T.C. Memo. 2000-53

UNITED STATES TAX COURT

ESTATE OF EILEEN KERR STEVENS, DECEASED,

 DAMON R. STEVENS, EXECUTOR, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 22643-97. Filed February 18, 2000.

David W. Hettig and Michael E. Klingler, for petitioner.

Steven Walker, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

GERBER, Judge: Respondent determined a deficiency in

petitioner’s Federal estate tax in the amount of $114,722. The

deficiency arose in connection with the valuation of undivided

interests in real property held by decedent’s estate. The

parties have settled some issues, including the fair market value

of two of the three properties at issue. The remaining issues we
- 2 -

consider concern the fair market value of one of the properties

and the discounts, if any, to be applied to each of the three 50-

percent undivided interests in real property held by decedent’s

estate and at issue here.

FINDINGS OF FACT

The stipulation of facts and the exhibits attached thereto

are incorporated herein by this reference.

Eileen Kerr Stevens (decedent) a resident of Santa Clara

County, California, died testate on September 7, 1993 (valuation

date). Before her death, she had been married to Roy Stevens.

The couple had four children, one of whom predeceased decedent.

One of those children, Damon Stevens, is the executor of

decedent’s estate. At the time of filing the petition Damon

Stevens resided in Santa Clara County, California.

Roy Stevens predeceased decedent on May 4, 1980, and through

his will, created the Roy Stevens Testamentary Trust (the Trust)

with decedent as trustee. As trustee, decedent had been given

the power to conduct business for the Trust, including the

authority to partition the Trust property if necessary. Decedent

was entitled to the entire net income of the Trust, as well as

any principal necessary for her “proper support, care and

maintenance” for her life. The Trust continued after decedent’s

death for the benefit of the Stevens children. The Trust and a

subsequent trust created by decedent both were to be terminated
- 3 -

and any remaining assets of the trusts distributed when the

youngest living Stevens child reached the age of 30.

At the time of decedent’s death, decedent and the Trust each

owned, as tenants in common, a one-half interest in the following

properties: (1) 5100 West 123d Street, Alsip, Illinois (Kmart

property); (2) 333 El Camino Real, San Bruno, California

(Walgreen property); and (3) 4540 El Camino Real, Los Altos,

California (Wells Fargo property). Decedent and her husband had

been jointly engaged in the business of developing, managing, and

leasing real estate, and these properties were purchased in

furtherance of that business. Each of the properties is

discussed in detail below.

Kmart Property

In 1980, decedent and her husband purchased the land and

improvements on the Kmart property. The 1,203,000-square-foot

site included a 464,818-square-foot, single-story warehouse, with

an office, a cafeteria, and a lounge, built in 1971. The

building was in good condition. In 1977, decedent and her

husband agreed to lease the property to Kmart Corp. for 20 years,

commencing on May 1, 1977. The lease rate was $1.19 per square

foot with no rent escalation clause in the lease. At the

valuation date, the market lease rate was $2 per square foot,

making the Kmart rental rate 40 percent below market. There was

an option to extend the lease for another 10 years and three more
- 4 -

successive options, each for 5 years, with no rent escalation. 

The lease was a triple-net lease, which meant there was no cost

to the owners of the property because Kmart paid all of the

operating costs of the building.

In 1991, Kmart wished to purchase the parking lot adjacent

to the Kmart property. The owners of the property refused to

sell the lot without the permission of the owners of the Kmart

property; namely, decedent and the Trust. The lease was amended,

granting consent to the purchase and extending the lease term by

10 years. This resulted in a lease extension to the year 2007 at

the same rental rate, leaving 14 years of the lease remaining at

the time of decedent’s death. The lease amendment also provided

another option to extend for an additional 10 years after the end

of the three successive 5-year extension options. The rental

rate for that second 10-year option was to be 90 percent of the

market rate at that time. 

Within a few months of decedent’s death in 1993, petitioner

engaged an appraisal company, Realty Consultants USA, Inc., to

perform an appraisal of the Kmart property (Realty appraisal or

estate appraisal). That appraisal was used to report the value

of the property for estate tax return purposes and for the

modification of the mortgage, which modification was completed in

1994. Decedent’s estate tax return valued the Kmart property in

its entirety at $5,300,000. The mortgage modification triggered
- 5 -

a $60,000 prepayment penalty and created a new “lock-in”

provision that prevented the newly modified loan from being paid

off in the first 5 years. At the time of the modification, the

property owners had no indication that the Kmart lease would not

continue for the remaining 14 years.

