Astleford has valuation professionals FLiP’n

Last month the U.S. Tax Court released its memorandum opinion in Astleford v. Com. (TC Memo 2008-128), a case dealing with the minority and marketability discounts applicable to family limited partnerships. In Astleford, the widow of a Minnesota real estate tycoon contributed her interests in real estate (which included real estate partnerships and trusts) to a family limited partnership (FLP) for the benefit of the parties’ children.

In valuing the interests gifted to the children for the donor’s IRS Form 709s, the taxpayer’s valuation expert took a 41.3% absorption discount against the value of the real estate. The taxpayer’s expert opined that the parcel of farmland was so much larger than the average comparable sales that it would flood the market, warranting a discount. The IRS, predictably, rejected the absorption discount.

On appeal, the Tax Court reduced the absorption discount considerably, to approximately 20%. In doing so, the Tax Court examined the specific data on which the taxpayer’s expert relied and reached its own conclusion from that data by excluding certain datapoints and determining its own weighting.

The taxpayer’s expert also discounted the value of the partnership donated to the FLP and the FLP interests conveyed to her children for lack of control and lack of marketability, relying on market data from sales of registered real estate limited partnerships (RELPs). Deriving a range of 22% to 46%, the donor’s expert settled on a 40% combined discount against the value of the partnership. The IRS did not discount at the partnership level, arguing the discounts should be applied only at the FLP level.

The taxpayer’s expert applied “tiered discounts” by discounting the partnership interests that were donated to the FLP and the FLP interests that were transferred to children. In other words, the value was discounted once at the partnership level and again at the FLP level. The Tax Court noted that tiered discounts were disallowed where minority interests comprised most of the assets of the FLP entity being valued, but since the partnerships were just 16% of the FLP’s value, the tiered discounts would be allowed. The TAx Court arrived at a 30% combined discount at the partnership level.

The IRS in calculating discounts at the FLP level applied data from REIT sales, which the Tax Court deemed more reliable than RELP data. Because of the data source, the IRS expert had to adjust his minority interest discount to account for the unusual liquidity of REITs. By eliminating the liquidity premium from the observed discount, the IRS arrived at a minority interest discount of 7-8%, which the Tax Court deemed too low. The Tax Court instead calculated a minority interest discount of 16-17%.

The Tax Court accepted the IRS’s marketability discount of 22% (which was slightly higher than the marketability component of the taxpayer’s combined discount).