Undivided Interests inInteresting Times A Sharing of Information from Many Generous ASFMRA Appraisers By: Eldon Krull
Technical Advice Memorandum 9336002 (May 28, 1993) “ the amount of any discount should be limited to the petitioner’s share of the estimated cost of a partition of the property.” Changed with LeFrak LeFrak V Commissioner – T.C. Memo 1993-526 (November 16. 1993): Appraiser must consider the “cost, uncertainty, and delays attendant upon partition proceedings as the basis for allowing a discount in valuing fractional interests in real property.”
Estate of Cervin T.C. Memo 1994-550 (October 31, 1994): “Such partition would involve substantial legal costs, appraisal fees, and delay.” Estate of Barge T.C. Memo. 1997-188 (April 23, 1997) Court developed its own cost-to-partition analysis and recognized that partition period could be up to 4 years. Court model became the most accepted model for undivided interest valuations.
Adjusting for Tax Implications of a delayed sale: Most sellers in today’s land market believe that increased taxes are coming in the future. Be careful about using deductions that have not been proven in court. Base any deductions on opinions of tax experts– poll at least three TAX CPA’s in the area where the subject is located. Would a jury or judge accept your facts as reasonable if challenged. Suggestions? Opinions?
Adjusting for Risk of Drop in Land Prices Due to a delayed sale: The agricultural land market is currently in the midst of a trend of land prices increasing at rates rarely seen before for such extended periods. Would most judges and juries accept a discount due to the probability of a return to a trend-line average? LeFrak decision required that valuation include uncertainty which increases with historic rises in land values. A standard disclaimer on any investment brochure will state that past performance does not indicate future performance. Be very careful as no court case backs this line of thought. Only consider using if land sale professionals in the area of the subject would state agreement.
Adjusting for Risk of Drop in Land Prices Due to a delayed sale: If the IRS argued that current trends indicate that land is going up and that land should be appreciated during the 3 year partition holding period, then the IRS would be accepting that past trends indicate future trends. If a tax court accepted the argument that past trends indicate the future trend, then the court may also have to accept that the past showed that when land prices became extended above trends lines (shown in the graph), then land prices would be expected to go back to the point where the current prices crossed over the exponential equation line. Comments?
33% and 25% Undivided Interest Sales Sales do not support greater discounts for smaller percentages of ownership. Indicates that buyers do not like uncertainty no matter what the percentage of ownership. Tax training manual supports greater discount for small % ownership. Use the summary data to back up other analysis but do not base the deduction solely on summary data. Courts may require comparable sale analysis.
Possible Adjustments to Consider 1.) Total Value of Property 2.) Value of Subject Interest 3.) Subject Percentage of Total Property 4.) Number of Owners 5.) Is the property income producing? Past Comparable Sales have shown greater discount to non-income producing properties such as timber. Possible long-term expenses which may require all current income to cover cost.
Possible Adjustments to Consider continued 6.) Property Type Hunting and Recreational Properties especially sensitive to lack of control of the entire property. 7.) Debt-Would a partition action cause a lender to call a loan. 8.) Are there Ownership Agreements that enable easy sale or make sales more difficult to non-owners? Is there risk of forced sale due to Ownership Agreements? 9.) Market Outlook or Trend 10.) State Laws that may affect sale?
Possible Adjustments to Consider continued 11.) Location Adjustments Would the location of the subject affect the discount for the undivided interest compared to the location of the comparable sales? 12.) Are there legal barriers to partition? 13.) Additional appraisal cost to determine value. 14.) What additional discount in value would there be if the property was partitioned and the property was split based on ownership percentage. Would the smaller acreage lead to inefficiency and/or possibly change highest and best use. Higher sale cost? 15.) Are there inheritance stipulations which limit division or sale of property.
The IRS Training Manual for Appeals Officers Coursebookdirects that the appropriate discount for a fractional interest in real property be based on several factors. In particular, the IRS Manual states that, in addition to the costs of dividing the land (i.e., partition), the following factors will also influence the amount of the discount: • The size of the fractional interest: smaller interest = larger discount. • The number of owners: more owners = larger discount. • The size of the tract (i.e., practicality of partition): smaller tract = larger discount. • The use of the land: farmland = larger discount. • Availability of financing for undivided interests: tighter financing = greater discount. The cost of partition. From IRS Training Manual for Appeals Officers Coursebook (CCH), Chapter 4, Pages 26 – 27.
Possible Outcomes for Partition Action Court may divide the physical property and allocate based on ownership %. Property may be sold and proceeds split. Court may allow one or more owners to buy out other interests. Court may divide the property and then adjust for inequity between the parties by payment between owners. Property may keep property intact and allocate time used based on ownership percentage. This outcome may be especially pertinent to recreational properties.