Valuation: General and Real Estate (Portfolio 830)

Tax Management Portfolio, Valuation: General and Real Estate, No. 830-3rd, reviews the methods commonly used in the valuation of assets, including real estate.

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Tax Management Portfolio, Valuation: General and Real Estate, No. 830-3rd, reviews the methods commonly used in the valuation of assets, including real estate. The fair market value of an asset ultimately determined must be one which fits within the definition of what a willing buyer would pay to a willing seller for the asset, neither being under any compulsion to buy or sell, with both parties having a reasonable knowledge of all relevant facts. In the case of real estate, the value generally is based upon the highest and best use of the property.
This portfolio outlines the various methodologies and approaches to valuation, and applies them to the valuation of specific types of real and personal property interests. This portfolio is also designed to assist tax practitioners and their clients with the issues involved in valuing assets for federal income, estate, gift, and generation-skipping tax planning purposes, to prepare informal estimates of value and valuation calculations in an effort to settle differences with the IRS during audit and prior to trial, and to work with qualified appraisers in connection with the preparation of a more formal appraisal for use either at audit or in a trial in the matter. Brief consideration is given to special use valuation of real estate under §2032A, to the special valuation rules of Chapter 14, and to the penalties that may be imposed for inaccurate valuations.
The Worksheets include samples of valuation reports and excerpts from various IRS documents, including audit guidelines, that provide insight into the IRS's valuation procedures.
This portfolio is to be used in conjunction with 833 T.M., Section 2032A — Special Use Valuation; 831 T.M., Valuation of Corporate Stock; 809 T.M., Estate Planning for Owners of Closely Held Business Interests; 835 T.M., Transfers of Interests in Family Entities Under Chapter 14: Sections 2701, 2703 and 2704; and 836 T.M., Partial Interests — GRATs, GRUTs, QPRTs (Section 2702).
This portfolio may be cited as Kelley, 830-3rd T.M., Valuation: General and Real Estate.


Carol A. Kelley, B.A., Providence College (1995); J.D., Duke University School of Law (1998); LL. M. (Taxation), New York University School of Law (2002); member American, New Jersey, and District of Columbia Bar Associations; also admitted to practice in New York; Counsel, Buchanan Ingersoll & Rooney PC, Washington, D.C.


Detailed Analysis

I. Introduction

A. Purpose and Scope

B. Role of the Estate Planner in the Appraisal Process

C. The Relevant Code Sections

D. Importance of Valuation for Transfer Tax Purposes

E. General Comments on Valuation Jurisprudence

F. Gift Tax Valuation Finality and Ability of IRS to Revisit Valuation of Gifts for Estate Tax Purposes

1. Adjusted Taxable Gifts as Reported on the Estate Tax Return

a. Gifts Made Prior to August 6, 1997

b. Gifts Made on or After August 5, 1997

2. Gift Tax Statute of Limitations

a. Generally

b. Gifts Made After December 31, 1996

G. Burden of Proof and Valuation Litigation

1. Examinations Commencing On or Prior to June 22, 1998

2. Examinations Commencing After June 22, 1998

3. Taxpayers Arguing Against a Valuation Return Position

4. Asking IRS for Valuation Assistance or Rulings

II. General Rules of Valuation

A. Fair Market Value

1. General

2. Relevant Market

3. Impact of Use on Fair Market Value

4. Impact of State Probate or Inheritance Tax Valuation on IRS

5. Individual Components of “Fair Market Value” Standard

a. Hypothetical Willing Buyer-Hypothetical Willing Seller

b. Highest and Best Use

c. No Compulsion to Buy or to Sell

d. Reasonable Knowledge

B. Valuation Date

1. In General

2. Alternate Valuation Date

C. Overview of the Methodologies and Approaches to Valuation

1. Present Value

2. Section 7520

D. Market Approach to Valuation

1. Actual Sales

a. Sales Within a Reasonable Time

b. Auction Sales

c. Unaccepted Offers

d. Relevant Markets

e. Expenses of Sale

2. Comparable Sales

a. Similar Property

(1) General

(2) Real Property

(3) Entities

b. Dissimilar Property

c. Timing of Comparable Sales

d. Effect of Method of Financing

3. Effect of Economic Conditions

4. Effect of Zoning and Land Restrictions

5. Probate Court Appraisal

6. Summation of Market Approach

E. Income Approach to Valuation

1. Rules of Thumb

2. Gross Income

a. Vacancy Factor

b. Effective Gross Income

3. Net Income

a. Expenses

b. Capitalization Rate

c. Capitalization Methods

(1) Direct Method

(2) Mortgage-Equity Method

(3) Discounted Cash Flow Method

(4) Ellwood Method

(5) Residual Method

F. Cost Approach to Valuation

1. General Description

2. Estimated Reproduction or Replacement Cost

G. Local Assessed Values

1. Use in Establishing Basis for Depreciation

2. Use in Valuation Cases

H. Adjustments to Value

1. Marketability/Minority

2. Blockage

3. Control Premium

4. Fractional Interest Discount

5. Retroactive Adjustment

6. Other Adjustments

I. Final Determination of Value

III. Special Use Valuation of Real Estate - § 2032A

A. Introduction

1. Exception to Highest and Best Use Valuation

2. Overview of § 2032A

3. Other Transfer Taxes

B. Qualification Requirements

1. In General; Elections

2. Pre-Death Qualified Use

3. Pre-Death Material Participation

4. Percentage Tests

5. Qualified Heir

6. Indirectly Owned Property

C. Computation of Value

1. In General

2. Capitalization of Rents

3. Five-Factor Method

D. Requirement to File Appraisal

E. Recapture and Other Downsides of § 2032A

IV. Special Valuations Rules - Chapter 14

A. Background - Former § 2036(c)

B. Overview and Scope of Chapter 14

C. Transfers of Interests in Corporations and Partnerships: § 2701

1. Gift Tax Analysis

2. Controlled Entities

3. Marketable Interests

4. Mechanics of Valuation

D. Transfers of Interests in Trust: § 2702

1. Retained Interests

2. Personal Residence

3. Tangible Property

4. Mechanics of Valuation

a. The Grantor Retained Income Trust (GRIT)

b. The Grantor Retained Annuity Trust (GRAT)

c. The Grantor Retained Unitrust (GRUT)

d. Qualified Personal Residence Trust (QPRT)

