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Valuing Fractional Share Of Farmland For Sale To Other Owners

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Doug T

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Illinois
I am a 1/3 owner in some cash-rented tillable farmland consisting of several tracts of different sizes that are not easily split into three equal portions. One of the owners wants to sell their 1/3 fractional-interest to the other two owners.

We had an appraisal done two years ago to value the land for purpose of transferring to trusts for two owners.
That appraisal applied a %20 fractional-share discount to determine the value of the gifts into the trusts.
An offer to purchase was given using the %20 discount. The seller is claiming that is not fair, but is not giving their asking price.

How do we determine a fair fractional-share discount to apply for the sale to the co-owners? What is a typical discount that would be applied in this case? The purchase does not make me a full-owner or even a majority-owner, and the seller would never be able to get full-value on the open market, so I feel some discount should be applied.

Just looking for opinions. I know, it can vary from %0 to %90...

Thank you!
 

hastalavista

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Certified General Appraiser
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California
I don't think anyone can tell you what the discount should be for your particular scenario.
Fractional ownership is discounted for two reasons:
A. Lack of marketability (not a lot of buyers for fractional ownership and difficult to market to potential buyers on a large-scale)
B. Lack of control (you don't own a controlling interest and even if you did, there are still minority interests that can impact the decision-making process involving the property)
Depending on the specific property type and market, these two factors will determine what a reasonable discount should be.

Just looking for opinions. I know, it can vary from %0 to %90...
My opinion is that you are correct; it could vary from 0% to 90%. In order to narrow it down from there you are going to need an appraisal (for the as-is value of the land) and then a fractional-interest valuation would be applied to that analysis (that can be done by an appraiser or another valuation expert).

Good luck!
 

Doug T

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Illinois


My opinion is that you are correct; it could vary from 0% to 90%. In order to narrow it down from there you are going to need an appraisal (for the as-is value of the land) and then a fractional-interest valuation would be applied to that analysis (that can be done by an appraiser or another valuation expert).

Good luck!
Thanks for the reply!
I believe we already have a recent appraisal with the as-is value that done when the farms were transferred to the trusts two years ago. That appraised the full value, then subtracted %20 to account for the multiple-owners. So the question is: can the %20 discount that the appraiser used for valuing the trust gift also be used for pricing a sale?
 

hastalavista

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California
So the question is: can the %20 discount that the appraiser used for valuing the trust gift also be used for pricing a sale?
Well, the favorite appraiser answer (which is true in this case) is, it depends!

I don't know how you acquired your fractional interest. Many times, such ownership interests are due to a partnership or an estate settlement. However, in such cases, there may be a contractual restriction on how the interests are to be sold among the owners.
For example, in a partnership agreement between Partner A & B; B dies and the ownership of his shares goes to his estate. However, in the partnership agreement, it is contractually identified that in such a case, Partner A can buy out Partner B's shares but must buy them at a pro-rata rate of 50% rather than the market value of the fractional 50% interest. This is somewhat common in partnerships where the two sides are amenable. The difference, using the 20% example, works like this:
Market Value = $500,000
50% pro-rata value = $250,000
Fractional interest value with a 20% discount = ($500,000/2) - 20%, or $250,000 - $50,000 = $200,000

You can see that the value difference in the example above is $50k. Again, not knowing how you acquired your interest, there may be language in the original partnership agreement that stipulates how existing owners buy out other existing owners.


Let's assume that there are no contractual stipulations regarding buyouts among the partners.
The trust gift valuation using the 20% discount rate is supposed to reflect the Fair Market Value of that fractional interest. Fair market value is defined as follows:
Fair market value (FMV) is the price that property would sell for on the open market. It is the price that would be agreed on between a willing buyer and a willing seller, with neither being required to act, and both having reasonable knowledge of the relevant facts.​
So, the gift tax appraisal should have valued the fractional interest based on the above definition. If it did, that reflects what that fractional interest was worth as-of the date of value. So, yes, you could agree to use that as the basis of your purchase price.

Here's the bottom line:
You don't want to over-pay for your interest and I assume you don't want to unfairly under-pay and penalize your partners.
If you all three put equal amounts into purchasing the property and each own an equal share, than all three have (presumably) benefited equally on a pro rata basis.
While a fractional interest discount represents what the interest would need to be discounted in the market to attract a buyer (for all the reasons already cited; mainly, non-marketability and lack of control) that dynamic may not be what actually fits your situation. If you purchased this property on an equal basis with your brother and sister, and now purchase one of their shares out from them, they will be penalized the fractional discount that they would experience if they were selling it on the market. You would now have a 66.7% ownership at a cost of 59.4% of the pro rata value. You may not want to do that if the other partners are your brother and sister.

On the other hand, if you have no special relationship (other than business) with your partners, and you want to make an offer based on what they could get if they tried to sell it to an outside party, then the fractional value (with the discount) is what someone (appraiser) said that fractional interest is worth in the market.

That's my 2-cents; hope it helps.
 

