Undivided Interests in Interesting Times

Report
Undivided Interests in
Interesting Times
A Sharing of Information from
Many Generous ASFMRA
Appraisers
By: Eldon Krull
Undivided Interest Spreadsheet
2
Brief History of Undivided Interest
Tax Case History
Estate of LeFrak v. Commissioner, T.C. Memo 1993-526.
Estate of Cervin v. Commissioner, T.C. Memo 1994-550.
Estate of Barge v. Commissioner, T.C. Memo 1997-188.
Estate of Williams v. Commissioner, T.C. Memo 1998-59.
Estate of Brocato v. Commissioner, T.C. Memo 1999-424
Estate of Busch v. Commissioner, T.C. Memo 2000-3.
Estate of Stevens v. Commissioner, T.C. Memo 2000-53.
Shepherd v. Commissioner, U.S. Court of Appeals for the 11th Circuit, No. 01-12250, February 28, 2002.
Estate of Forbes v. Commissioner, T.C. Memo 2001-72.
Estate of Baird v. Commissioner, T.C. Memo 2001-258.
Estate of Pearl I. Amlie, T.C. Memo 2006-96
3
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.”
4
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.
5
Estate of Williams
T.C. Memo. 1998-59 (February 12. 1998)
“The inability to find sales of fractional interests
in comparable real property shows that there
was no market for fractional interests in such
property.
Court ruled that there were many other reasons
to discount a fractional interest beyond the Costto-Partition including lack of control, difficulty
in selling… etc.
6
Estate of Baird
T.C. Memo. 2001-258 (September 28, 2001).
Court found that problems and likely discounts
to undivided interests increased due to:
1.) having multiple owners with more
problems as number of owners increased,
2.) lending institutions not willing to lend to
fractional interest,
3.) costs incurred during partition period
while investment is ‘frozen,’
4.) severely limited market increases discount
due to lack of competition,
5.) problems of management of undivided
interest due to differing goals.
7
Sample Barge Type Analysis
Undivided Interest as Analyzed in Barge
Sample Facts
Time (Years) for Partition-
Uncontested
Contested
Fees
Deeded acres=
160
Tillable acres=
154
Rental Rate/Til acre with 3 yr Lease=
$400
Annual Rental Income=
$61,600
Annual Operating Expenses=
$11,088
Appraised Value
$1,386,000
Years
Attorney
Survey
3 Appraisals
Attorney's Opinion
1
2
3
2
2.5
1.5
3
3.5
2.5
$22,000 $24,000
$2,500 $2,500
$4,500 $4,500
CPA's Opinion
1
2
3 Yr. Tax Increase 4.00% 6.00%
Referee's Fees 5.00% 5.00%
Average
2.00
3.00
$20,000 $22,000
$2,500 $2,500
$4,500 $4,500
3
Average
2.00% 4.00%
5.00% 5.00%
8
Sample Barge Type Analysis
Year 1
Cash Flow
Rental Income (3 year lease)=
$61,600
Cash Outflow
Operating Expenses=
Appraisal Cost=
Survey Costs=
Legal Fees (1/2)=
$11,088
$4,500
$2,500
$11,000
Year 1 Net Cash Flow=
$32,512
9
Sample Barge Type Analysis
Year 2
Cash Flow
Rental Income (3 year lease)=
$61,600
Cash Outflow
Operating Expenses=
$11,088
Year 2 Net Cash Flow=
$50,512
10
Sample Barge Type Analysis
Year 3
Cash Flow
Rental Income (3 year lease)=
Value/Appraisal=
$1,386,000
3 Year Land Appreciation
3.00% $41,580
Value at end of proceedings=
Discount related to judicial sale
10.00% $142,758
Referee's Fee's=
5.00%
Net Sale Result=
Cash Outflow
Operating Expenses=
Legal Fees (1/2)=
Additional Estimated Increased Tax Risk
4.00%
Risk of Drop in Land Market Based on Current land market
Year 3 Net Cash Flow=
$61,600
$1,427,580
$1,284,822
-$64,241
$1,220,581
$11,088
$11,000
$48,823
$1,211,270
11
Sample Barge Type Analysis
AnnualNet Present Value Discount Rate
5.00%
Year 1 Net Cash Flow Discount Factor=
Year 1 Net Cash Flow=
Year 1 Discounted Net Cash Flow=
$0.95238
$32,512
$30,964
Year 2 Net Cash Flow Discount Factor=
Year 2 Net Cash Flow=
Year 2 Discounted Net Cash Flow=
$0.90703
$50,512
$45,816
Year 3 Net Cash Flow Discount Factor=
Year 3 Net Cash Flow=
Year 3 Discounted Net Cash Flow=
$0.86384
$1,211,270
$1,046,340
Present Value of Proceeds from Partition=
$1,123,120.00
Full value of Proceeds=
$1,386,000
Less Discounted Value=
$1,123,120
Amount of Discount arising from partition=
Percentage Discount from undivided interest=
$262,880
18.97%
12
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?
