I. FRACTIONAL INTERESTS IN GENERAL 1 II. CONTROL/DECONTROL DISCOUNTING 6

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1 I. FRACTIONAL INTERESTS IN GENERAL 1 II. CONTROL/DECONTROL DISCOUNTING 6 A. Unity of Ownership Squelched Rev. Rul and its Progeny 6 B. Aggregation of Various Interests in Same Property 11 C. Stock Valuation Varies for Gross Estate and Marital/ Charitable Deduction Purposes 18 D. Control Premium 20 E. Transfers to Remove Control 23 F. Partnership Amendment after Cancer Diagnosed Allowed 29 III. FAMILY PARTNERSHIPS/RESTRICTIONS 29 A. Restrictions Outside of Chapter B. Chapter 14 Restrictions 35 IV. BUY/SELL AGREEMENT RECOGNITION 37 V. VALUATION DISCOUNTS/IMPORTS OF POST TRANSACTION EVENTS 48 M. Built In Capital Gains Tax Relevance 57 Z. Attacks On Family Partnerships 71 OO Tax Court Behavioral Presumptions Rejected 97 VI. BEST USE 106 VII. ACTUARIAL TABLES APPLICATION 108 VIII. SPECIAL FORMULAS 120 IX. APPLICATION OF PENALTIES FOR UNDERVALUATION 124 X. THE COURT'S ATTITUDE RE APPRAISAL EXPERTS 127 A. Taxpayer's Appraiser Followed In Part--Had Significant Impact on Holding 127 B. Appraiser "Carried the Day" 128 C. Taxpayer's Appraiser Ignored 129 D. Incompetent Appraiser Overlooked -- Bailed Out by New Appraiser in Tax Court 135 E. Not Appraising Second Element Up Front: Entity Securities-Hurt Taxpayer 135 F. IRS Burned by Poor Appraisal Expert 136 G. Neither IRS Nor Taxpayer's Appraiser(s) Acceptable 136 XI. IRS EXAMINATION ATTITUDES/NEW FORM 709 REPORTING 137 ALI-ABA PLANNING TECHNIQUES FOR LARGE ESTATES

2 IS VALUATION THE BEST PLANNING GAME REMAINING? Byrle M. Abbin Wealth & Tax Advisory Services, Inc. McLean, VA I. FRACTIONAL INTERESTS IN GENERAL A. Twenty percent fractional interest discount for 50% farm and homestead tenancy in common interest Decedent had a 50% interest (the balance was owned as an undivided 25% interest by each of his two children) of a farm and homestead. A considerable amount of the farm was suitable only for ranching, a significant portion was floodplain and only a portion had direct access to a paved road. His estate claimed a 25% fractional interest discount. IRS disallowed the entire discount. Its expert claimed that the farm was "ripe" for a partition and that a forced sale proceeds would result in no discount to the homestead. The Tax Court concluded that a 20% fractional interest discount should be applied to both segments of realty, disagreeing with taxpayer that partition was impossible. Rather, it concluded that partition would be difficult and would entail substantial legal costs, appraisal fees, and delay that resulted in the propriety of a 20% fractional interest discount. Estate of Cerbin v. Comm., T.C. Memo B. Gift value reflected bad economy no appreciation expectation; fractional interest discount, not partnership, controlled LeFrak owned numerous rental properties in New York. In 1976, he contributed 7.5% interests to each of four children (6.5% in others) in most of the properties, then he pooled his 70% with his children in two straight up partnerships, each one for a separate real estate parcel. All properties were heavily mortgaged; in advance of transfers, donor contributed cash so no property's value was less than the mortgage on it. The buildings, subject to over $25 million in debt, were valued at $255,000 and the gifts at $59,925 (30% or $76,500) less a minority discount. IRS asserted FMV of the buildings was $34.8 million and the gifts value $2.6 million (30% of the buildings' value $34.8 million less mortgage of $25+ million or under $9.8 million). The Tax Court determined that LeFrak gave his children fractional interests in real estate, rather than partnership interests as the LeFraks contended. Although both parties' experts agreed that the buildings should be valued based on their income-generating capacities, it rejected, however, IRS's assumption that the net income from the buildings and their value would increase in the future, relying instead on the taxpayers' evidence on the downward trend in the New York City economy and the city's rent stabilization laws. In addition, the court found that IRS's estimation of the expenses a willing buyer would expect to pay was too low. With respect to the discount for minority interests, the court pointed out that a holder of a

