UNITED STATES TAX COURT



ESTATE OF W.W. JONES II, DECEASED, A.C. JONES IV, INDEPENDENT
                    EXECUTOR, Petitioner v.
         COMMISSIONER OF INTERNAL REVENUE, Respondent



   Docket No. 13926-98.                     Filed March 6, 2001.

        D formed a family limited partnership (JBLP) with
   his son and transferred assets including real property,
   to JBLP in exchange for a 95.5389-percent limited
   partnership interest. D also formed a family limited
   partnership (AVLP) with his four daughters and
   transferred real property to AVLP in exchange for an
   88.178-percent limited partnership interest. D’s son
   contributed real property in exchange for general and
   limited partnership interests in JBLP, and the
   daughters contributed real property in exchange for
   general and limited partnership interests in AVLP. All
   of the contributions were properly reflected in the
   capital accounts of the contributing partners.
   Immediately after formation of the partnerships, D
   transferred by gift an 83.08-percent limited
   partnership interest in JBLP to his son and a
   16.915-percent limited partnership interest in AVLP to
   each of his daughters.
                               - 2 -


          Held: The transfers of property to the
     partnerships were not taxable gifts. See Estate of
     Strangi v. Commissioner, 

(2000).

          Held, further, sec. 2704(b), I.R.C., does not
     apply to this transaction. See Kerr v. Commissioner,
     

(1999).

          Held, further, the value of D’s gift to his son
     was 83.08-percent of the value of the underlying assets
     of JBLP, reduced by a lack-of-marketability (8%)
     discount. The value of D’s gift to each of his
     daughters was 16.915 percent of the value of the
     underlying assets of AVLP, reduced by secondary
     market (40%) and lack-of-marketability (8%) discounts.

          Held, further, the gifts of limited partnership
     interests are not subject to additional lack-of-
     marketability discounts for built-in capital gains.
     Estate of Davis v. Commissioner, 

(1998),
     distinguished.



     William R. Cousins III, Robert Don Collier, Robert M.

Bolton, and Todd A. Kraft, for petitioner.

     Deborah H. Delgado and Gerald L. Brantley, for respondent.



     COHEN, Judge:   Respondent determined a deficiency of

$4,412,527 in the 1995 Federal gift tax of W.W. Jones II.    The

issues for decision are (alternatively):   (1) Whether the

transfers of assets on formation of Jones Borregos Limited

Partnership (JBLP) and Alta Vista Limited Partnership (AVLP)

(collectively, “the partnerships”) were taxable gifts pursuant to

section 2512(b); (2) whether the period of limitations for

assessment of gift tax deficiency arising from gifts on formation
                                 - 3 -


is closed; (3) whether restrictions on liquidation of the

partnerships should be disregarded for gift tax valuation

purposes pursuant to section 2704(b); and (4) the fair market

value of interests in the partnerships transferred by gift after

formation.   Unless otherwise indicated, all section references

are to the Internal Revenue Code in effect on the date of the

transfers, and all Rule references are to the Tax Court Rules of

Practice and Procedure.

                          FINDINGS OF FACT

     Some of the facts have been stipulated, and the stipulated

facts are incorporated in our findings by this reference.   W.W.

Jones II (decedent), resided in Corpus Christi, Texas, at the

time the petition in this case was filed.    Decedent subsequently

died on December 17, 1998, and a motion to substitute the estate

of W.W. Jones II, deceased, A.C. Jones IV, independent executor,

as petitioner was granted.   The place of probate of decedent’s

estate is Nueces County, Texas.    At the time of his appointment

as executor, A.C. Jones IV (A.C. Jones), also resided in Nueces

County, Texas.

     For most of his life, decedent worked as a cattle rancher in

southwest Texas.   Decedent had one son, A.C. Jones, and four

daughters, Elizabeth Jones, Susan Jones Miller, Kathleen Jones

Avery, and Lorine Jones Booth.
                                - 4 -


     During his lifetime, decedent acquired, by gift or bequest,

the surface rights to several large ranches, including the Jones

Borregos Ranch, consisting of 25,669.49 acres, and the Jones Alta

Vista Ranch, consisting of 44,586.35 acres.    These ranches were

originally acquired by decedent’s grandfather and have been held

by decedent’s family for several generations.    The land on these

ranches is arid natural brushland, and commercial uses include

raising cattle and hunting.