13
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.
14
$9,000
IOWA STATE UNIVERSITY LAND SALES SURVEY 1950-2012
5.96% Compounded Annually
$8,000
$7,000
$6,000
$5,000
$4,000
$3,000
$2,000
$1,000
$0
15
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?
16
Undivided Interest Report Summary
Report
Source
Date
%
Fractional
Interest
Robertson to Orr
Scrivner to Kinney
Harris-McCormick-Davis Study
Poskey to Hodges
Peterson-Hansen-Klafter Study
Williamette Management Study
Healy Study
Patchin Study
Hall Study
Gillman
Allendale County, SC Study
Westman to Palmer
LeFrak Court Decision
Sorbel Estate-Various
Cervin Court Decision
Confidential
Confidential
Confidential
Humphrey Study
Barge Court Decision
Williams Court Decision
Harper Trust to Tom Smith
Brocato Court Decision
Stevens Court Decision
Busch Court Decision
Forbes Court Decision
Baird Court Decision
Leonard to Hugh & Pence
Shepard Court Decision
Hodshire to Thomas & kay
Holtom to Pfannestiel Sheriff Sale
Eckhoff Accountancy Corp Study
McCreary to Canepari
Wika to Havelange
Amie Court Decision
McCreary to Canepari
Gipson to Riverside Coleman
Rymer to Prater Sale
Eagen
Hesse Sale
Halderman Real Estate Services
AgCountry FCS
American Society of Appraisers
Lightle
1978
1981
1983
1985
1986
1986
1988
1988
1988
1989
1991
1991
1993
1993
1994
1995
1996
1996
1997
1997
1998
1999
1999
2000
2000
2001
2001
2002
2002
2002
2002
2003
2004
2004
2006
2006
2006
2007
2008
2012
20.00%
50.00%
Various
20.00%
Various
Various
Various
Various
Various
50.00%
25.00%
25.00%
7.50%
80.00%
50.00%
33.00%
46.00%
50.00%
Various
25.00%
50.00%
79.17%
50.00%
50.00%
50.00%
42.50%
24.00%
20.83%
50.00%
50.00%
50.00%
Various
33.00%
25.00%
54.00%
33.00%
50.00%
40.00%
33.00%
50.00%
Median Undivided Interests=
The Appraisal Journal
Real Estate Issues
Valuation Strategies
AgCountry FCS
Sook
Van Vleet and Stumpf
AgCountry FCS
Van Vleet and Stumpf
Hudson
Hudson
Hudson
The Appraisal Journal
Van Vleet and Stumpf
Van Vleet and Stumpf
Halderman Real Estate Services
Van Vleet and Stumpf
Van Vleet and Stumpf
Van Vleet and Stumpf
Van Vleet and Stumpf
Van Vleet and Stumpf
Halderman Real Estate Services
Van Vleet and Stumpf
Halderman Real Estate Services
Lechtenberg
Valuation strategies
Lightle
AgCountry FCS
Van Vleet and Stumpf
Lightle
Lightle
Mark Williams
AgCountry FCS
Lechtenberg
27.30%
#
Sales in
Study
1
1
21
1
13
9
100
54
30
1
1
1
1
1
1
1
1
1
24
1
1
1
1
1
1
1
1
1
1
1
1
61
1
1
1
1
1
1
1
1
Average Undivided Interests=
Average
Discount
25.06%
30.00%
32.05%
26.00%
50.00%
15.00%
23.50%
36.80%
34.80%
26.00%
39.50%
20.00%
30.00%
13.00%
20.00%
33.00%
40.00%
36.00%
26.00%
44.00%
16.10%
11.00%
25.00%
38.00%
30.00%
60.00%
14.96%
