932 / How is timber valued for federal transfer tax purposes?

The estate tax regulations offer little guidance in the selection of an appropriate method for valuing timber property. However, Treasury Regulation Section 1.611-3(f), covering the depletion allowance deduction for income tax purposes, contains the following useful information:

(f)  Determination of fair market value of timber property.

(1)     If the fair market value of the property at a specified date is the basis for depletion deductions, such value shall be determined, subject to approval or revision by the district director upon audit, by the owner of the property in the light of the most reliable and accurate information available with reference to the condition of the property as it existed at that date, regardless of all subsequent changes, such as changes in surrounding circumstances, and methods of exploitation, in degree of utilization, etc. Such factors as the following will be given due consideration:

(i)   Character and quality of the timber as determined by species, age, size, condition, etc.;

(ii)  The quantity of timber per acre, the total quantity under consideration, and the location of the timber in question with reference to other timber;

(iii) Accessibility of the timber (location with reference to distance from a common carrier, the topography and other features of the ground upon which the timber stands and over which it must be transported in process of exploitation, the probable cost of exploitation and the climate and the state of industrial development of the locality); and

(iv) The freight rates by common carrier to important markets.

(2)     The timber in each particular case will be valued on its own merits and not on the basis of general averages for regions; however, the value placed upon it, taking into consideration such factors as those mentioned in this paragraph, will be consistent with that of other similar timber in the region. The district director will give weight and consideration to any and all facts and evidence having a bearing on the market value, such as cost, actual sales and transfers of similar properties, the margin between the cost of production and the price realized for timber products, market value of stock or shares, royalties and rentals, valuation for local or State taxation, partnership accountings, records of litigation in which the value of the property has been involved, the amount at which the property may have been inventoried or appraised in probate or similar proceedings, disinterested appraisals by approved methods, and other factors.”

In a case involving estate tax valuation of undivided minority interests in timberland, the Tax Court, quoting from paragraph (2) of the foregoing regulation, added that, where available, the use of comparative sales is the method of valuation most preferred by that court and by the Ninth Circuit (to which appeal lay). As the Court found, few sales exist of undivided minority interests in timberland based on the inability of the owner to control the timberland, which should impact the overall value as no market may exist.

In that case, the government’s appraisers based their valuation on 24 sales of “stumpage” believed by them to be the most comparable because of their similar characteristics and their proximity in time to the valuation date and in location to the subject property. In addition, the appraisers used seven other transactions involving timber and land in the same general vicinity. The prices of the sales considered comparable were adjusted by the appraisers for differences in timber, quality, accessibility and other logging costs, volume, species mix, and time of sale. The government’s appraisers concluded that the total value of the timber on the land in which decedent had an undivided interest was $29,500,000 at the date of her death. With one exception, the government’s appraisers used the same sales as comparables to determine that the value of the underlying land supporting the timber at decedent’s death was $9,500,000.

The executor, however, contended that the sales upon which the government’s appraisers relied involved timber that was not comparable to the timber in which the decedent had an undivided interest. He also contended that the sales used as comparables by the government’s appraisers were not properly adjusted to bring them into comparability. With respect to the government’s land valuation, the executor contended that the appraisal failed to adjust for acreage in the subject land that was barren, or to adjust adequately for differences in steepness of terrain.

The court examined the points of difference between the parties, found merit in several of the executor’s contentions, and concluded that the government’s valuation should be reduced by 20 percent, i.e., to $31,200,000.

The final issue in the case was the issue of a minority discount to be applied to the decedent’s undivided aliquot portion of the $31,200,000 valuation. The government contended that no minority discount should be allowed. The executor contended that a discount of at least 60 percent was warranted. On this issue the estate’s witnesses were persuasive. The court was convinced from their testimony of the disabilities associated with a minority undivided interest in timber property, including lack of marketability, lack of management, lack of general control, lack of liquidity, and potential partitionment expenses, that a minority discount of 60 percent was reasonable, and the court so held.¹ See also Harwood v. Comm.,² which concerned valuation of a minority interest in a limited partnership engaged in the timber business.