Discounts for layered interests?
The taxpayer treated the transfer of the 50% GP interest to AFLP as an assignee interest, largely because the other 50% owner hadn’t given consent. Under Minnesota law, because an assignee would only have rights to the profits—and no management control—the taxpayer’s expert, as a preliminary matter, discounted the interest by 5%.
But the AFLP partnership resolution treated the transfer as one of all the taxpayer’s rights and interests, the IRS pointed out. Further, as AFLP’s sole GP, the taxpayer was essentially in the same management position whether she transferred a GP or assignee interest. The substance of the transfer should trump its form, the IRS argued. The court agreed, finding that the taxpayer funded AFLP with a 50% GP interest.
To determine a combined discount for lack of marketability and control for the 50% GP interest, the taxpayer’s expert examined comparable data from sales of 17 registered real estate limited partnerships (RELPs), which established a range of 22% to 46%. But then, “without explaining further,” according to the court, the expert applied a 40% combined discount to the 50% interest.
The IRS expert believed that because the 50% GP interest was “simply an asset of AFLP,” the discounts he applied at the entity level obviated the application of discounts to the particular 50% interest. But in an interesting footnote, the court observed that in previous cases, the IRS (as well as the Tax Court) had applied layered discounts when a taxpayer held a minority interest in an entity that in turn owned a minority interest in another entity. “The 50-percent. . . interest constituted less than 16% of AFLP’s [net asset value] and was only 1 of 15 real estate investments” that AFLP held at the time of the transfer, the court said. Lack of control and lack of marketability discounts at both the entity and shareholder levels were appropriate.
The court eliminated four of the RELP comparables selected by the taxpayer’s expert because their data came from the wrong year. The remaining data showed trading discounts of 30% to 36%, and a 1997 sample of 130 RELPs ranged from 28.7% to 30%. The court thus concluded that a 30% combined discount applied to the 50% GP interest, valued at nearly $1.3 million.
LP discounts turn on selected comparables
In determining discounts for the gifts of LP interests, the taxpayer’s expert examined four RELP comparables, with trading discounts that ranged from 40% to 47%. He ultimately applied a lack of control discount of 45% for the first gift year (1996) and 40% for the second (1997).
But his RELP comparables were “significantly more leveraged” than AFLP, according to the court. Moreover, because AFLP’s cash distribution rate was significantly higher than the average RELP comparable’s, the court found that the discount should have been even lower than the 38% observed average. The RELP comparables were “too dissimilar” to AFLP to warrant the expert’s reliance, it ruled, and his combined discounts were “excessive.”
By contrast, the IRS expert examined comparable sales of REITs (Real Estate Investment Trusts). The abundance of data was more reliable, he said, and any differences between REITs and the FLP interests could be minimized by “backing out” any liquidity premiums from the REIT sales price, resulting in lack of control discounts. REITs generally traded at a 7.79% liquidity premium over private real estate partnerships, the expert said. Combining this with the 1996/1997 trading data, he arrived at a lack of control discount for the LP interests of 7.14% in 1996 and 8.34% in 1997.
A good method misapplied
The court agreed with the IRS expert’s method but held that, on their face, his discounts appeared unreasonably low. Moreover, other studies cited by the same expert suggested that the applicable liquidity premiums were nearly two times the levels he used.
A better method, the court said, was to look at the difference in average discounts observed in private placements of registered and unregistered stock, since a public market is available to the former but not the latter. This difference amounted to approximately 14%, according to a study cited by the IRS, resulting in a general liquidity premium of 16.27%. After backing out this premium from the median REIT trading data and making other adjustments, the court arrived at a lack of control discounts of 16.17% and 17.47% for the respective LP gifts.
As a final matter, the Tax Court compared the taxpayer’s 15% marketability discount for the 1996 limited partnership gifts to the IRS’s 21.23% and saw “no reason” not to adopt the higher discount. The court also adopted the parties’ stipulated 22% marketability discount for the 1997 gifts and adjusted its findings accordingly.
Astleford v. Comm’r (T.C. Memo 2008-128, May 5, 2008)