15.00%
28.12%
36.20%
37.00%
27.30%
30.00%
15.00%
23.40%
33.00%
25.30%
23.00%
27.00%
28.62%
17
Location of Undivided Interest Sales or Court Decisions
18
50% Undivided Interest Sales
Scrivner to Kinney
Gillman
Cervin Court Decision
Confidential
Williams Court Decision
Brocato Court Decision
Stevens Court Decision
Busch Court Decision
Shepard Court Decision
Hodshire to Thomas & kay
Gipson to Riverside Coleman
Holtom to Pfannestiel Sheriff Sale
Hesse Sale
Median 50% Undivided Interests=
AgCountry FCS
AgCountry FCS
Van Vleet and Stumpf
Hudson
Van Vleet and Stumpf
Van Vleet and Stumpf
Van Vleet and Stumpf
Van Vleet and Stumpf
Van Vleet and Stumpf
Halderman Real Estate Services
Lightle
Lechtenberg
Lechtenberg
28.12%
1981
1989
1994
1996
1998
1999
2000
2000
2002
2002
2006
2002
2012
50.00%
50.00%
50.00%
50.00%
50.00%
50.00%
50.00%
50.00%
50.00%
50.00%
50.00%
50.00%
50.00%
1
1
1
1
1
1
1
1
1
1
1
1
1
Average 50% Undivided Interests=
30.00%
26.00%
20.00%
36.00%
44.00%
11.00%
25.00%
38.00%
15.00%
28.12%
33.00%
36.20%
27.00%
28.41%
19
33% and 25%
Undivided Interest Sales
McCreary to Canepari
McCreary to Canepari
Confidential
Eagen
Allendale County, SC Study
Barge Court Decision
Westman to Palmer Sale
Wika to Havelange
Lightle
Lightle
Hudson
AgCountry FCS
Van Vleet and Stumpf
Sook
AgCountry FCS
2006
2004
1995
2008
33.00%
33.00%
33.00%
33.00%
1
1
1
1
23.40%
27.30%
33.00%
23.00%
Average 33% Undivided Interests=
26.68%
1991
1997
1991
2004
39.50%
26.00%
20.00%
30.00%
25.00%
25.00%
25.00%
25.00%
1
1
1
1
Average 25% Undivided Interests=
28.88%
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.
20
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.
21
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?
22
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.
23
The IRS Training Manual for Appeals Officers Coursebook directs 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.
24
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.
25
Gifting with Undivided Interests
Total Donors
2
Gifting Limit=
$13,000
320 Acres
25.00%
5 Married Children
$9,000 /Acre
undivided interest reduction
Value after reduction=
Donor 1's Gift to
Donor 2's Gift to
Donor 1's Gift to
Donor 2's Gift to
10
10
10
10
$2,880,000
$720,000
$2,160,000
Recipients December 31st=
Recipients December 31st=
Recipients January 1st=
Recipients January 1st=
$130,000
$130,000
$130,000
$130,000
Total Reduced Value Gift=
$520,000
% of Reduced Value=
24.07%
Total Gift of Current Market Value=
$693,333
Undivided Interest Gifted Per Gift
0.6019%
Annual Gift with Discount=
$17,333
Total Gift/Years=
$346,667
2 Year Gifting=
$693,333
26

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