     Motivated by his desire to keep the ranches in the family,

decedent became involved in estate planning matters beginning in

1987.    In 1994, decedent’s certified public accountant suggested

that decedent use partnerships as estate and business planning

tools.    Following up on this suggestion, A.C. Jones prepared

various projections for decedent concerning a hypothetical

transfer of the ranches to partnerships and the discounted values

that would attach to the partnership interests for gift tax

purposes.

     A.C. Jones, Elizabeth Jones, Susan Jones Miller, Kathleen

Jones Avery, and Lorine Jones Booth each owned a one-fifth

interest in the surface rights of the Jones El Norte Ranch.      They

acquired this ranch by bequest from decedent’s aunt in 1979.     The

Jones El Norte Ranch was also originally owned by decedent’s

grandfather and has also been owned by decedent’s extended family

for several generations.
                                - 5 -


     Effective January 1, 1995, decedent and A.C Jones formed

JBLP under Texas law.    Decedent contributed the surface estate of

the Jones Borregos Ranch, livestock, and certain personal

property in exchange for a 95.5389-percent limited partnership

interest.   The entire contribution was reflected in the capital

account of decedent.    A.C. Jones contributed his one-fifth

interest in the Jones El Norte Ranch in exchange for a 1-percent

general partnership interest and a 3.4611-percent limited

partnership interest.

     On January 1, 1995, the same day that the partnership was

effectively formed, decedent gave to A.C. Jones an 83.08-percent

interest in JBLP, leaving decedent with a 12.4589-percent limited

partnership interest.    Decedent used a document entitled “Gift

Assignment of Limited Partnership Interest” to carry out the

transfer.   The document stated that decedent intends that A.C.

Jones receive the gift as a limited partnership interest.

     Federal income tax returns for 1995, 1996, 1997, and 1998

were filed for JBLP and signed by A.C. Jones as tax matters

partner.    Attached to each return were separate Schedules K-1 for

each general partnership interest and each limited partnership

interest.   The Schedules K-1 for the limited partnership interest

of A.C. Jones included the interest in partnership received by

gift from decedent.
                                - 6 -


     Also effective January 1, 1995, decedent and his four

daughters formed AVLP under Texas law.      Decedent contributed the

surface estate of the Jones Alta Vista Ranch in exchange for an

88.178-percent limited partnership interest.     The contribution

was reflected in decedent’s capital account.     Susan Jones Miller

and Elizabeth Jones each contributed their one-fifth interests in

the Jones El Norte Ranch in exchange for 1-percent general

partnership interests and 1.9555-percent limited partnership

interests, and Kathleen Jones Avery and Lorine Jones Booth each

contributed their one-fifth interest in the Jones El Norte Ranch

in exchange for 2.9555-percent limited partnership interests.

The following chart summarizes the ownership structure of AVLP

immediately after formation:

          Partner              Percentage          Interest

          Elizabeth Jones       1.0                 General
                                1.9555              Limited
          Susan Jones Miller    1.0                 General
                                1.9555              Limited
          Kathleen Jones Avery 2.9555               Limited
          Lorine Jones Booth    2.9555              Limited
          Decedent             88.178               Limited

     On January 1, 1995, the same day that the partnership was

effectively formed, decedent gave to each of his four daughters a

16.915-percent interest in AVLP, leaving decedent with a

20.518-percent limited partnership interest.     Decedent used four

separate documents, one for each daughter, entitled “Gift

Assignment of Limited Partnership Interest” to carry out the
                                - 7 -


transfers.    Each document stated that decedent intended for his

daughters to receive the gifts as limited partnership interests.

     Federal income tax returns for 1995, 1996, 1997, and 1998

were filed for AVLP and signed by Elizabeth Jones as tax matters

partner.    Attached to each return were separate Schedules K-1 for

each general partnership interest and each limited partnership

interest.    The Schedules K-1 for each daughter’s limited

partnership interest included the partnership interest received

by gift from decedent.