In June 1996, a real estate broker informed the owners that

Kmart wanted to move out of the property and attempt to sublease

it. In November 1996, the Kmart owners signed an agreement to

sell the entire Kmart property, including the adjacent parking

lot, to Security Capital Industrial Trust (Security Capital) for

$8,250,000. A few weeks later, Kmart agreed to sell the adjacent

parking lot to the Kmart property owners for $350,000. On the

same day, the Kmart property owners terminated the Kmart lease,

paying a $150,000 lease termination fee to Kmart Corp. The sale

of the Kmart property to Security Capital was completed in

January 1997. 

Walgreen Property

Decedent and her husband purchased the Walgreen property in

1968. The Walgreen property is a 57,106-square-foot site, with a

25,560-square-foot, single-story, commercial building on it,

built in 1972. The building was in average condition at the time

of decedent’s death. The building fronts a heavily traveled

arterial street and is located in a commercial/retail complex in
- 6 -

San Bruno, California, which is approximately 8 miles from San

Francisco.

In 1992, decedent and the Trust agreed to a 35-year lease to

Walgreen Co., a pharmacy/retail business, to commence in 1993. 

At the time of decedent’s death, there were approximately 34

years remaining on the lease.

The parties agree that the fair market value of a 100-

percent interest in the Walgreen property was $2,670,000 as of

the valuation date.

Wells Fargo Property

Decedent and her husband owned the Wells Fargo property at

least since 1977. The Wells Fargo property is a 14,400-squarefoot site, with an 8,051-square-foot, single-story, commercial

building on it, built in 1978. The building was in very good

condition at the time of decedent’s death. The property is

located in a commercial/retail complex and fronts a heavily

traveled arterial street in the city of Los Altos. Los Altos is

approximately 30 miles from San Francisco.

In 1977, decedent and her husband agreed to a 25-year lease

to Wells Fargo, a retail banking operation, to commence in 1978. 

At the time of decedent’s death, approximately 10 years remained

on the lease. The lease was a triple-net lease, meaning that the

property owners bore none of the operating costs.
- 7 -

1 Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect as of the date of decedent’s

death, and all Rule references are to the Tax Court Rules of

Practice and Procedure.

The parties agree that the fair market value of a 100-

percent interest in the Wells Fargo property was $987,950 on the

valuation date.

OPINION

For Federal estate tax purposes, property includable in the

gross estate is generally included at its fair market value on

the date of decedent's death. See secs. 2031(a) and 2032(a);

sec. 20.2031-1(b), Estate Tax Regs.1 Fair market value is

defined as the price that a willing buyer would pay a willing

seller, both persons having reasonable knowledge of all relevant

facts and neither person being under a compulsion to buy or to

sell. See sec. 20.2031-1(b), Estate Tax Regs.; see also United

States v. Cartwright, 411 U.S. 546, 551 (1973); Mandelbaum v.

Commissioner, T.C. Memo. 1995-255, affd. without published

opinion 91 F.3d 124 (3d Cir. 1996). The willing buyer and the

willing seller are hypothetical persons, instead of specific

individuals and entities, and the characteristics of these

imaginary persons are not necessarily the same as the personal

characteristics of the actual seller or a particular buyer. See

Estate of Bright v. United States, 658 F.2d 999, 1005-1006 (5th

Cir. 1981). Fair market value is a factual determination for
- 8 -

which the trier of fact must weigh all relevant evidence and draw

appropriate inferences and conclusions. See Commissioner v.

Scottish Am. Inv. Co., 323 U.S. 119, 123-125 (1944).

Real estate valuation is a question of fact to be resolved

on the basis of the entire record. See Ahmanson Found. v. United

States, 674 F.2d 761, 769 (9th Cir. 1981); Estate of Fawcett v.

Commissioner, 64 T.C. 889, 898 (1975). After determining the

gross value of the property, there may be adjustments upward or

downward for such factors affecting value as minority discounts,

discounts for lack of marketability, control premiums, and

fractional interest discounts. See Estate of Andrews v.

Commissioner, 79 T.C. 938, 953-956 (1982) (minority discount);

Estate of Piper v. Commissioner, 72 T.C. 1062, 1084-1086 (1979)

(discount for lack of marketability for stock); Estate of

O’Keeffe v. Commissioner, T.C. Memo. 1992-210 (blockage discounts

for works of art); Estate of Salsbury v. Commissioner, T.C. Memo.

