Giustina v. Commissioner: Taxpayer-Friendly Tax Court Decision Provides Guidance on Estate Valuations
After several years of legal wrangling, the valuation issue, which was the crux of the dispute in Giustina v. Commissioner, was recently revisited by US Tax Court, which provided an updated valuation methodology and calculation. The news is heartening for high net worth individuals preparing for estate planning and gifting as well as for those who advise high net worth individuals – especially in Western states (AK, WA, MT, OR, ID, CA, NV, AZ, HI, and Guam/Mariana Islands). As this latest Tax Court decision is taxpayer-friendly, it is possible the IRS could appeal, but for the time being, this recent case provides substantial guidance.
The original 2011 case centered on divergent valuation methods related to a testamentary transfer of a 41% limited partnership ownership interest in a family-owned timber and forestry business. The agreed value of the underlying land was $143 million plus $10m of additional assets. The two methods in dispute were Discounted Cash Flow (DCF) and Net Asset Value (NAV). The IRS expert originally argued the DCF method, while the national valuation firm for the estate argued for the remainder value using the NAV method.
After hearing arguments, the original Tax Court ruling concluded that the value was to be based 75% on DCF because, in part, the company had continuously acquired and held assets and a liquidation was unlikely. The Court reasoned that the cash flow was 75% likely, and the remainder of the value (25%) should follow the NAV, with further discounts on lack of marketability, arriving at a net value of $27.5m for the 41% interest. The estate had argued for approximately half that value.
The estate appealed to the 9th Circuit and won a remand which resulted in the current recalculation released June 13, 2016. The Appeals Court struck down the DCF because it did not want to delve into the probability of a liquidating sale or the retention of the underlying assets. In the current decision, the Tax Court revalued the case purely on the discounted cash flow model, as if the timber company were retained as a going concern and the assets would not be liquidated. The other aspect of the remand was more detailed and speaks to the various risk premiums used to calculate the net DCF result and what the cost of capital used in the discounting process would yield. The newly revised value totaled $13.9 million – or roughly half of the original Court's valuation.
The key takeaway from the new ruling is that the revised model essentially ignores the underlying land value completely and relies solely on the cash flow generated by operations.
The Giustina family was very persistent, and the Tax Court actually came back with a better result. The new method doesn't include a value for the land, but only the "picked" trees and the value generated by the continued holdings by "farming" the underlying land.
The key issue in this final result is that it is possible to transfer appreciated property at the cash flow value only and to essentially ignore the underlying value of the assets which generate that cash flow.