In a presentation that sparked 20 minutes of debate at the 3rd annual National IRS Symposium sponsored by the ASA’s Los Angeles Chapter in L.A. last week, IRS Engineer Team Manager Neil Mills-Mazer introduced a model that addresses his “pet peeve” in the area of fractional interest discounts: the “minority premium.”(Reminder: The views and opinions expressed are those of the presenter and do not necessarily reflect the views and opinions of the IRS.)
Briefly—consider the owner of a 99% undivided interest in a $2 million property. (Thus, the 99% owner can claim $1.98 million of the property, the 1% owner, $20,000.) Mills-Mazer has seen a 99% owner claim a 35% discount for his fractional interest. Yet—even a 1% discount for the majority interest would be worth $19,800, or nearly enough to pay off the minority owner, in effect giving the latter a 99.8% “premium,” Mills-Mazer explained. More importantly, how can the majority interest claim a higher discount than what it would cost to buy-out the minority owner at a substantial premium?
Mills-Mazer’s model takes similar calculations through several levels of minority interests, and concludes that even when ownership is 50/50, the maximum fractional interest discount that should be considered is 30%. Audience questions abounded. For instance, why is there empirical market data that suggests fractional interests trade at discounts of 30% and higher? Aren’t the facts and circumstances of many such holdings much more complicated than the IRS model suggests? Perhaps the most critical question went to U.S. Tax Court Judge James Halpern, who was asked for his thoughts on the model. “Read my decision in Holman v. Commissioner,” he responded (in which FLP provisions permitting the buy-out of LP interests placed a natural cap on marketability discounts). Even more critical: “Would a 99% owner ever be willing to sell at a 30% discount? Not if he can buy out the 1% owner at the equivalent of a 1%-2% discount,” Halpern said.
We’ve invited Mills-Mazer to present his complete fractional interest model and analysis in a future Business Valuation Update. Stay tuned for more analysis and debate…
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