Robert Buchanan (PCE Valuations) reports on a pending Tax Court case that will address the valuation of an undivided interest in real estate—a tenant-in-common (TIC) interest. A valuation his firm had performed several years ago was of a 40% TIC where there was no formal entity into which the real estate or the interest had been contributed.

“Our valuation approach was that this interest was a security and is a passive investment because investors do not have any decision-making power,” he says. “When it comes to real estate joint ventures, like TIC interests, a non-managing, non-control, undivided interest is likely to meet the definition of a security established by the Investment Advisors Act and various case law. Therefore, our approach focused on the rate of return that would be required by investors to buy the interest, given an assumed holding period and related risks. Conceptually, we viewed this as no different from valuing a non-control interest of an entity that holds the same real estate.”

IRS challenge: The IRS disagrees with his company’s analysis and views the TIC interest as a mere real estate interest, with its value based on an appraisal of the underlying real estate by a qualified real estate appraiser. That appraisal was for $4 million, so the value of the 40% interest, without consideration of its noncontrolling and nonmarketable nature, would be $1.6 million.

“The reason for the IRS challenge was that our valuation approach produced a materially lower value,” he says. “We are anxiously awaiting the ruling … fingers crossed.