In this recent United States Tax Court case (T.C. Memo. 2013-263) concerning a real estate holding company operating as an LLC, two valuation issues were discussed: the sole consideration of a net asset value technique and the extent of lack of control and lack of marketability discounts. In an unrelated issue, the petitioner later attempted to negate his own expert’s property appraisal.  The Court rejected his attempt.

Net Asset Value Method
The two parties’ experts both relied on a net asset value technique.  The Court, in its decision, remarked,

“It is well established that, in general, an asset-based method of valuation applies in the case of corporations that are essentially holding corporations, while an earnings-based method applies for corporations that are going concerns.” Estate of Smith v. Commissioner, T.C. Memo. 1999-368, 1999 WL 1001184. That rule of thumb is no doubt based in part on the notion that a holding or investment company may be managed not for current income but, rather, for appreciation in the value of its holdings. If ownership interests in a holding or investment company are not traded in an established market, then net asset value may be the best indicator of the firm’s value. See, e.g., Hess v. Commissioner, T.C. Memo. 2003-251, 2003 WL 21991627;  Estate of Ford v. Commissioner, T.C. Memo. 1993-580, 1993 WL 501917, 53 F.3d 924 (8th Cir. 1995). The point is well stated in Rev. Rul. 59-60, sec. 5(a), 1959-1 C.B. 237, 242: “In general, the appraiser will accord primary consideration to earnings when valuing stocks of companies which sell products or services to the public; conversely, in the investment or holding type of company, the appraiser may accord the greatest weight to the assets underlying the security to be valued.”

“We have on occasion been presented with, and sanctioned, the valuation of a closely held real estate firm using a weighted approach, i.e., using both a net value approach and an income capitalization approach, attaching weight to each. E.g., Estate of Andrews v. Commissioner, 79 T.C. 938, 956-957 (1982); Estate of Weinberg v. Commissioner, T.C. Memo. 2000-51. We have here no evidence that an explicitly income-based approach to valuing the subject interest would necessarily have reached a different valuation conclusion, or what that valuation conclusion would be.”

Discounts
The Court validated a lack of control, or minority, discount applied as the membership interest must be valued under the willing buyer-willing seller paradigm.  The Court pointed out that the willing buyer and willing seller did not have to have the same personal characteristics of the actual buyer and actual seller.  This is key when membership interest transfers are restricted to within the defined group, in this instance, a family group. Chapman Glen Ltd. v. Commissioner, 140 T.C.  (May 28, 2013).

“Certainly, in applying the willing buyer-willing seller standard to determine the value of the subject interest, it would be appropriate to take into consideration limitations in the operating agreement on the rights of a nonfamily member transferee to participate in control and management of the LLC and limitations on the transferee’s rights otherwise to be treated as a member.”

The IRS valuation expert, John Thomson of Klaris, Thomson & Schroeder, Inc, explained the lack of control discount or minority interest discount: “The hypothetical minority interest investor cannot control, or has little influence on, the disposition of assets, the payment of distributions, the appointment of management, or other prerogatives of control. Therefore, a lack of control discount is applied to account for the absence of these control features.”

His discount, which the Court affirmed, was at 10%.  The original petitioner’s valuation provided by the petitioner prepared by Management Planning, Inc. applied a lack of control discount at 20%.  No support for either of these discounts is provided in the Court filings.

The Court indicated a lack of marketability discount was appropriate to allow for the restrictions in the members agreement regarding transfers of interests.  Mr. Thomson provided a 26% lack of marketability discount.  Management Planning, Inc. applied a 35% lack of marketability discount.  The Court sided with Mr. Thomson.  Again, no support for either of these discounts is provided in the Court filings.

Conclusion
The Tax Court continues to allow both lack of control and lack of marketability discounts, though, as in the past, the justification for the scope of these discounts remains nebulous.  The Court allowed a net 33% discount from the pre-discounted value of the proportionate interest.