Estate of Lehmann v. Commissioner
| Decision Date | 26 August 1997 |
| Docket Number | Docket No. 1282-96. |
| Citation | 74 T.C.M. 415 |
| Parties | Estate of George A. Lehmann, Deceased, Walter G. Kealy, Jr., Personal Representative v. Commissioner. |
| Court | U.S. Tax Court |
James M. Kefauver and Lawrence L. Bell, Rockville, Md., for the petitioner. Warren P. Simonsen and Susan T. Mosley, for the respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
Respondent determined a deficiency in petitioner's Federal estate tax in the amount of $266,970. Petitioner is the Estate of George A. Lehmann (decedent). The issue for decision is whether petitioner correctly valued the partnership interests in LKB Associates for purposes of decedent's gross estate.
Unless otherwise indicated, all section references are to the Internal Revenue Code in effect as of the date of decedent's death, and all Rule references are to the Tax Court Rules of Practice and Procedure.
Some of the facts have been stipulated and are found accordingly. The stipulation of facts and accompanying exhibits are incorporated herein by this reference.
The Decedent died testate on April 1, 1992 (valuation date). Decedent resided in Montgomery County, Maryland. At the time the petition was filed, Walter G. Kealy, Jr., decedent's personal representative, resided in Gaithersburg, Maryland.
Decedent and his sister, Marie Louise Kealy, each owned, as tenants in common, one-half interest in the land located at L Street, in Washington, D.C. (property). On December 21, 1962, they agreed to lease the property for 99 years beginning as of January 1, 1963.
The lease required the lessee to construct any type of office building or commercial structure having a value of at least $500,000 in excess of the value of the land, but the agreement gave the lessee sole discretion in the design and subsequent demolition of the constructed structure during the firs— 69 years of the lease term. Thereafter, the lease required the lessee to seek permission before making any structural changes. The lease also permitted the lessee to sublet the property. During 1963 and 1964, the lessee improved the property by constructing a hotel on the property.
Decedent and Marie Louise Kealy and the lessee amended the ground lease on March 29, 1963, October 28, 1963, June 2, 1964, and November 4, 1964. The ground lease included procedures for resolving any disputes arising between the landlords and the tenant, providing in pertinent part:
14. The Lessors and the Lessee shall each appoint a disinterested real estate appraiser not related to any of them by consanguinity or affinity and who shall have knowledge of the value of commercial real estate in Washington, D.C. Written notice of such appointments by each party shall be given to the other on or before the twentieth (20th) day following the [designated] adjustments dates of the particular year, and the two appraisers so appointed shall on or before the tenth (10th) day thereafter appoint a third appraiser of like qualifications and non-interest who shall act as their chairman.
* * * * *
18. In the event that for any reason, whether through failure to appoint appraisers, or failure of the appraisers to act, no report of the fair market value is made within the time or times, respectively, * * * either party may apply to the American Arbitration Association or its successor for the appointment of an appraiser or appraisers to the end that the fair market value as contemplated by this Lease shall be determined.
19. In the event of a refusal or failure by the American Arbitration Association Or its successor to appoint an appraiser or appraisers either party may apply to the president or senior office of the Washington Real Estate Board or its successor for the appointment of an appraiser. No appraisal shall be invalid by reason of having been delayed or not having been made within the time or times, respectively * * *. Whenever an appraisal is so delayed, it shall be effective and binding upon the parties as to the rentals to be paid by the Lessee to the Lessors commencing on the adjustment date that a new rental basis shall begin according to the terms [of the lease]. The cost of any such appraisal made under this paragraph shall be borne and paid by the parties hereto whose neglect or default had made such appraisal necessary.
On December 19, 1983, decedent and his sister formed LKB Associates, a limited partnership organized under the laws of the District of Columbia (partnership). After forming the partnership, decedent and his sister conveyed the land subject to the 99-year lease to the partnership.
