Court Says No to IRS Attempt to Aggregate Gifts for Discount Purposes

In a recent case out of the United States District Court for the District of Connecticut, the Court denied the IRS’ motion for summary judgment and refused to aggregate the gift of partial interests in real estate together for purposes of valuing the gifts and thus determining appropriate discounts.[1] The IRS alleged that no discount was warranted where the taxpayer gifted his two sons each a 48% interest in several tracts of land and retained the remaining 4% of each tract.   Under the IRS theory, since the taxpayer owned the entirety of each tract prior to the gift, the two gifts of 48% interests in the tracts, one to each son, should be valued together and thus no discount was warranted. The Court disagreed.

Facts

The taxpayer, Peter Buck (“Buck”), bought several tracts of timberland for a combined purchase price of $82,853,050. The exact number of tracts purchased is not listed, but the purchase of the relevant tracts took place over a period time spanning from 2009 to 2013. Beginning in 2010, and through 2013, Buck gifted a 48% interest in these tracts to one son, another 48% interest in the tracts to another son, retaining 4% for himself. Buck reported the gifts on timely filed gift returns for each year and paid the resulting gift tax. In valuing the gifted interests, Buck asserted discounts applied based on the fact the gifts were partial interests that were less valuable to a hypothetical buyer. Ultimately, Buck valued the collective total of the 48% interests given to each son at $18,496,249, for total gifts of $36,992,498 between the two sons. As the Court notes, this represented a 55% discount from the purchase price.

The IRS audited Buck’s gift tax returns and challenged the discounted valuations. The IRS assessed deficiencies in the gift tax based on its own valuations. Buck paid the assessment in full and sued for a refund in the United States District Court for the District of Connecticut.

The IRS filed a motion for partial summary judgment on what it considered to be a matter of law, the premise that “no discount should be available for a gift of a fractional interest unless the taxpayer held such interest in fractional form before the gift, rather than viewing several simultaneously gifted portions of the property as fractional interests in the hands of the donor for the purpose of valuing the gift.”

Analysis

The Court began its analysis with a cite to Rule 56 of the Rules of Civil Procedure which states that a court may only grant summary judgment if “there is no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law”. The Court noted that this was a high standard and that the Court must view the facts and the record “in the light most favorable to the non-movant.”[2]

The Court then briefly discussed fractional interest discounts noting they reflect ownership over parts of the whole[3] and allow taxpayers to value property lower than its respective percentage of the whole due to lack of control and lack of marketability discounts.[4] Next the Court moved into the IRS’s two principal arguments, noting at the onset that both were “unavailing”.

First, the IRS alleged that allowing the fractional discounts on gifts such as Buck’s would prevent the gift tax from serving its primary purpose, that being to ensure the estate tax is not avoided. The IRS correctly noted in its argument that had Buck died owning the tracts, then there would be no applicable discount when valuing the tracts for estate tax purposes. Accordingly, since the purpose of the gift tax is to prevent a circumvention of the estate tax, then discounts should not be applicable for gift tax purposes because “the gift tax is construed in pari materia[5] with the estate tax” in order to prevent taxpayers from “avoiding the estate tax altogether” by “depleting their estates through inter vivos transfers.”

In support of its arguments, the IRS cited to three cases[6], each of which supported its argument that the gift tax statutes and regulations must be interpreted in pari materia with the estate tax statutes and regulations. The Court acknowledged this but nevertheless distinguished these cases as not providing support for the legal conclusion that “if there would be no discount in determining the value of property for purposes of the estate tax, the interests in the property should be aggregated and there should be no discount in determining the value of those interests for purposes of the gift tax.” Each of the cases noted relied on the Estate of Stewart[7]which the Court noted actually went against the IRS’s position, as the court in that case stated:

Estate planners have, however, found a highly effective way to lower both estate and gift taxes when passing real estate to the next generation. Dividing the real estate into separate interests usually lowers the property’s fair market value and thereby also the taxes due on it. See David Westfall et al., Estate Planning Law & Taxation ¶ 2.05[3] (2009). The fair market value of separate interests is typically discounted by about 10-20% for lack of control and marketability.

The Court noted that while a big part of the Estate of Stewart case was that the main purpose of the gift tax was to prevent the avoidance of the estate tax, the case must nevertheless be read in the proper context which was ultimately an estate inclusion case, not a case discussing the rule of construction for gift tax statutes. As such, the Court failed to be persuaded by the IRS on its first argument that the gift and estate tax statutes must be read and applied in pari materia and thus no discounts should be allowed for gift tax purposes in the present case.

Next, the IRS argued that the value of the property for purposes of the gift tax statutes was the value of the property in the hands of the donor, not the donee. In the IRS view, the value of the gift made by the donor, not the value of enrichment to the donee, should be determinative.

However, the relevant law requires that the courts look at the value of each gift at the time in passes from the donor to the done. Citing the §2512(a) governing gift tax values, the Court noted that “the value thereof at the date of the gift shall be considered the amount of the gift.” On the flip side, citing §2033 governing estate tax values, the Court noted “the value of all property to the extent of the interest therein of the decedent at the time of his death” is what is included in the decedent’s estate. The Court noted this distinction is also reflected in the applicable regulations for both estate and gift tax purposes. Reg. § 25.2512-1 states that the gift tax is measured by the “value of property passing from the donor” whereas Reg. §20.2031-1(a) states that “the value of the gross estate of a decedent … is the total value of interests [included in the decedent’s estate]”.

The Court went on to discuss two relevant cases which stand for the “well established principle that gifts should be valued at the time of the gift, not before or after they are made.”[8] In both cases, there were multiple gifts involved and each case was clear on the premise that they should be valued separately. Accordingly, the Court was also unpersuaded by the IRS’s second argument, that the gift should be valued in the hands of the donor, which in this case, was a 100% interest in tracts of land that did not warrant any valuation discount.

Conclusion

In conclusion, it is no secret that the IRS is not a fan of valuation discounts for gift tax purposes or estate tax purposes, whether that discount be for a partial interest in real estate or an interest in some type of entity such as a family limited partnership. Nevertheless, as the Court noted and cited in this case, there is well established case law for the premise that such discounts are warranted and do in fact reflect the reality of what the fair market value of a partial interest might be, whether that be in real estate or an entity or some other asset such as a piece of art.

 

[1] Buck v. U.S., 128 AFTER 2d 2021-XXXX (DC CT).

[2] Weinstock v. Columbia Univ., 224 F.3d 33 (2nd Cir. 2000).

[3] Recovery Group v. Commissioner, T.C. Memo 2010-76.

[4] Estate of Stewart v. Commissioner, 617 F.3d. 148 (2nd Cir. 2010).

[5] “In pari materia” is a doctrine in statutory construction that statutes that are in pari materia must be construed together.

[6] Merrill v. Fahs, 324 US 308 (1945); Commissioner v. Converse, 163 F.2d 131 (2nd Cir. 1947); Heringer v. Commissioner, TC Memo 2010-076.

[7] 617 F.3d. 148 (2nd Cir. 2010).

[8] LeFrak v. Commissioner, TC Memo 1193-526; Shepherd v. Commissioner, 115 TC 376 (2000).