Valuation Reduction
IRS Definition of Value of Property—The Willing Buyer-Willing Seller Test
The value of the property is the price at which such property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell, and both having a reasonable knowledge of relevant facts.Imagine that you are a Willing Buyer. Ask yourself the following questions. After you answer the following questions for yourself, you will understand why there are valuation discounts.
- Would you pay as much for property over which you have a lack of control as compared to property over which you have control?
- Would you as much for property that has restrictions on transfer as compared to property that could be freely transferred?
- Would you pay as much for a minority interest in property as compared to a controlling interest in property?
Appraisers have been able to quantify the effect that lack of control, restrictions on transfer and minority interests have on the value of property—They reduce the value of the entity that has a lack of control, restrictions on transfer, and minority interests from the underlying value of the entity’s property.
For the IRS to respect the valuation reduction when transferring property to entities that provide lack of control, restrictions on transfer and minority interests, the transfers must have a non-tax reason for making these transfers. Also, if the transfers are made to family members, the IRS will not recognize any restrictions that are more restrictive than the default state law.
Some non-tax reasons are:
- Asset protection
- Pooling investments
- Using a unique investment strategy
- Loser pays attorney fees
- Mandating alternative dispute resolution
- Providing confidentiality
- Making gifts without destroying incentive in the junior generation
Structures that provide Valuation Reduction
- Limited Partnerships
- Limited Liability Companies
- Tenancy-in-Common Agreements
- Restricted Management Accounts