In 1996, Mrs. Astleford formed the Astleford Family Limited Partnership (AFLP) to own and develop interests in real property, as well as facilitate gifs to her three adult children. She gave each of the children a 30% limited partnership (LP) interest, with no voting rights or capital requirements, while she remained a 10% general partner (GP), controlling the assets.

After initially funding AFLP with real property worth nearly $1 million, in 1997 Mrs. Astleford transferred 3,000 acres of land, including 1,187 acres of farmland that she held through a 50% GP interest in a development company. She gifted additional LP shares to her children to keep the 30-30-30 ownership configuration of AFLP, while staying on as 10% GP.

Upon audit of her 1996 and 1997 federal gift tax returns, the IRS found higher fair market values for the transferred properties and a higher net asset value (NAV) for the partnership. The IRS also decreased some of the discounts related to the gifted LP interests. Through various stipulations, the parties disputed only three issues at trial: 1) the fair market value of the farmland; 2) whether the 50% interest in the development company was as a GP or assignee interest; and 3) the applicable discounts.

'Market absorption' discount appropriate?

The taxpayer's real property appraiser considered the 1,187-acre farm property to be "extraordinarily large and unique," worth nearly $3.7 million. But its sale would flood the local market, he believed, reducing the price and requiring a market absorption discount. Assuming the property would sell over the four years, appreciating 7% per year -- and using a 25% discount rate to present-value the expected cash flows -- the expert's final fair market value came to $1,817 per acre, or $2.16 million total.

The IRS appraiser examined 125 Minnesota properties, ultimately selecting two comparables to value the AFLP farmland at $3,500 per acre, or nearly $4.16 million total. The IRS expert omitted a market absorption discount; the development company originally purchased 1,187 acres in a single transaction, he said, so it could also sell the entire tract. In the alternative, he argued that a 25% present-value discount rate was excessive, when a 1997 Minnesota study showed farmers earning an average rate of return of 9.2%.

The Tax Court credited the IRS expert with a "unique knowledge" of the area and adopted his $3,500 per-acre value. But it also applied a market absorption discount based on the 9.2% rate of return, rounded up to 10% and applied over four years -- which returned $2,786 per acre, or a total fair market value of $3.31 million. Read more

Is a 35% Minority Discount Appropriate in a Statutory Buyout of a Real Estate Partnership?

Here is yet another case in which the parties might have saved substantial effort and expense if their partnership agreement had included a buy-sell clause, providing direction on the standard of value and the application of discounts. Instead, because state law (Louisiana) permitted a factual determination of minority discounts in a partnership buyout case, the trial court faced widely divergent sources and expert opinions.

Expert discounts range from 0% to 80%

A partner who owned a one-third interest in a partnership that harvested and sold timberland wanted to withdraw, but he and the remaining partners were unable to agree on a buyout price, forcing a judicial determination of his interest.

At trial, both sides presented a professional forester appraiser to value the partnership's 562 acres of timber. Each party also presented a CPA/valuation expert to value the total partnership assets. From the competing evidence, the trial court determined that the gross value of the partnership was $1.05 million, and the plaintiff's one-third interest was $351,456.

To this value, the partnership urged the court to apply a combined discount for lack of control and lack of marketability, calculated by its expert to equal nearly 80%. It relied on a 1989 state Supreme Court precedent that permitted courts to use discounts as a broad, discretionary "tool" when determining the fair market value of a withdrawing partner's share. In that case -- which also valued a real estate partnership -- the court applied a 33% minority discount. The partnership also cited a 1994 pricing study of limited partnerships, which found an average 38% minority discount for partnerships traded in the private, secondary market. Read more

Tax Court Takes Novel Approach to DLOM Holding Period

The IRS has aggressively -- and for the most part, effectively -- challenged the efficacy of Family Limited Partnerships (FLPs) as tax avoidance devices, particularly through the application of Internal Revenue Code (IRC) §2036(a). Now, with the Tax Court's binding opinion in Holman v. Commissioner, the IRS has resurrected IRC §2703, regarding transfer restrictions, in its scrutiny of FLPs. Moreover, the court addresses discounts for lack of control and lack of marketability -- including an interpretation of the holding period component in these determinations.