During his lifetime, decedent made gifts of partnership interests to various family members and to trusts, of which family members were beneficiaries. As of the valuation date, decedent owned a 1-percent general partnership interest and a 23.965903-percent limited partnership interest (decedent's interest). The partnership agreement granted the partners a right of first refusal, which required the selling partner to offer his or her interest to the other partners on the same terms before selling the interest to a third party. The agreement provided in pertinent part:
The interest of any Limited Partner may be assigned, transferred, sold, exchanged or otherwise disposed of (* * * collectively referred to as "assigned") in whole or in part, and each Limited Partner shall have a right to substitute an assignee as a Limited Partner in his place and stead, without in either case the consent of the General Partners, unless such assignment would cause a termination of the Partnership for federal income tax purposes, but any such assignment shall not relieve the assigning Partner of his obligations hereunder, unless consented to by the other Partners; provided, however, that no such assignment to a person other than a person related by blood or marriage to Marie Louise Kealy, Walter G. Kealy or George A. Lehmann shall be effective unless the interest assigned is first offered to the Partners, both collectively and individually, on the same terms and conditions for a period of ninety (90) days [hereafter referred to as right of first refusal].
The partnership agreement granted the general partners sole discretion in setting the management fee that they were entitled to receive from the partnership. Historically, the rate had been 2 percent of the partnership's gross rental income. In 1991, the general partners raised the fee from 2 percent to 5 percent of such income.
During 1983, a lawsuit was filed regarding the interpretation of certain terms of the ground lease. TO resolve the dispute, the partnership and the lessee amended the terms of the lease on January 30, 1984, to provide for, inter alia, periodic rent adjustments during the life of the lease (fifth amendment). The lease and the fifth amendment directed that the rent was to be adjusted every 10 years, beginning on January 1, 1993, to an amount equal to a specified percentage per annum (rental rate) of the fair market value of the land on the first day of the 10-year period as if the land were not encumbered by the lease (unencumbered land).
The fifth amendment specified that the rental rates for the periods from January 1, 1993, through December 31, 1998, and from January 1, 1999, through December 31, 2012, were 5.44 percent and 6.4 percent, respectively. Thereafter, the partnership and the lessee were to negotiate the rental rate for each 10-year period beginning on January 1, 2013, through the end of the lease, but in any event the negotiated rate was not to be less than 6.4 percent or more than 7.7 percent. The fifth amendment also required the partnership and the lessee to set the fair market value of the unencumbered land as of the first day of the 10-year period (adjustment date).
The fifth amendment added additional procedures for resolving disputes, providing in pertinent part:
If the parties are unable to agree on the * * * Rental rate to be applicable in the following period prior to any decennial rent adjustment date from and after January 1, 2013, the appropriate [p]ercentage (not less than 6.4% or more than 7.7%) shall be determined by appraisers appointed to determine such * * * Rental rate consistent with the procedure for determining the fair market value of the unimproved land under the [ground lease].
As of the valuation date, the principal assets of the partnership were the leased fee interest in the property and a cash balance of $64,339. In addition, as of that date, the lessee maintained a 99-room hotel with an occupancy rate of 65 percent.
In connection with the preparation of the estate tax return, petitioner obtained a valuation of decedent's interest from P. Richard Zitelman of the Zitelman Group, Inc. Zitelman determined that, as of the valuation date, the fair market value of decedent's interest was $399,000. Petitioner included this amount in the gross estate. Respondent determined the fair market value of the decedent's interest as of the date of death was $1,070,000. Subsequently, respondent conceded $262,000 of that adjustment.
OPINIONWe must decide whether petitioner properly valued decedent's interest in the partnership for purposes of section 2031(a). Petitioner must prove that respondent's determination of value set forth in the notice of deficiency is incorrect. Rule 142(a); Welch v. Helvering [3 USTC ¶ 1164], 290 U.S. 111, 115 (1933); Estate of Gilford v. Commissioner [Dec. 43,622], 88 T.C. 38, 51 (1987).
The parties agree that decedent's interest should be valued as a limited partnership interest notwithstanding the fact that decedent held a 1-percent general partnership interest as of the valuation date but do not agree upon the value of that interest or upon the method by which decedent's interest should be valued. Respondent's expert used the fractional discount method, whereas petitioner's expert used the discounted cash-flow (DCF) method.
The parties primarily...
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