SUMMARY: An appellate opinion granting a 44.75% discount for a fractional ownership interest in artwork has limited precedential value.
The Fifth Circuit Court of Appeals recently overruled the Tax Court's 10% fractional interest discount allowed for artwork in an estate tax valuation case. Instead, the appellate court allowed in full the 44.75% discount taken on the Form 706.
The case is of benefit to taxpayers because it does affirm the Tax Court's conclusion that a fractional interest discount is allowable for divided family ownership interests in artwork. The IRS had argued (and lost) before the Tax Court that no fractional interest discount was appropriate. After determining that some fractional discount was appropriate, the Tax Court crafted its own appropriate discount of 10%.
However, the case is not an endorsement the 44.75% discount is appropriate. Instead, the appellate court allowed the full discount taken based more on procedural issues than an objective determination that such a large discount is sustainable in a bona fide valuation dispute. This is because in the Tax Court proceeding, the IRS offered no testimony or evidence on value other than its zero discount position. Once the Tax Court determined that the zero discount position was incorrect, the Tax Court had to determine the value based on the evidence before it. Since the only evidence before it was evidence of the taxpayer supporting the 44.75% discount, the appellate court found that the Tax Court was obligated to accept that 44.75% discount because there was no contrary testimony or evidence offered by the government.
So what does this case offer us? It does sustain a fractional interest discount in artwork in a family situation, but only provides limited guidance as to what an appropriate discount should be. Also, the Tax Court opinion conclusion that restrictions in a co-tenancy agreement that limited the sale of the co--owned art only upon agreement of all owners was not a restriction that could be considered in valuing the fractional interests (i.e., it could not be used to reduce value) is an item to consider in transfer tax valuations. The Tax Court's conclusion was that Code Section 2703(a)(2) prevented the consideration of such a restriction. That Code provision provides that "[f]or purposes of this subtitle, the value of any property shall be determined without regard to... any restriction on the right to sell or use such property." Interestingly, the Tax Court did not hold that the unanimous consent provision was a restriction on sale per se, because cotenants cannot sell the jointly owned property without the consent of all joint owners even without such an agreement. Instead, the unanimous consent provision was interpreted as a waiver of the right of partition of the cotenants, which restriction was nonetheless still described under Code Section 2703(a)(2) and thus was not allowed to enter into the valuation equation.
Estate of Elkins, Junior V. Comm., 114 AFTR 2d 2014-5985 (CA5), 09/15/2014