In a case filed on May 5, 2008, the Tax Court addressed several valuation matters in connection with the gifting of family limited partnership (FLP) interests.  The issues in Jane Z. Astleford v. Commissioner, T.C. Memo. 2008-128, are the value of 1,187 acres of Minnesota farmland, whether a particular interest in a general partnership held by the FLP should be valued as a partnership interest or an assignee interest, and the lack of control and lack of marketability discounts that should apply to the limited and general partnership interests.

 

Jane Z. Astleford’s husband, M.G. Astleford, was a successful real estate investor who owned numerous properties, primarily in Minnesota.  He owned the properties individually and through various entities.  Mr. Astleford passed away in 1995.  In 1996, Mrs. Astleford created the Astleford Family Limited Partnership (AFLP).  After transferring property to the AFLP, she gifted a 30% limited partnership interest to each of her three children, and retained a 10% general partnership interest. 

 

At the end of 1997, Mrs. Astleford transferred additional properties to the AFLP including a 50% general partnership interest in Pine Bend Development Co. which owned 3,000 acres of land near St. Paul, Minnesota.  As a result of this transfer, Mrs. Astleford's interest in the AFLP increased significantly.  Desiring to get back to ownership percentages of 10% for Mrs. Astleford and 30% for each of her children, Mrs. Astleford made additional gifts to each of her three children.

 

Mrs. Astleford filed gift tax returns for 1996 and 1997.  After discounts, the taxable value of the gifts for 1996 and 1997 were reported as $277 thousand and $3.9 million, respectively.  On audit, the IRS increased the value of the taxable gifts to $627 thousand and $10.9 million, respectively. 

 

Concerning the value of the 1,187 acres of Minnesota farmland, the taxpayer's appraiser and the IRS appraiser each used a market approach by reviewing sales of similar properties.  However, the IRS appraiser was "particularly credible, highly experienced and possessed a unique knowledge of farm property located in the county in which the subject property was located."  Accordingly, the Court used his initial value of $3,500 per acre.  The IRS appraiser did not apply an absorption discount to this value.  The Court determined that an absorption discount was appropriate, but not to the extent applied by the taxpayer's appraiser.  Using an absorption discount of about 20%, the Court settled on a per acre price of $2,786.

 

Concerning the valuation of the AFLP's 50% interest in Pine Bend Development Co., the taxpayer's appraiser argued that it should be valued as an assignee interest.  As such, he discounted the interest because under Minnesota law a holder of an assignee interest would have an interest only in the profits of the partnership and would have no influence on management.  The IRS appraiser argued that the "substance over form doctrine" should apply, and therefore, the interest should be valued as a general partnership interest.  The Court adopted the "substance over form doctrine" and rejected the taxpayer's argument.

 

For purposes of the discounts for lack of control and lack of marketability of the 50% interest in the Pine Development Co. partnership, the IRS appraiser relied on publicly traded REIT data and the taxpayer's appraiser relied on publicly registered real estate limited partnership (RELP) data.  The Court did not choose one set of data over the other.  However, the taxpayer's appraiser applied a 40% discount without fully explaining his position.  The IRS appraiser did not apply any discount believing that the discounts should be applied at the AFLP level only.  The Court rejected the position of each appraiser, and performed its own analysis of the RELP data.  The conclusion was a 30% combined discount for lack of control and lack of marketability at the Pine Development Co. partnership level. 

 

For the discounts for lack of control and lack of marketability of the gifted AFLP interests, the Court concluded that the RELP comparables used by the taxpayer's appraiser were not similar to the AFLP.  Accordingly, the 45% and 40% discounts for lack of control for 1996 and 1997, respectively, were considered excessive.  Rather than sifting through the RELP data for better comparables, the Court used the REIT data used by the IRS appraiser.  However, the Court determined that the IRS discount for lack of control was unreasonably low and calculated a discount of 17.47%.  The Court also accepted the IRS appraiser's discount for lack of marketability of 21.23% (taxpayer's appraiser used 15%).

 

It's interesting to note that the Court allowed so many discounts in this case, and that the discounts were applied at several levels.  In fact, the discounts total about 85%!  It appears that layered discounts are alive and well!  It's also interesting to note the Court's treatment of the data used to develop the partnership discounts.  Better data from the RELP's was rejected because there wasn't enough available.  Instead, REIT data was used because of its abundance and because it could be adjusted to reflect differences in the subject property.

 

The Astleford case will be debated for months, but one thing is for certain, it sure seems to provide practical solutions to some complex valuation issues.

 

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