1975-333 (control premiums).

Valuation is an inexact process. See Buffalo Tool & Die

Manufacturing Co. v. Commissioner, 74 T.C. 441, 452 (1980). As

the trier of fact, we may use experts to assist in deciding upon

a value, but we are not bound by those experts’ views or

opinions. See Silverman v. Commissioner, 538 F.2d 927, 933 (2d

Cir. 1976), affg. T.C. Memo. 1974-285; Chiu v. Commissioner, 84

T.C. 722, 734 (1985). One expert may be persuasive on a
- 9 -

particular element of valuation, and another expert may be

persuasive on another element. See Parker v. Commissioner, 86

T.C. 547, 562 (1986). Consequently, we may adopt some and reject

other portions of expert reports or views. See Helvering v.

National Grocery Co., 304 U.S. 282 (1938).

There are generally three kinds of valuation methods used to

determine fair market value of real property: (1) The comparable

sales method, (2) the income method, and (3) the cost method. 

See Marine v. Commissioner, 92 T.C. 958, 983 (1989), affd.

without published opinion 921 F.2d 280 (9th Cir. 1991).

Property Valuation

Petitioner is attempting to show that the fair market value

of the Kmart property is $5,300,000, the same amount that was

used to compute the value reported on the Estate’s tax return. 

Petitioner’s primary trial expert reviewed the appraisal used in

connection with the estate tax return. He relied heavily on the

two income approach methods of valuation and calculated a

$5,300,000 fair market value for the Kmart property. 

Respondent’s expert used one of the income approach methods and

the comparable sales approach. His approaches resulted in fair

market values ranging from $5,700,000 to $6 million. Finally,

petitioner’s rebuttal expert reviewed respondent’s expert’s

report and concluded that the fair market value was just over

$5,400,000.
- 10 -

The estate appraisal used the cost approach, the market

approach, and two of the income approach methods, the direct

capitalization method and the discounted cash-flow method. 

Norman C. Hulberg, petitioner’s primary expert, opined that the

estate appraisal was sound. His report mainly focused on the two

income approaches.

The direct capitalization approach is based on estimates of

potential gross income that might be expected from the rental of

real estate and any possible losses and/or expenses that might be

incurred by the owner/lessor. In the direct capitalization

approach, the estate appraiser converted 1 year’s projected

rental income into a value by dividing adjusted income by an

income capitalization rate. The capitalization rate, which is

market derived, represents the relationship between net operating

income and value.

Using comparable leased properties with rental rates between

$1.72 and $3.25 per square foot, the estate appraiser opined that

like property would rent for approximately $2 per square foot. 

The rental rate was affected by the fact that the market for

older properties, such as the Kmart property, was relatively soft

at that time due to the availability of newer properties in the

area. The actual rental rate in the Kmart lease was $1.19 per

square foot. The holding period for this type of property is

usually 10 to 15 years, although the actual holding period of
- 11 -

this leased interest was 20 years, with a 10-year option that had

been exercised and three 5-year options remaining. One real

estate investors’ survey, the Peter F. Korpacz National Investor

Survey, Third Quarter 1993, reported that the average going-in

capitalization rate on industrial properties such as this was

9.55 percent. The CB Commercial National Investor Survey for the

2d Quarter 1993 in the “Warehouse/Distribution” category,

reported a going-in capitalization rate of 9.8 percent. Because

the property had a highly credit-worthy tenant with a long-term

lease, Hulberg increased the rate slightly to 10 percent. The

estimated net operating income (NOI) of the subject property was

then divided by this rate. Because the property owners bear no

costs beyond their management, the $1.19 rental rate was reduced

to $1.17 per square foot to reflect the management fee, resulting

in an NOI of $542,081. The resulting property valuation would be

$5,420,810.

The second element of petitioner’s income approach valuation

is a discounted cash-flow analysis. Under this approach, the

value of the property is equal to the present value of the future

cash. The owner also possesses a reversionary interest at the

end of the holding period. The rate used to discount the

projected cash-flows and eventual reversionary interest takes

into consideration the inherent risks of real estate ownership

and competitive alternative investments. The estate appraiser
- 12 -

used an 11-percent discount rate, based on the national investor

survey averages along with a 3-percent property reversion rate.