3 fractional interest in real estate has the power to compel partition of the property, which adds cost and delay. It rejected IRS's argument that no minority discount is appropriate when all the owners are members of the same family. The court concluded that a 20% minority discount was appropriate. Finally, the court determined that an additional 10% discount for lack of marketability was also proper, accepting the estimation of the IRS expert. LeFrak, et ux, v. Comm., T.C. Memo C. Discount for undivided interest in real estate is cost of partition. LTR D. Real estate fractional discount allowed; hazardous waste discount denied A decedent's estate was entitled to a 15% discount in the valuation of its undivided fractional interests in certain parcels of real estate, but was not entitled to a discount for a potential hazardous waste problem associated with one of the properties. In addition, the estate was not entitled to a discount with respect to the valuation of its fractional interest in certain personal property because it did not present any evidence in support of the discount. In applying the 15% discount, the court noted that the fair market value of a fractional interest in real estate could not be derived merely by applying the percentage of the interest in the whole property to the value of the whole property where evidence was presented in support of a discount. In addition, the court distinguished its decision in A. McMullen Est., 56 T.C. Memo In that case, a discount claimed in the valuation of a fractional interest in a trust was denied because the trust instrument required that the trust corpus (real property) be sold as an entire fee simple interest, whereas the trust agreement in the present case did not include such a requirement. Further, the court held that the 15% discount applied by the estate in valuing the property on the decedent's estate tax return was an admission as to the maximum discount. Therefore, the conclusion of the estate' expert at trial that a 20% discount was appropriate was rejected, absent proof that the 15% discount was wrong. In denying a discount with respect to a potential hazardous waste problem arising from underground storage tanks associated with one property, the court noted that neither the appraiser nor the estate believed that a problem existed on the alternate valuation date. Further, no evidence was presented that a hypothetical buyer would have had reason to believe that potential liability existed on the valuation date since the lessee of the property bore all costs regarding the tanks. Thus, the court concluded that the estate failed to satisfy its burden of proof as to any foreseeable liability associated with the underground tanks. E. Pillsbury Est. v. Comm., T.C. Memo E. 44% Fractional Interest Discount Decedent's one half tenancy in common of timberland was afforded a 44% discount by the Tax Court representing 20% for lack of marketability and 30% of lack of control (a seriatim discount amounting to 44%). IRS had not through its expert referenced any fractional interest discount, but conceded a 5% amount at Tax Court. The Tax Court

4 noted other fractional interest discounts were allowed, of 40% (Estate of Wildman v. Comm., T.C. Memo ) and 60% in Estate of Sels v. Comm., T.C. Memo Estate of Williams v. Comm., T. C. Memo F. No Fractional Interest Discount for Joint Tenancy with Right of Survivorship "Under the scheme of section 2040(a), the amount includable in a decedent's gross estate does not depend on a valuation of property rights actually transferred at death, or on a valuation of the actual interest held by the decedent (legal title); instead, decedent's gross estate includes the entire value of property held in a joint tenancy by him and any other person, except to the extent the consideration for the property was furnished by such other person. * * * Section 2040(a) provides an artificial inclusion of the joint tenancy property: the entire value of the property less any contribution by the surviving joint tenant. Except for the statutory exclusions in section 2040(a), there is no further allowance to account for the fact that less than the entire interest is being included. [Citation and fn. Ref. Omitted.)" Est. of Young v. Comm., 110 TC 297 (1988) cited as above for authority by Est. of Fratini v. Comm., T.C. Memo G. 20% Fractional Interest Discount Allowed: IRS Cost to Partition Theory Rejected Decedent owed 100% of six small apartment buildings and 50% in three others, all located in the Marina District of San Francisco. 2 of the 3 in which decedent held a 50% tenancy in common interest were subject to a similar ownership interest of 50% by decedent's husband's estate. Taxpayer's Form 706 filing based on expert's report: a. Discount for "blockage" (1) on 6 buildings 20% b. Discount for fractional interest on 50% ownership interest 20% Taxpayer's Tax Court Brief a. Discount for "blockage" 12.5% b. Discount for fractional interest 20.0% IRS Deficiency Notice a. Discount for blockage 1.92% b. Discount for fractional interest Cost to partition The Tax Court essentially accepted taxpayer's expert and rejected IRS' expert. It recognized that competition between the properties for buyers would result in a 6 months period to sell, but that taxpayer overstated the number of properties that would compete for sale. The court reduced the blockage discount for noncompeting properties but

