TrustLawyer

Valuation Discounts

Now you see it. Now you don’t.
Valuation Discounts in Plain English

Quick Quiz: Q. How much is half of $1 Million
A. $500,000
B. $400,000
C. $300,000 or less
D. All of the answers are correct. One half of $1Million can be worth anywhere from less than $300,000 to $500,000.

Answer D is correct. Let’s see why, for estate and gift tax purposes, assets may be worth less than what you might think.

A simple discount example

Ajax and Bjax are each own a one half interest in “Greenacre,” a parcel of land worth $1 Million. What is the value of each of their shares?

Without the consent of his co-owner, neither Ajax nor Bjax can control the property. They can’t easily turn their one half interests into cash. Their interests lack “marketability and control.” A buyer would take this into account and offer less than $500,000 for either of their one half interests. Typical discounts on partial interests in real property are from 15 to 25 percent. Each of Ajax’ and Bjax’ shares would be worth approximately $400,000 for estate and gift tax purposes.

Family limited partnerships

Ajax” and Bjax’ brothers, Cjax an Djax, were looking for larger discounts. They form a partnership to own a property similar to Greenacre. The partnership agreement restricts their right to transfer their interests in several respects. Discounts on a partial interests in family partnerships are generally higher than those for partial interests owned outright. Each of Cjax’ an Djax’ interests might be valued at $350,000 or less.

Family limited partnerships, sometimes called an “FLPs” are often used in business succession contexts. Even if there were no estate tax, we still would have FLPs. Designing and managing the partnership is a complex task involving several professional disciplines.

Frederick’s of Hollywood

“Mrs. Frederick” died owning stock in her family’s eponymous company. Additional stock was in a trust for her benefit. Because the trust assets were included in Mrs. Frederick’s taxable estate, the IRS sought to combine them into one block for valuation purposes. The court held that, because Mrs. Frederick didn’t have full ownership rights in the trust stock, the two holdings could not be aggregated. Each portion was entitled to a minority discount. This case creates some planning possibilities for family business owners.

Relationships generally don’t matter

For estate and gift tax purposes, the value of an asset is the value which a willing buyer would pay a willing seller for that particular asset, assuming that each of them knew all relevant facts and that neither of them was under a compulsion to buy or sell. The “particular asset” is the partial interest in the property or in the business entity.

It does not matter whether family members, or even the donor's spouse own, other "parts" of the asset. In one IRS ruling, Papa gave equal interests in a company to each of his eight children. Each gift was valued separately and was entitled to a minority interest discount. In a court case involving the estate of the lingerie purveyor, Fredericks of Hollywood, stock owned by “Mrs. Frederick” and stock owned by a trust what was included in her taxable estate were valued separately, using appropriate discounts.

Conclusion

Now you know the answer to the Quick Quiz. “Family value” and estate and gift tax value are not necessarily the same thing. If you want to discuss planning for valuation discounts, please let us know.