Applied to the NOI, the resulting value under the discounted

cash-flow method is $5,100,000.

The appraiser then compared the two values and, giving

somewhat heavier weight to the direct capitalization method due

to the relatively flat income stream, reached a $5,300,000 value. 

As further support for the estate appraisal value, Hulberg

calculated the cash-flow of the Kmart lease through 2022. The

present value, using a 10-percent discount with a 2-percent

management fee expense, resulted in a value of $5,106,000.

Hulberg then calculated the reversion value of the property at

the 2022 projected end of the lease. Assuming that the 51-year

old building would have a terminating useful life, Hulberg used

the 1993 appraisal value, appreciated the property using a 2-

percent inflation factor, and deducted demolition costs (at $2

per square foot) and sales expenses, yielding a net land value of

$1,678,000. Finally, using a 10-percent present value discount

rate, the land value would be $106,000, which when added to the

cash-flow figure results in a proposed $5,212,000 value.

Respondent’s expert, John A. Thomson, used the discounted

cash-flow method (income approach) coupled with a comparable

sales approach. To determine the appropriate discount rate for

the discounted cash-flow method, Thomson did not look to rates of
- 13 -

return from similar rental real estate, as Realty and Hulberg

did. Instead, Thomson looked at alternative investment rates for

investments of a certain level of risk. Relying on Kmart’s

creditworthiness, he determined that long-term debt instruments

of Kmart are ranked by Moody’s Corporate Bond ratings in the

various “A” classifications. “A” corporate bonds had a rate of

7.05 percent in September 1993, while “Baa” corporate bonds had a

7.34-percent rate. Adjusting for an existing 40-percent belowmarket lease contract rate and the illiquidity of the leased

property, Thomson derived a 9-percent discount rate to apply to

rents through 2022. The lease rate increases to 90 percent of

market in 2023 through 2032, but because of the additional risk

of no longer having a significant rent advantage and having an

older building, Thomson increased the rate to 12 percent. These

discount figures result in a present value of the cash-flow of

$5,936,335.34.

Then assuming the building will have a $71,910.40 residual

economic value beyond 2032, Thomson added this to the cash-flow

value reaching a $6,008,245.34 value for the Kmart property.

Thomson also used a comparable sales approach to value the

Kmart property. He used three of the four properties that the

estate appraiser had used and arrived at the same undiscounted

value of $9 million before discounting for the below-market lease

rate on the property. Thomson and the estate appraiser used the
- 14 -

$2-per-square-foot market rental rate and calculated an annual

rent loss of $376,502.58. The estate appraiser had used a 10-

percent discount rate, equal to the discount rate used in its

direct capitalization method and 1 percentage point lower than

the rate used in the discounted cash-flow method. Thomson, on

the other hand, discounted the rental loss at 11 percent, 2

percentage points above his discount rate on the income stream

and increased it to 14 percent for the portion of the lease

between 2023 and 2032. This resulted in a value of $5,700,000.

Petitioner’s second expert, Morgan W. White (White),

presented a rebuttal of Thomson’s report/opinion. While White

acknowledged that direct capitalization was an accepted

methodology for valuing investment property, he chose not to use

it in this situation due to the type and length of lease,

specifically a long-term, flat-rate lease. Instead, White

followed Thomson’s method and evaluated the property using the

discounted cash-flow method.

White criticized Thomson’s choice of discount rates because

of the heavy reliance on the lessee’s high credit rating and

failure to recognize the long-term illiquidity and end-value

uncertainty. Instead, White concluded that the discount rate for

this type of investment calls for a premium to compensate the

lessor. He used a 3-percent premium for the first portion of the

lease. Using Thomson’s “Baa” bond rate of 7.34 percent as
- 15 -

representative of what Kmart’s 29-year bonds would trade at in

the open market, the addition of the premium would result in a

rate of 10.34 percent. Then, as Thompson had, White applied a

higher rate to the second portion of the lease, extending from

2023 to 2032. He chose a 13-percent rate to reflect the high

uncertainty surrounding the financial viability of the property

so far into the future, the difficulty of re-leasing a large,

aging facility for any brief remainder of its life and the high

likelihood of having to make significant capital improvements in

order to do so. While saying that he thought that, in all

likelihood, only the land would have any value and that

significant costs would be attached to necessary capital

improvement at the lease’s end, White accepted Thomson’s residual

value of $71,901 to be “as good a guess as anyone’s”. White

calculated a gross value of $5,408,784 for the Kmart property.