5 allowed the claimed 20% discount for fractional interest. Bracato v. Comm., T.C. Memo H. Is IRS Retreating? It says cost of partition is one method to determine fractional interest discount in applying the willing seller-willing buyer concept. TAM I. Court Establishes Fractional Interest Discount as Cost to Partition. Busch v. Comm., T.C. Memo (See V.AAA) J. 25% Fractional Interest Discount For One Half Interest in 3 Real Properties The Tax Court agreed with taxpayer's approach that evaluated 3 parcels of realty based on cost, market (comparables), and two income approaches direct capitalization and discounted cash flow. The main contention at Tax Court was the aspect of fractional interest discounts. IRS' expert essentially used cost to partition of 10% for 2 parcels and 20% for a third that was of small size. Taxpayer's experts proposed FID as follows: Parcel Primary Expert Secondary Expert A. K-Mart 35% 35.4% B. Walgreen 30% 35.4% C. Wells Fargo 35% 35.4% The Tax Court allowed 25% FID for all 3 properties "we do not limit the discount to the costs of partitioning because such a discount does not account for the factors of control and marketability in the circumstances of this case. An interest in income-producing, improved real property without control and in a closely held family property may be difficult to sell." Est. of Stevens v. Comm., T.C. Memo II. CONTROL/DECONTROL DISCOUNTING A. Unity of ownership squelched Rev. Rul and its progeny 1. Family's degree of control not considered in valuing stock transferred to family members IRS ruled that the extent of a family's control over a corporation should not be considered in determining the value of stock interests transferred from one family member to another for gift tax purposes. Under the facts of the ruling, a parent

6 owned all of the outstanding shares of a corporation with a single class of stock. He subsequently transferred his entire interest to his five children, giving each child 20% of his shares. Based on Bright, Popstra and Andrews, IRS ruled that when a donor transfers shares in a corporation with a single class of stock to other members of his family, the shares will be valued for gift tax purposes without regard to the family relationship of the parties. In so ruling, it substituted its acquiescence for the nonacquiescence in the Tax Court's decision in Estate of Lee v. Comm., 69 TC 860 (1978); and it revoked Rev. Rul , CB 187. Rev. Rul , IRB Rev. Rul overwhelmingly approved in detail! An individual owned 100% of a corporation's sole issue of common stock. He transferred the entire block by making equal gifts of 9+% to each of his 11 children. The IRS field office had questioned whether this should not be treated as a simultaneous gift of the entire block, as it would be for federal estate tax determination, i.e., an aggregation on a unity of ownership theory. In a technical advice, the IRS National Office strongly reiterated that each gift is to be considered separately and not aggregated based on all of donor's holdings immediately before the gift. Thus, application of discounts for lack of control or marketability are to be determined in connection with each separate gift to each donee, based on Rev. Rul In the advice, IRS made a lengthy review of the history, going back 50 years, on discounts for minority blocks in gifts made to family members. In many respects, it supplants as an expository interpretation of minority block gifts and the valuation thereof. Its analysis is based on what a willing buyer would pay a willing seller and the fact that whether donees are family members or not is without effect, that price based on a unity of ownership approach is just inappropriate in making a valuation determination for lifetime gifts. It is not a factor in valuing a block or deciding whether a separate gift is subject to a minority discount. LTR Minority block transferred subject to discount recipient's block ignored (100% ownership occurred as a result of the bequest) The parent owned 48.59% of a corporation's stock, and his son owned the balance of 51.41%. Decedent's will bequeathed all of his stock to his son who then owned the entire 100%. IRS, following Rev. Rul , CB 202, did not apply the unity of ownership concept. Rather, it ruled that a minority discount cannot be disallowed solely because the decedent's interest transferred to the recipient, when aggregated with the transferee's block, would be controlling. A willing buyer would pay a willing seller at the moment of death for the actual shares involved that were a minority block, i.e., that passing from decedent. Neither the relationship of the legatee to decedent nor his control after the blocks were joined together to represent sole ownership were proper consideration for federal estate tax valuation. IRS did note that, in this technical advice, the percentage of minority interest includible in decedent's gross estate could affect