation scenario Joe had a binding agreement with Moe which provided that Moe could buy Joe’s half of the building for $500,000 in cash.  Because Joe’s estate has a guaranteed market, the agreement price is the estate tax value.

 

Real Estate Valuation: $400,000   

Joe left his half of the building to Moe in his will.  For estate tax purposes, the value of an asset is the price that a hypothetical, unrelated buyer would pay to a seller in a commercial transaction. An investor would not pay $500,000 for one half interest in the building because he could not manage it alone. He could not turn it into cash without a court proceeding called a “partition”.   

An investor could reasonably demand a discount for lack of control and lack of marketability. Discounts on partial interests in real property, are generally in the range of 15-20% because either owner could demand a partition.  Larger discounts are possible when an asset is owned by an entity such as an LLC or partnership. 

 

Real Estate Valuation: $300,000   

in this valuation scenario the building was owned by “J & M Enterprises, LLC” rather than by Joe and Moe, individually. The operating agreement of the LLC contained restrictions on how, and to whom, interests could be transferred.  For example, one restriction states that no member of the LLC can force a sale of the building through a partition suit.  Because an LLC or partnership agreement generally contains restrictions on transfer, discounts on properties held in these entities are greater than those on partial interests owned outright so in this situation it is reasonable to value the business at $300,000.  

As you can see, the estate tax value of an asset depends on a variety of circumstances. If you are in the process of settling an estate, talking with an estate settlement attorney can help you identify your unique circumstances and use that information to assign the right value to real estate or a business.