Although the 1997 sale reflects the value of the property at

that time, it is not close enough in time, and it depended on

information that was unknown and unforeseeable at the time of

decedent’s death. The termination of the Kmart lease, inclusion

of the parking lot property, and penalties for early loan payoff

were all factors that were not under consideration on September

7, 1993. We cannot consider unforeseeable future events that may

affect the value of property at a later date. See sec.

20.2031-1(b), Estate Tax Regs.; see also Estate of Newhouse v.
- 16 -

Commissioner, 94 T.C. 193, 218 (1990); Estate of Gilford v.

Commissioner, 88 T.C. 38, 52 (1987). The owners decided to

refinance the property in 1994, even though a penalty was due and

a strict prepayment restriction was added to the modified

mortgage. This would indicate that there was no intention on the

owners’ part to sell at any time soon after the modification was

completed. For this reason, we do not consider the 1997 sale

price.

Both parties used acceptable methodologies for valuing the

subject property. Although the methodologies were appropriate,

we do not agree in all respects with the manner in which they

were applied. With respect to the Kmart property valuations, we

tend to favor petitioner’s applications. The use of the bond

return by respondent’s expert is less reflective of the belowmarket return to be expected from the lease. Comparable real

estate investment returns are more appropriate here. In

addition, we disagree with Thomson’s manipulation of the rates to

cause a higher discount rate for the rental loss. Thomson’s

approach resulted in a higher value favoring respondent but was

without explanation for differing discounts for simultaneous

monetary events.

Moreover, Thomson did not explain his reasons for concluding

that the life of warehouse would exceed 60 years and therefore

have a residual value at the end of the Kmart lease. We accept
- 17 -

petitioner’s data that indicates that warehouses in good or

excellent condition, as the Kmart property is, are estimated to

have economic lives of approximately 50 years. Assuming a 45- to

50-year life for the Kmart improvements, Thomson was overly

optimistic to conclude that the building would have useful life

value. We also accept petitioner’s data that indicate that

demolition costs average $2 per square foot. Using Thomson’s

estimated values of $6 million and $5,700,000, then deducting the

costs of demolition at $2 per square foot, the result would be

lower than petitioner’s claimed value of $5,300,000.

Petitioner, on the other hand, presented evidence of

generally consistent values for the property, using four

different methods. The comparable sales approach used in the

Realty appraisal and approved of by Hulberg, yielded a value of

$5,200,000. The income approach methods yielded values of

approximately $5,420,000 and $5,100,000. As a further crosscheck, Hulberg calculated the present cash-flow of the Kmart

lease through 2022, using a 3-percent reversion rate for the

land, a 10-percent discount rate for the income stream and the

net land value, and deductions for the demolition costs and sales

expense, resulting in a fair market value of $5,212,000 for the

property. Throughout all of these different valuation methods,

petitioner’s experts consistently used discount rates within 1

percentage point of each other. Discount rates between 10
- 18 -

percent and 11 percent, such as those that petitioner’s experts

used, are supported by the national real estate investors’

surveys at the time of decedent’s death. Furthermore,

petitioner’s experts did not attempt to manipulate rates to

produce inconsistent, yet favorable, discounts on income and loss

from the same period within a single valuation method. For these

reasons, we sustain petitioner’s reported fair market value and

hold that the value of the Kmart property at the date of

decedent’s death was $5,300,000.

Discounts

Discounts to the fair market value of property may be

appropriate to reflect a lack of control and/or a lack of

marketability. A lack of control is the inability to change

corporate or business attributes. See Estate of Casey v.

Commissioner, T.C. Memo. 1996-156. The owners here are all

family members, but it cannot be assumed that a family will

always act as a unit in matters regarding the property. See 

Citizens Bank & Trust Co. v. Commissioner, 839 F.2d 1249, 1253

(7th Cir. 1988). Generally, there is no ready market for a

partial interest in a closely held property and that lack of

marketability causes a reduced liquidity. See Estate of Casey v.