E. Buy-Sell Agreements: § 2703

F. Impact of Certain Lapsing Rights: § 2704

G. Other Provisions

1. Extension of Gift Tax Statute of Limitations

2. Special Adjustment to Avoid Double Taxation

V. Specific Types of Property

A. Real Estate

1. Apartment Building

2. Office Building

3. Shopping Center

4. Hotel/Office Complex

5. Residential Property

6. Vacant Land

7. Leasehold Interests

8. Option to Purchase

9. Conservation and Facade Easements

10. Other Interests in Real Property

B. Stocks and Bonds

1. Listed and Over-the-Counter Stocks

2. Bonds

3. Restricted Securities

4. Mutual Funds

5. Options

6. Closely Held Corporations

C. Partnerships, LLC's and Joint Ventures

1. General Treatment of Value

2. Restrictive Agreements

a. Traditional Analysis

b. Chapter 14 Analysis

D. Sole Proprietorships

E. Mortgages, Notes and Cash

F. Insurance, Annuities, Life Estates, Terms for Years, and Future Interests

1. Life Insurance

a. In General

b. Alternate Valuation

c. Entity-Owned Policies

d. Simultaneous Death of Owner and Insured

2. General Discussion of Annuities, Life Estates, Terms for Years, Remainders, and Reversions Valued Pursuant to § 7520

a. Application of § 7520 to Valuation Provisions

b. Special Rule for Charitable Transfers

c. Operation of § 7520

d. Planning Implications

3. Annuities

4. Life Estates and Terms for Years

5. Remainder and Beneficial Interests

G. Other Types of Property

1. Household and Personal Effects

2. Goodwill

3. Franchise Rights

4. Retirement and Deferred Compensation Benefits

5. Miscellaneous Interests

a. Royalties

b. Patents

c. Contingent Claims for Services

d. Interest-Free Loans

e. Timber

f. Works of Art

g. Other Property Interests

VI. Accuracy-Related Penalties

A. Prior Law and Overview of Current Law; Subjectivity Implications

B. Understatement Penalties

C. Misstatement Penalty

D. Negligence or Disregard of Rules and Regulations

VII. Appraisals and Expert Witnesses; Appraisal Standards; Appraisal Process

A. Appraisal Standards

1. General


a. Types of Guidance

b. Standards

c. USPAP Applicability

B. Types of Appraisers; Appraisal Associations

1. General

2. Appraisal Trade Associations

a. ASA

b. Business Appraisal Trade Associations

(1) ASA

(2) IBA



(5) Association for Investment Management and Research

c. Real Property Appraisal Trade Associations

(1) ASA

(2) Appraisal Institute



C. Review of Appraisals

D. Federal and State Regulation of Appraisers

E. General Advisability of Appraisals

F. IRS and Valuation

G. Appraisers as Expert Witnesses

H. Appraisal Reports

I. Art

J. Assembling Information

1. General Data

2. Specific Data

3. Comparable Data

4. Maps

VIII. Other Tax Issues

A. Income Tax Basis

B. Payment of Donor's Taxes or Indebtedness

C. Noncash Charitable Contributions

D. Information to Be Submitted with Return

E. Section 1060 - Special Allocation Rules for Certain Acquisitions

F. Foreign Property


Working Papers

Table of Worksheets

Relevant Worksheets Appearing in Other Portfolios:

Worksheet 1 Apartment Building Valuation Summary

Worksheet 2 Office Building Valuation Summary

Worksheet 3 Partnership Valuation Summary (Real Estate)

Worksheet 4 Partnership Valuation Summary (Operating Company)

Worksheet 5 Excerpts from Internal Revenue Manual, Valuation Assistance Procedures [8.18.1]

Worksheet 6 IRS Business Valuation Guidelines (dated Jan. 14, 2002, last revised Aug. 15, 2002, effective Oct. 1, 2002)

Worksheet 7 Excerpts from IRS Valuation Training for Appeals Officers Coursebook (issued May 1997) - Lesson 3, Real Estate - An Overview

Worksheet 8 Excerpt from IRS Valuation Training for Appeals Officers Coursebook (issued May 1997) - Lesson 4, Real Estate Appraisal Methods

Worksheet 9 Excerpts from IRS Valuation Training for Appeals Officers Coursebook (issued May 1997) - Lesson 9, Discounts

Worksheet 10 Excerpt from IRS Valuation Training for Appeals Officers Coursebook (issued May 1997) - Lesson 9, Exhibit 9-4, Case Chart for Discount & Factors

Worksheet 11 Excerpt from IRS Valuation Training for Appeals Officers Coursebook (issued May 1997) - Lesson 13, Valuing Intangible Assets

Worksheet 12 Excerpts from IRS Valuation Training for Appeals Officers Coursebook (issued May 1997) - Lesson 14, Valuation of Notes





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Treasury Rulings