News 2017

White Paper - Fractional Interest Discounts Real Estate

By: John D. Penner, MAI

A fractional (or partial) interest discount on the value of a real estate property is allowable by the IRS when there is less than a 100% interest in the business entity that owns the real estate. The discount relates to the fact that the ownership interest has a "Lack of Control" over the operation and disposition of the real estate and a "Lack of Marketability" due to the difficulty in selling an interest that is not publicly-traded and is not easily financeable.

Examples of ownership entities that own a fractional interest include:

  • Limited Partnerships (LP)
  • Limited Liability Partnerships (LLP)
  • Limited Liability companies (LLC)
  • Tenants in Common (TIC)

The two instances where this discount generally applies are for the gifting of a fractional interest or upon the death of a person that owns a fractional interest in real estate.

Courts have held that discounts for lack of control and marketability exist in the market and should therefore be considered when valuing a fractional ownership interest. The amount of the discounts can vary depending upon the:

  • Particular ownership entity to be valued
  • Percentage of ownership
  • Rate of return on the investment
  • Amount of debt
  • Market time and conditions in which it is to be considered

Based on our experience in the market we have seen discounts as low as 15% and as high as 67%. The majority of these transactions ranged from a discount of 25% to 40%. In each instance, the ownership interest needs to be valued based on its own specific merits.

Finally, it is noted that upon submission, the IRS requires support in the form of an appraisal for the determination of a discount pertaining to a fractional interest. Per IRS guidelines, the appraisal must consist of a "qualified appraisal" and be completed by a "qualified appraiser."

Valbridge Property Advisors is the largest independent commercial valuation firm in North America and includes a proprietary national database of fractional interest sales. Our appraisals are the most comprehensive in the industry and will help your client sleep better at night.

For more information or questions contact the National Director for Fractional Interest Valuation John D. Penner.

Phone: (714) 449-0852