The combination of death and taxes may be both inevitable - in the form of estate tax - and very unpleasant. In the attempt to reduce estate taxes, one important goal is to determine that the value of property passing subject to the estate tax is as low as possible.
A major battleground in the valuation war is that of "discounts," amounts subtracted from some hypothetical valuation of a property in order to determine the actual value that is subject to tax. Taxpayers' experts seem to be ever more creative and aggressive in identifying new discounts and quantifying their effects. Some of the discounts sought by taxpayers are well known and rather well accepted, such as discounts for minority interests. When a claimed discount is less common, though, one cannot always count on a favorable result, as two recent cases illustrate.
At the time of his death, Eldon Auker owned three apartment complexes in Genesee County, Mich. The complexes comprised over 900 units and each included amenities such as a clubhouse, a swimming pool and tennis courts. Auker also held interests in other entities, which owned, in whole or in part, 55 additional parcels of real estate, including commercial properties, residential properties and vacant land. The IRS reached agreement with Auker's estate regarding the values of all these properties, giving effect to economic conditions in Genesee County and conditions particular to Auker's properties, such as vacancy and rental rates; they could not agree, however, on whether to apply a "market absorption discount" to reduce further these agreed values.
A "market absorption discount" reflects the fact that the market can handle only a certain quantity of a certain type of property at a given price. When a seller attempts to sell more of that type of property than the market can handle, the market is flooded, lowering the price per unit from that which would be set for a smaller quantity of the same property.
The Tax Court, in Estate of Auker v. Commissioner (May 19, 1998), determined that Auker's estate was entitled to a market absorption discount, but only with respect to the apartment complexes, which were so similar to each other in characteristics such as use, location, value, etc., that a sale of each of the properties would compete with an attempted sale of the others. Thus, such a discount (which in this particular case the court determined to be 6.2% of the value of the complexes) was appropriate. As to Auker's other properties, the court denied the discount. At least in part, the court was influenced in its decision as to those other properties by the fact that they were held in multiple entities, so that, in some sense, the same sort of hypothetical competition of a single owner's property with other property of that same owner was not present.
Our other case, Estate of Welch v. Commissioner (May 6, 1998), involved an issue that arises with some frequency, the proper impact on valuation of potential corporate taxes. It is not uncommon for an individual to own a real estate investment through a "C corporation." If stock in that corporation were sold, the individual income tax consequences would vary, depending in part on whether the sale was before or after the individuals's death; frequently, little tax would be payable with respect to a stock sale shortly after death. If the corporation were to dispose of the underlying real property, however, whether before or after the individual's death, a full corporate income tax would often be payable.
Prior to 1986, techniques existed through which this corporate tax could often be avoided. In that context, the Tax Court in 1982 ruled that, unless an actual taxable sale of the underlying property was likely to occur, a hypothetical corporate income tax could not be taken into account to any extent in valuing the stock for estate tax purposes. The Tax Reform Act of 1986 changed that background; it is now difficult, if not impossible, to avoid the corporate income tax. A buyer of stock will therefore generally apply some discount for this inherent tax, compared to the amount that would be paid for the underlying assets. Nevertheless, the Tax Court continues to stand by the "no discount" rule, even in the face of evidence that the potential corporate tax in fact has some impact on value. In Welch, the corporation's property was sold shortly after the estate tax valuation date; however, because the property was sold under threat of condemnation, the corporation qualified to "roll over" the proceeds into a new property and no corporate tax was payable at that time. On these facts, the Tax Court declined to change its longstanding rule of ignoring the corporate tax entirely.
Valuation is a factual exercise, in which the characteristics of a particular property and the quality of the appraisers of the property may be decisive. However, these cases serve as a reminder that there are lessons for each taxpayer to learn from how courts deal with others' valuation disputes.
Code section 198: * Provision allows taxpayers to elect to treat certain environmental remediation costs that otherwise would be required to be capitalized as deductible in the year paid or incurred.
* Limited benefits because it applies only to qualified environmental remediation expenses incurred with respect to geographical tracts or zones and does not apply to building-specific expenditures.
Revenue Procedure 98-17: * This provides a procedure for requesting written guidance on the tax treatment of environmental cleanup costs incurred in projects that may span several years.
* It is currently available for a two-year trial period which began on Feb. 2.