Barge v. Commissioner Confirms VSI Valuation Approach for Tenant in Common Interests

In a previous issue of Eye on Value (Issue No. 3, Summer 1997) we discussed the risks associated with owning real estate through tenant in common interests. In that article, we touched on, but did not fully describe the Valuation Services, Inc. ("VSI") methodology for valuing tenant in common ("TIC") interests. VSI developed its own approach to TIC valuations several years ago. The validity of our valuation methodology was recently confirmed in a Tax Court case, Barge v. Commissioner T.C. Memo. 1997-188.

Myth vs. Reality

In previous issues, we have discussed various aspects of valuing fractional real estate limited partnership interests. We introduced some of the factors that serve to reduce the value of a fractional interest below its proportionate share of the underlying assets of the entity. These factors are referred to as valuation discounts. Now, after having held ourselves out as experts in determining and quantifying valuation discounts, this article sets the record straight. The valuation discount may be a myth!

Did you hear the latest real estate ownership joke? How many tenants in common does it take to change a light bulb? If you said all of them, you are correct.

If you own real estate as a tenant in common with other persons, you may not be laughing. The fact of the matter is, owning real estate as a tenant in common ("TIC") may be one of the least attractive forms of ownership. Accordingly, VSI believes that estate tax reporting opportunities exist for TIC interests due to the fact that substantial valuation discounts may be available for these interests.

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Two buildings may look the same to the naked eye, but to the trained Valuation Expert an ownership interest in these Buildings can be vastly different. Let’s take a look…….

The Facts

Building A is location at 123 Main Street, was built in 1984 for $12 million and has 100% occupancy in its 100,000 square feet of rentable office space. Building A is owned by Good Limited Partnership ("Good LP").

In two recent tax court decisions this summer (Eisenberg v. Commissioner, 2nd Cir., No. 97-4331, USTC and Davis v. Commissioner 110 T.C. No. 35 Tax Ct. Dkt. No. 9337-96 USTC), the courts have finally concluded that for gift tax purposes, a taxpayer is entitled to reduce the fair market value of closely held stock to take into account potential capital gains tax liabilities. Prior to these decisions, courts had generally held that no reduction in the value of closely held ownership interests may be taken to reflect the potential capital gains tax liability where evidence fails to establish a liquidation or sale of the corporation or its assets is likely to occur. The reasoning was that absent this expectation of a sale or liquidation, the tax liability was purely speculative.

In our last Eye on Value we spoke about the IRS scrutiny of family limited partnerships. As we were going to press on our newsletter, so was the Clinton Administration. In February, the Administration published revenue raising proposals for fiscal year 1999 which could end the use of valuation discounts for ownership interests in family limited partnerships and limited liability companies used for gift and estate tax reporting purposes. Specifically, the General Explanations of the Administration’s Revenue Proposals issued by the Treasury Department states the "the proposal would eliminate valuation discounts except as they apply to active businesses.

Internal Revenue Code Section 2701 and the Treasury Regulations thereunder govern certain partnership "freeze" transactions. These rules provide a very specific methodology for valuing partnership equity interests and the resulting gift amounts to gift tax reporting purposes. Partnership freezes can be a good vehicle for reducing value of an estate and saving significant gift and estate taxes. The specific valuation methodology are quite complicated. VSI has prepared several valuations which successfully utilized the four step valuation approach of Section 2701. If you are considering a partnership freeze and need assistance in working through the valuation calculations, VSI can be a valuable member of your team.