Commissioner, supra. The need for employing a discount is

dependent on whether a decedent’s partial interest would affect

the marketability of a property. See Propstra v. United States,
- 19 -

680 F.2d 1248 (9th Cir. 1982). Petitioner bears the burden of

showing that a discount is appropriate and the amount of any

discount. See Rule 142(a); Estate of Van Horne v. Commissioner,

78 T.C. 728 (1982), affd. 720 F.2d 1114 (9th Cir. 1983).

The parties provided experts’ opinions regarding the

appropriate discounts for the three properties. Petitioner’s

primary expert used a variety of methods, including a survey of

companies purchasing and selling partnership interests, a 10-

factor fractional interest analysis, and a comparable sales

approach. The three methods resulted in similar discount

amounts, ranging between 29 percent and 35 percent. Petitioner’s

expert concluded that the appropriate discounts were as follows: 

Kmart property–-35 percent, Walgreen property--30 percent, and

Wells Fargo property--35 percent. Petitioner’s rebuttal expert

reviewed respondent’s expert report on the Kmart property and

opined that the discount for that property should be 35.4

percent. Respondent’s expert looked only at the cost to

partition the properties, then increased the amount of the

discounts for unspecified costs. His report opined that the

discounts should be as follows: Kmart property-–10 percent,

Walgreen property--10 percent, and Wells Fargo property--20

percent.

Accordingly, respondent, through his expert, agrees that

some discount is appropriate. Thomson calculated the partition
- 20 -

costs of the three properties to be between $30,000 and $40,000

if no trial were necessary and between $90,000 and $120,000 if a

trial were necessary. He estimated these costs to be 3 to 4

percent of his estimated value of a one-half interest in the

Kmart property. Without a clear explanation of the increase,

Thomson increased his estimation of the partition cost discount

to 10 percent for the Kmart property, rounding up to an estimated

partitioning cost of $300,000. He applies the same 10-percent

discount to the Walgreen property interest, rounding up to an

estimated partitioning cost of $135,000, and explains the

difference in partitioning costs of the Kmart property and the

Walgreen property by stating that partitioning costs increase

with the size of the property. He increased the discount amount

of the Wells Fargo property to 20 percent, reasoning that the

discount is increased due to the cost of partitioning relative to

the lesser value of the Wells Fargo property.

Thomson concluded that the need to discount for control or

marketability is minimized because partitioning would cure any

control problem. He does include, but does not apply,

information on limited partnership discounts at the time of the

valuation date. The range of the rates is between a premium of

8.33 percent (-8.33 percent) to discount of 50.52, with a median

of 12.71 percent and a mean of 13.56 percent.
- 21 -

Petitioner challenges respondent’s partition cost approach. 

Petitioner contends that the three properties could not be

partitioned, claiming that decedent and her husband, later

represented by the Trust, waived any right to partition the

properties held jointly by reason of oral and written contracts. 

If no partition is available, petitioner maintains that Thomson’s

discount methodology based on partitioning costs is pertinent

only as one of the factors of the loss of control discount.

Petitioner’s argument must fail because the Trust and

decedent’s trust each provide the trustee with the power to

partition the property. The importance of partitioning costs is

dependent on the circumstances of each case. Partition is a more

viable approach where real property is unimproved. Where

significant income-producing improvements are involved, partition

is a less plausible approach. Respondent’s use of partition cost

alone does not give adequate weight to other reasons for

discounting a fractional interest in this case such as the

significance of the control factor and the historic difficulty of

selling an undivided fractional interest in improved real

property. See Williams v. Commissioner, T.C. Memo. 1998-59.

Petitioner contends that the discount applied to decedent’s

50-percent interests should be greater than just the cost to

partition. Hulberg, petitioner’s primary expert, estimated the
- 22 -

2 This reflects a 15-percent discount for lack of control

and 20 percent for lack of marketability.

3 This reflects a 15-percent discount for lack of control

and 15 percent for lack of marketability.

4 This reflects a 15-percent discount for lack of control

and 20 percent for lack of marketability.

discount on the Kmart property to be 35 percent,2 the Walgreen

property discount to be 30 percent,3 and the Wells Fargo property

to be 35 percent.4 Hulberg based his discounts on several

factors. First, he emphasized the fact that neither owner of the

property had control. He pointed out that any potential buyer of

decedent’s property interest would consider the lack of control,

the risk in terms of cost to partition, delay of partition, lack

of liquidity of the real property, lack of marketability for

resale, and the inability to finance without consent of the other

owner.

Hulberg used three different approaches to determine the

proper discount. The first was the “Company Survey Method”,

which was described as a “survey of companies in the business of

purchasing and selling partnerships.” This method is less

relevant because the properties are closely held family-owned

entities and less marketable than diversely held entities. 