Red Flint

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May 15, 2005
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State
Michigan
Really want to study the market for fractional sales, clue is to see whether the prior appraisal either presented supportive evidence, or discussed it. The 20% may be high (probably), or may be low, or may be 20% or so, depending on the property and ownership interests and market.

Here is some case law if you need help sleeping:

In the Estate of Bright v. United States, 658 F, 2d 999 (5th Cir. 1981), the court held that because community-owned shares were subject to partition, the descendent’s own interest was equivalent to 27.5% of the outstanding shares and, therefore, should be valued as a minority interest. In Propstra v. United States, 680 F. 2d 1248 (9th Cir. 1982), the district court maintained that the estate was entitled to a discount on the undivided one-half interest in several pieces of real estate owned by the deceased and his wife as a community property. The Estate of Andrews v. Commissioner, 79 T.C. 938 (1982) and Estate of Lee v. Commissioner, 69 T.C. 860 (1978), nonacq., 1980-2 C.B. 2. are two cases in which the courts held that corporation shares owned by other family members cannot be atrributed to an individual family member for determining whether shares should be valued as a controlling interest of the corporation.
 

hastalavista

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California
To follow-up on Red's good citations...

Case citations are excellent sources to review and see how a court has handled a specific situation; what it allowed and didn't allow, etc.
But do not rely on a court case's determination of a discount rate for your specific; the valuation process may have some similarities, and the ultimate discount rate may be similar, the specific data to get there will not be the same.
I was in a presentation given by one of the judges who sits on the tax court in DC; he flat-out said that when a side cites a prior cases' discount rate as a basis for its discount rate, he gives that very little consideration.

Again, good luck!
 

Terrel L. Shields

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Certified General Appraiser
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Arkansas
two years ago
Land prices are possibly higher or lower than two years ago. Here prices are 15% higher than two years ago. The IRS generally scrutinizes anything over 25%. update the appraisal and draw straws. In a court case I was in 10 years ago, five different appraisers valued the property. $900 (3), $1,000 (1), $1,250 (1). The judge picked the middle one and allowed no discount because the three way partnership allowed for each side to get an appraisal and if disagreed, a third value which fell between the end points. Good enough for the judge.
 

Sid Holderly

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Certified Residential Appraiser
State
Indiana
In this cropland area, most partial interests transfer at near and sometimes above market. Most are between close or distant family members. I know of none that were advertised sales. The local attorneys all want a market value appraisal for estates that may have partial interest transfers. They or the accountant then determine a discount if any. A few sales disclosures show partial interest but not enough to find any discount trend. In a few cases, the partial interest was discounted on non-controlling interests, <50%. Those that I know of followed an IRS guideline on the discount rate.

There are no matched pairs to support a discount in this area.
 

Doug T

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Illinois
Thanks for all of the excellent information, opinions, and suggestions! From this I concluded:

* The discount should vary depending on if the other party is a business partner or an "amenable" family member. In this case it is a "strained" relationship, so I would lean toward the business partner end of the range. (higher end discountb

* Most sales of partial interests are done by private sale, so there isn't a good way to find out what discount is usually applied. Even if we had them, they would likely be to amenable family members, with less than a discount than my case would warrant.

* It seems most of the court cases where discounts are documented are forced-sale cases, which do not apply here. Noone is being forced to sell, so they should not have to rely on a court to determine what is fair.

* There is not much of an outside market for this type of partial-interest farmland property, so I am the market, and whatever price I am willing to pay is essentially the current "market price". If the seller does not want to accept it, then their asking price is too high. (Econ 101) We have no restrictions that limit how it can be sold, so the seller can always put their share up for public sale. (I know, not easy to do...)

I came up with discounts I believe are fair for 1/3 interests, 1/2 interests, and controlling interests (over 1/2). I am going to suggest creating a buy/sell agreement with all owners that indicates any future sales will determine the discount applied by averaging between the seller's current discount and the buyer's new discount. Kind of late to do this since someone already wants to sell... We will have fun trying to agree on the correct discounts to use, but at least future owners will not have as much of an issue. As trustee of a trust, I have an obligation to make sure I do not overpay.

For example, say all owners can agree that a 1/3 interest has a %20 discount, a 1/2 interest has %16, controlling interest has %10, and whole-interest has %0. (This assumes smaller interests should have higher discounts since they are farther away from having controlling interest.)
Then a sale of a 1/3 interest that makes the buyer a 1/2 owner would apply a %18 discount (average of %20 and %16). Then if two 1/2 interest parties complete a sale, the discount applied would be %8 (average of %16 and %0)
Or if a 1/3 interest only sells to one of the other 1/3 interests (giving them a 2/3 controlling interest), the discount is %15 (average of %20 and %10).
This method seems to fairly factor in the fact that the buyer ends up with a more marketable share, and has more of a controlling interest. The numbers given here are just for example, and are not necessarily what I believe should be applied to my situation. (the IRS seems to indicate they can be much higher)
 
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