Discount Percentages / Real Estate Fractional Interests

If you have taken the time to search you may already know that there are a lot of articles out there on the web regarding fractional interests.  So, what do appraisers do when faced with having to develop an appropriate discount for their assignment?

If a property suffers no loss due to a lack of marketability and no loss due to a lack of control, due generally to owning a minority interest in a property, then discounting it may not be appropriate.  A joint tenancy interest in a property may mean that you only own a portion of the whole, but claiming that your interest should be discounted is tenuous at best. 

Tenancy-in-common (TIC) is usually the basis for undivided fractional interests and appraisers value a subject property in its entirety, or as a whole, then valuing the fractional interests.  The fractional interests are generally discounted and that’s why some attorneys and accountants advise their clients to hold their real property as TIC and not as joint-tenants with a right of survivorship (JTWROS).  Their argument is, “why not hold a property as TIC and take the discount?”  A 17% discount was allowed in Ludwick v. Commissioner, the U.S. Tax Court as noted here.

Anyone who is concerned about the Internal Revenue Service (IRS) and what it considers appropriate will consider the factors that they consider when making their determinations.  The IRS goes beyond a simple determination that a fractional interest exists and analyzes the interest, they want to know specifics that apply to a property including: fractional interest size (percentage), the number of owners, the size of the property, the land use, available financing for the undivided interest and the approximate cost of a partition action.  A partition may not be an appropriate alternative, but it must be considered.

So what percentage applies to your fractional interest?  Here is one of the ways to look at the discounting that uses the IRS criteria as its basis.  The table generalizes all of the important IRS criteria and the fractional interest percentages are just filled in at what I believe are approximate locations.  At very least it does give a real property analyst an idea of what is being considered and the relative location of the factors on a continuum.

Using the following table is not an “accepted” methodology, so don’t state that I claimed that, the table is only loosely tied to IRS factors.  If you are going to use it consider what you are doing as you work your way through the analytic process. 

I developed this table as a way for me to keep in my mind what factors that I believe are important in a fractional interest analysis.  The table is provided as a way for an appraiser to consider important factors and it is not meant to be a definitive method for determining a discount.

© Glenn Rigdon, Horizon Village Appraisal, 2018

Of course, the IRS is always trying to keep discounts to a minimum and often ends up in tax court disputing discounts.  Final determinations generally fall between 15% and 60%, as displayed in my table.  So, the IRS criteria is looked at much more closely than the table would imply but there are no hard and fast rules. 

Most appraisers are familiar with discounted cash flow (DCF) analyses, and an anticipated cash flow from a fractional interest ownership can be analyzed using a DCF-like methodology with the cost of a partition at some future date.  Being able to calculate the actual or projected dollar benefits that can be derived from a fractional interest ownership is a powerful argument in valuation.  In many cases however it is impossible for an appraiser to determine an actual or potential cash flow.

Real estate appraisers are often involved in the valuation of fractional interests and many appraisers have a background in business valuation (BV).  Some understand how difficult it is to market a fractional interest in a business and they also understand the serious negative impact of a minority interest.  Fractional business interests are often traded, more often than fractional real property interests, and thus business data on fractional transfers is used to as a basis for a discount concluded for a fractional interest in a real property.

For real property appraisers its better to include a discussion of fractional interests in business as a basis for their determination than to not consider it.  Courts have not however been favoring discounts based on business valuation studies, so you may want to not hang your hat solely on fractional interest conclusion based on BV data.

For more appraisal information contact Glenn J. Rigdon MA, MRICS, ASA is a Las Vegas / Henderson Nevada based appraiser who can be contacted via email or via his business website known as Appraiser Las Vegas  (http://www.appraiserlasvegas.com), or http://www.horizonvillageappraisal.com, or you can also click on “Contact Us” on the home page of this website or visit my public profile at LinkedIn at http://www.linkedin.com/pub/glenn-rigdon-ma-mrics-asa/1a/30b/879/

Article source: http://www.appraisalarticles.com/Real-Property-Appraisal/Fractional-Interest-Appraisals/4688-Discount-Percentages-Real-Estate-Fractional-Interests.html