Hulberg uses this method due to the limited number of comparable

sales of fractional interests in real estate and suggests that

there is a close analogy between fractional real property
- 23 -

interests held as tenants in common and real property partnership

interests. The information he received from one company

marketing public and private partial interests was that those

interests are typically discounted between 35 and 70 percent,

depending on certain factors. Another company marketing only

privately held interests reported a tighter range of 42-percent

to 49-percent discounts for privately held, family-oriented

general partnership interests. A third source of data for real

estate partnerships reported that during 1993, the average

discount for such an interest in the triple-net lease category

was 20 percent.

Hulberg found the indicated discount range for a triple-net

lease property with a 47-percent loan-to-value ratio, such as the

Kmart property, using these comparison figures, was between 20 to

51 percent. He estimated the proper discount to be 35 percent

due to the flat rate of income on the Kmart property. He found

that partnership interests with similar characteristics to the

Walgreen property had an average discount of 20 percent, which he

adjusted for control and marketability, arriving at a discount of

30 percent. The 35-percent Wells Fargo property discount was

based on the same 20-percent figure, adjusted for the lack of

investment appeal for an older building and for marketability and

control.
- 24 -

The second method Hulberg used was the “Fractional Discount

Method”. The method was set out in an April 1992 journal

article, Davidson, “Fractional Interests in Real Estate Limited

Partnerships”, The Appraisal Journal, 184-194 (Apr. 1992), in

which 10 factors were used to analyze the amount of a fractional

interest and a partnership discount. The factors included:

Relative risk of assets held, historical consistency of

distributions, conditions of assets, market’s growth potential,

portfolio diversification, strength of management, magnitude of

the fractional interest, liquidity of the interest, ability to

influence management, and ease of asset analysis. Using those

factors, Hulberg arrived at a 35-percent discount for Kmart

property, a 33-percent discount for the Walgreen property, and a

34-percent discount for the Wells Fargo property. However, the

factors are applicable to going real estate limited partnership

interests and are not fully applicable to the present situation

due to the family ownership, the lack of diversity of assets, and

the lack of a professional management company. The applicable

factors would appear to be risk of assets held, historical

consistency of distributions (i.e., rental income history),

conditions of assets, the magnitude and liquidity of the

interest, and management influence. The total discount

attributable to these factors ranges from 25 percent to 27

percent.
- 25 -

The third method used by Hulberg was the Comparable Sales. 

He found two sales which he believed were comparable. The first

was a 50-percent undivided interest in a $2 million, multitenant

office building. The fractional interest discount was 35

percent. The second comparable was a 50-percent general

partnership interest in a family property worth $3,390,000. The

discount was 29 percent.

Petitioner’s second expert, White, agrees with Hulberg that

partnership discounts are relevant to the facts at hand because

they represent diversified pools of leases on multiple buildings

to different tenants, thus reducing the risk of a single

obligation by a single tenant at one location. Also a

partnership unit is more valuable than an undivided private

interest because a negotiated, secondary market exists for the

former. White reasons that the median discount in the traded

market for a multilease, private partnership interest should be

doubled due to these factors. He arrives at a 25.4-percent

discount. He then adds an additional 10-percent discount to

compensate for the highly valued professional management

available for partnership units that is not available on

decedent’s properties.

Considering the parties’ experts’ reports and opinions, we

find that the appropriate discount amount should be neither as

low nor as high as those suggested. We find that a 25-percent
- 26 -

discount is appropriate for all three of the properties. This

figure is supported by the factor analysis for fractional

interests, which gave us a figure between 25 percent and 27

percent. 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. But, on the positive side, the properties are

in average to very good condition, with remaining economic lives. 

They all had good rental histories with creditworthy tenants and

are well located.

In summary, we hold that the fair market value of the Kmart

property was $5,300,000 as of the date of decedent’s death and

decedent’s 50-percent undivided interest had a value of

$1,987,500 after a 25-percent marketability discount. The 50-

percent undivided interest in the Walgreen property had a fair

market value of $1,335,000 before a 25-percent discount,

resulting in a returnable value of $1,001,250. Finally, the 50-

percent undivided interest in the Wells Fargo property had a fair

market value of $493,975 before a 25-percent discount, resulting

in a returnable value of $370,481.
- 27 -

To reflect the foregoing,

Decision will be entered

under Rule 155.