Valuation

Had a client pass recently and may go over the exemption amount. The largest assets in estate are couple of partnership interests and stock in a non-publicly traded corporation. The attorney started the process on gathering appraisals for the partnerships and corporation. Both basically contain rental properties; so, the attorney is obtaining appraisals for each property in the entities vs. getting an appraisal of the entity. Since I'm new to estate tax, I'm wondering if this is the correct approach?

Seems like the attorney is going to combine the value of all the properties in each entity. Then after applying a lack of marketability and/or minority interest interest discount, he'll report the client's value based on ownership percentage of each entity.

Unless the attorney has a valuation credential, I wouldn't have him do anything other than add up the values provided by such a professional. The valuation professional should be engaged to provide a report taking all these dynamics into account.

If the various entities consist mainly of real estate, then I think the logical first step is to obtain the values of the real estate inside the partnership and corporation. The lawyers may want to control the process by using an appraiser that they are familiar with it. When they mention to the appraiser "we have a taxable estate" that is code for make sure you come in on the low end.

From there, they will probably provide a certified valuation pro with the info to draft the reports

I see nothing wrong with the approach, that is the way it normally plays out.

Just as an example, there was a recent successful case that used the cash flow method of valuing a parcel of real estate that brought down the initial value to less than half of what an appraisal for sale would likely have provided.
Just my $0.02...

In 2015 about 1/3 of estates with a value of over $10,000,000 were audited; only 22% had no change.

An experienced appraiser would probably be valuable especially when:
dealing with marketability and minority discounts,
considering the tax rate involved, and
considering how long the estate (or trust) may stay open due to disagreements with the IRS.

If the attorney comes up with discounts that place the value below the exemption amount and the estate doesn't file a return, but should have due to an incorrect appraisal, the penalties could be substantial. (Unless a return is filed anyhow to determine the DSUE.)

Would you prepare the 706 or would the attorney? If it is you, you should consider your risks resulting from a lack of well done appraisal.

Even if you use the best professionals, a taxable estate is sure to have issues. Look at the Michael Jackson estate that is still not settled (he died in 2009). His attorney's valued the estate at $7 million, the IRS said $1.3 billion.

For the valuation of his likeness and image, attorneys said $2,105 (I like that they did not use a round number) and the IRS originally said $434 million. They have since dropped that number to $134 million.

Can you imagine if we have to start doing wealth tax returns?

For a taxable estate, I agree use a valuation pro, unless the estate atty is also a CPA, I assume they dont know their way around a financial statement. Complying with professional standards as evidence by a formal valuation report can be more important than the number itself in a dispute.

But, this is how I would look at it:

Valuation on property is generally based on market comparables, i.e. what are other properties in the neighborhood selling for. You can get real estate appraisals fairly easy by people who do this type of work frequently. I dont think I would take discounts on lack of marketability on real estate. A lack of control for minority interest sounds right.

I would value the business portion separately. If it is a stable business with cashflows, I would use Discounted Cash Flows. Getting comps on a closely held business is difficult. You should be able to apply both discounts. I would also look whether you just lost the key man in which case I would consider liquidation value (net assets) as the method instead of DCF.

You will want to have a business valuation professional determine the fair market value of the decedents ownership interest in the subject entities. The process will include a real estate appraisal and a determination of the appropriate discount for lack of control and lack of marketability. A real estate appraiser values the real estate and the business valuation professional determines the appropriate level of discounts depending upon various factors.

Thanks for the feedback. Not sure if I was clear but the attorney is obtaining appraisals for the real estate inside of the entities. I was just wondering if that was the correct approach vs. some kind of valuing of the entity AS A WHOLE. Does make sense that the property valuation should be done for individual real estate and added up before applying any kind of discount...by the appraiser. The business portion will be done separately.

Need to look for that case regarding discounted cash flow for valuing real estate. One of the CPAs that prepares the tax return for the corporation with rental real estate made mention of that as a possibility but didn't think too much about it as both the attorney and I didn't know if that would be too aggressive. With a court case...maybe.

When valuing interests in real estate LLCs there should be an appraisal of the real estate which is then used for the valuation of the LLC.

When valuing interests in real estate LLCs there should be an appraisal of the real estate which is then used for the valuation of the LLC.

Agreed.

The case is Estate of Aaron Jones v Comm.

Updating this post vs. starting a new one since a lot of background information is in various posts above. Appraisals have been ordered and most have been done. One of the partnerships that my client is a part of is being prepared. Another partnership that he is/was a part of has been given to me to prepare since the former preparer is winding down his practice. Unfortunately, this partnership's real estate appraisals are not done for the most part with the 9/15 deadline looming. Some questions came to mind:

1. If I file the partnership without the appraisals, would you later amend or update in the 2020 going forward? I'm dreading having to file amended returns for the partnership, my client's trust and my client's wife's returns (the trust pays out to wife).

2. Step-up in basis (Sect 754?): Initially my thought was once appraisals come in, I would step-up the basis of the rental property for his 25% portion and depreciate. I looked at the other partnership K-1 from last year and there was a line item for Sect 754 depreciation (a different partner passed in a prior year) so I thought I was going in right direction. Now I'm thinking about the actual details and am not sure how to handle. Say for one of the rentals, the cost basis is $400K and fully depreciated (left land out to keep it simple) and the appraised value is $800K. Looks like in the software, I can create a "new" asset and allocate the depreciation to only his trust's K-1; so, will not affect the rest of the partners. Since his portion is 25%, I’ll create a $200K Rental and depreciate over 27.5 years. Do I leave the entire original $400K and accumulated depreciation on the books or do I just book a $100K asset? I was thinking the $200K since that should be depreciated.

3. Transfer of interest: I would show the transfer of interest from the individual to the trust at book value using the software capabilities as it can do it as of date of death. If I create an asset for the step up in basis, the balance sheet and the depreciation schedules would not match; so, book the step up as a capital contribution?

Been asking other preparers and received some confusing answers. Hoping someone more experienced in this situation can shed some light. This is what I've been dreading when I first started my practice. Told my clients not to die. Had a 80+ year old client tell me he's happy that he finally has a preparer that will outlive him. I had to tell him that if I don't, I'll be pissed.