In Stone v. United States, No. 07-17068 (9th Cir. March 24, 2009), the U.S. Court of Appeals for the Ninth Circuit affirmed the decision of the U.S District Court for the Northern District of California to adopt a 5 percent discount offered by the government.

The District Court had rejected the estate’s claimed discount of 44 percent, because the estate’s appraiser (an expert in valuing businesses) was not persuasive on how discounts should apply to artwork as compared to other types of investments.

The District Court held that a fractional interest discount did apply to the estate’s interest in the artwork, but that it was limited to the cost and time to obtain a court-ordered partition.

When the parties were unable to reach an agreement on the amount of such a discount, the District Court defaulted to the overall 5 percent discount proposed by the Internal Revenue Service, holding that the estate had not demonstrated that a higher discount was warranted.  

The 5 percent discount included 2 percent to account for the actual costs of selling the art by an auction house, $50,000 to account for legal fees required to enforce the hypothetical seller's right to partition, and a “time value” discount (for the time it would take to sell the artwork.)

The Ninth Circuit agreed with the District Court that the estate bore the burden of establishing that the appropriateness and size of a fractional interest discount. The Ninth Circuit also found no error in the District Court’s conclusion that the estate’s evidence was neither probative nor convincing.

Stone makes clear that an estate’s holding or a taxpayer’s giving away partial interests in artwork must provide valuation reports that are specific and tailored to partial interests in art.

Generally, appraisers should be experienced in valuing the specific type of property at issue.  

Given the infrequency of sales of partial interests in art and the corresponding lack of data, it may be difficult to justify a significant discount of such interests.  To obtain larger discounts on partial interests in artwork, owners could contractually waive their partition rights.

Alternatively, they could transfer their interests to a family limited partnership or limited liability company, thereby obtaining a discount based on the lack of control over the entity and the lack of marketability of their interests.

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