Four reasons for formation

The Holmans -- husband and wife -- formed the Holman Limited Partnership (HLP) on November 2, 1999, funded with $2.8 million of Dell Computer stock. Six days later, they gifted limited partner (LP) interests to each of their four children. The Holmans made smaller gifts of Dell stock to HLP in 2000 and 2001, each time causing reconfiguration of the partnership so that by 2001, they owned just over 12% as general and limited partners, while the remaining LPs owned nearly 88%. Given the overriding reasons for forming the HLP -- asset protection and educating the children on wealth management -- the partnership agreement included substantial restrictions on the transfer of LP shares, including a "buy-back" provision in the event of a non-permitted transfer.

On their gift tax returns for each of the three transfers, the Holmans relied on an independent appraisal, which applied an overall 49.25% discount to the value of the LP transfers. The IRS challenged the transfers, claiming that the first (1999) was an indirect gift; that §2703 voided the transfer restrictions; and that all the discounts were excessive. Read more

Failure to Present Goodwill Value Proves Fatal for Damages Claims

It's hard to tell what went wrong in this California case -- whether the attorney and/or the financial expert failed to tie the damages calculations to the discrete causes of action, so that the jury could clearly allocate liability to the various claims. What is clear: The opinion, although unpublished, offers a good reminder how important it is for attorneys and experts in lost profits/lost business cases to communicate often regarding the issues and the applicable law on damages calculations.

Same name -- very different company

The defendents began a messenger service, Quick Pick Express, Inc., with one employee. Over thirteen years, they developed it into a four-division company with annual sales of $4 million? When the defendants decided to sell, the plaintiffs/buyers reviewed the balance sheets and profit and loss statements, which appeared to present a "well-established, growing, profitable company with a capable management team." The plaintiffs agreed to buy the company for $1.5 million (mostly in cash, and the remainder by a note payable). The new owners retained the name but reorganized the company as an LLC.

Shortly after taking over, the plaintiffs discovered that the prior owners had misrepresented the company's financial health. Several creditors demanded payment on unpaid invoices; $200,000 of the accounts receivable turned out to be uncollectible; and, significantly, the largest account in the company's trucking division was about to terminate its contract -- worth almost $480,000 in annual sales.

The plaintiffs stopped payment on the note and sued for breach of contract, concealment and misrepresentation, claiming damages over $5.5 million. During a jury trial, the plaintiffs presented a forensic accountant, who -- rather than assign specific damages to the different causes of action -- allocated them to three distinct categories: 1) one-time out-of-pocket costs and lost assets; 2) lost profits, based on the "benefit of the bargain" theory (i.e., the plaintiffs were entitled to what they paid for); or, alternatively, 3) lost value, or the difference between what the plaintiffs paid for and the actual value of the company's assets.

The expert claimed out-of-pocket damages of $283,812, based on the overstated accounts receivable and unanticipated costs -- such as creditors' claims and unpaid bills. For his lost profits calculations, he examined financial statements, adjusted for the "true" revenues and expenses of the company, and then calculated the difference between the profit shown on the defendents' financials and the adjusted financials. Because he believed the business would continue to lose profits, he calculated lost profits (using a net present value for future losses) for periods of five, seven and ten years. Totaled, these damages amounted to over $2 million.

Moreover, because the company had no historical profit record or proven capacity to make profits, the expert explained, it had zero goodwill value (which he defined simply as "the ability to make money"). The company's only value lay in its collectible accounts receivable and tangible assets. After calculating these values and subtracting them from the $1.5 million purchase price, he arrived at a lost business value of nearly $1.15 million. Read more