A father owned over 1,000 acres of California ranch land, worth $6.4 million at his death. The estate applied a 48% combined discount for lack of marketability and lack of control, because thirty years before, the father had gifted equal, undivided interests to his five children as tenants-in-common, reserving “full use and control” of the property throughout his life. The IRS disallowed the discounts, claiming that due to the retained life interest, Sec. 2036(a)(1) of the Tax Code included the full fair market value of the property in the estate.
The Tax Court began by noting that when a person dies holding a fractional interest in property, discounts are often appropriate to reflect its lack of control and marketability. But their application depends on when the interests were separated. If the split occurs prior to death, then discounts might be appropriate. Control is also key: In this case, the father used the ranch for 30 years and paid all its expenses. “It was as if he retained the entire interest in the land during his life,” the court held, finding that ownership was divided after the father’s death and the property was taxable at full value. Read the complete digest of Estate of Adler v. Commissioner, T.C. Memo. 2-11-28 (Jan. 31, 2010) in the April 2011 Business Valuation Update; the Tax Court’s decision will be posted soon at BVLaw.
Are discounts ever free from doubt? If one of the children passes away now, a fractional interest valuation would likely be appropriate, blogs tax attorney Charles Rubin (Feb. 7, 2011). In that case, “wouldn't the discount tend be a lot less than if a partnership was used, particularly if there is a right of partition?” asks one commentator. “That's probably the case,” Rubin replies. “However, you may avoid some of the issues that can be troublesome to partnership discounts.” Join the discussion or send your comments to the BVR editor for posting here.