Estate Does Not Receive Fractional Interest Discount on Land Gifted to Decedent’s Children

The Tax Court has held that the full fair market value of an 1,100 acre parcel of land previously divided and transferred to the decedent’s five children was includible in his estate since he continued to use and treat the land as his own during his lifetime.

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Estate Of Axel O. Adler, TC Memo 2011-28

Transactional Facts.  Axel O. Adler (“Adler”) owned an 1,100 acre parcel of land in California.  In December of 1965, Adler transferred undivided 1/5th interests in the property to his five children, as tenants in common.  The deed transferring such interest included language reserving “the full use, control, income and possession” of the property for Adler during his lifetime.

After the deed was executed, Adler continued to use the property as he had before, including paying all of the expenses, taxes and maintenance fees.  None of his children resided on the property or interfered with his use, possession, or enjoyment of the land, and Adler did not request permission prior to altering or improving the property.  In August of 1991, one of Adler’s daughters executed a quitclaim deed transferring her 1/5th interest back to her father (although the deed was never recorded).

Adler died on June 20, 2004, and his daughter subsequently executed a grant deed transferring her interest in the property to the estate in May of 2005.  The parties stipulated that as of Adler’s date of death, the fair market value of a fee simple interest in the entire property was $6,390,000.

On its Federal Estate Tax Return (Form 706), the estate reported that Adler owned a one-fifth interest in the property, and applied a 32% marketability discount and a 16% minority-interest discount to its value.  Further, the, on Form 706, Schedule G, Transfers During Decedent’s Life, the estate reported four separate one-fifth interest transfers in the property, each subject to a 22% marketability discount and a 16% minority-interest discount.  The parties stipulated that the date-of-death fair market value of a fee simple interest in the entire property was $6,390,000

Tax Court’s Analysis and Holding. The Tax Court disallowed the marketability and minority-interest discounts taken by Adler’s estate on Form 706 and held that the full fair market value of the property was includible in his gross estate.  In so holding, the Tax Court rejected the claim by the estate to apply fractional interest discounts since Adler effectively retained a 100% interest in the property during his lifetime.  The Court explained that, for tax purposes, the property should not be considered to have been divided among Adler’s children until after his death; therefore, his children each held a life estate in the property.  Accordingly, the property’s full fair market value of $6,390,000 was included in Adler’s gross estate.

Recommendations.  Although Adler executed a deed purportedly transferring his interest in his real property to his children, his actions clearly demonstrated that he retained full interest in the property until the time of his death.  If Adler had paid rent to his children for use of the property, or gifted a fractional interest in the land to his children during his lifetime (and the children contributed to pay the property tax and upkeep), then he may have been able to transfer a portion of his assets out of his estate and received fractional discounts for lack of marketability and minority interests.  The Tax Court’s ruling in this case prevents a taxpayer from reducing the value of his estate by making lifetime transfers that are essentially testamentary in nature, since the children were really only given a life estate in the property.