     Decedent’s attorney drafted the partnership agreements of

both JBLP and AVLP with the intention of creating substantial

discounts for the partnership interests that were transferred by

gift.   Both partnership agreements set forth conditions for when

an interest that is transferred by gift or by other methods may

convert to a limited partnership interest.    Section 8.3 of the

JBLP agreement provides that the general partner and 100 percent

of the limited partners must approve the conversion to a limited

partnership interest in writing, and section 8.3 of the AVLP

agreement provides that the general partners and 75 percent of

the remaining limited partners must approve the conversion in

writing.    Both agreements also require that an assignee execute a

writing that gives assurances to the other partners that the

assignee has acquired such interest without the intention to

distribute such interest, and the assignee must execute a
                               - 8 -


counterpart to the partnership agreement adopting the conditions

therein.

     Sections 8.4 and 8.5 of the partnership agreements provide

that, before a partner may transfer an interest in the

partnerships to anyone other than decedent or any lineal

descendant of decedent, the partnership or remaining partners

shall have the option to purchase the partnership interest for

the lesser of the agreed upon sales price or appraisal value.

The partnership may elect to pay the purchase price in 10 annual

installments with interest set at the minimum rate allowed by the

rules and regulations of the Internal Revenue Service.

     Section 9.2 of the agreements provides that the partnerships

will continue for a period of 35 years.   Section 9.3 provides

that a limited partner will not be permitted to withdraw from the

partnership, receive a return of contribution to capital, receive

distributions in liquidation, or redemption of interest except

upon dissolution, winding up, and termination of the partnership.

     Section 9.4 of the partnership agreements provides for the

removal of a general partner and the dissolution of the

partnership.   The AVLP agreement provides that a general partner

may be removed at any time by the act of partners owning an

aggregated 75-percent interest in the partnership.   The JBLP

agreement provides that a general partner may be removed at any

time by the act of the partners owning an aggregated 51-percent
                                - 9 -


interest in the partnership.   After removal, if there is no

remaining general partner, the remaining limited partners shall

designate a successor general partner.   If the limited partners

fail to designate a successor general partner within 90 days, the

partnership will dissolve, affairs will be wound up, and the

partnership will terminate.    Except upon dissolution, windup, and

termination, both partnership agreements prohibit a limited

partner from withdrawing and receiving a return of capital

contribution, distribution in liquidation, or a redemption of

interest.

     Section 5.4 of the AVLP agreement originally provided that

the general partners could not sell any real property interest

that was owned by the partnership without first obtaining the

consent of partners owning a majority interest in the

partnership.   This section was later amended so that partners

owning 85 percent of the partnership must consent to a sale of

real property.

     On January 1, 1995, the Jones Alta Vista Ranch had a fair

market value of $10,254,860, and the Jones Borregos Ranch,

livestock, and personal property that were contributed by

decedent to JBLP had a fair market value of $7,360,997.   Neither

partnership ever made a section 754 election.   At the time that

decedent transferred interests in the partnerships by gift to his

children, the net asset values (NAV) of the underlying
                               - 10 -


partnership assets that were held by AVLP and JBLP were

$11,629,728 and $7,704,714, respectively.    JBLP and AVLP had

bases in their assets of $562,840 and $1,818,708, respectively.

     Attached to his 1995 Federal gift tax return, decedent

included a valuation report prepared by Charles L. Elliott, Jr.

(Elliott), who also testified as the estate’s expert at trial.

The partnerships were valued on the return and by Elliott at

trial using the NAV method on a “minority interest,

nonmarketable” basis.   Nowhere in his report did Elliott purport

to be valuing assignee interests in the partnership.    The

valuation report arrived at an NAV for the partnerships and then

applied secondary market, lack-of-marketability, and built-in

capital gains discounts.    The expert report concluded that a

66-percent discount from NAV is applicable to the interest in

JBLP and that a 58-percent discount is applicable to the interest

in AVLP.    On the return, decedent reported gifts of “an

83.08 percent limited partnership interest” in JBLP valued at

$2,176,864 and a “16.915 percent limited partnership interest” in

AVLP to each of his four daughters, valued at $821,413 per

interest.

     In an affidavit executed on January 12, 1999, A.C. Jones

stated that the gifts that he and his sisters received from

decedent were “limited partnership interests”.    The sole activity
                              - 11 -


of AVLP is the rental of its real property.   AVLP produces an

average annual yield of 3.3 percent of NAV.

                              OPINION

Gift at the Inception of the Partnerships

     In an amendment to the answer, respondent contends that

decedent made taxable gifts upon contributing his property to the

partnerships.   Using the value reported by decedent on his gift

tax return, respondent argues that, if decedent gave up property

worth $17,615,857 and received back limited partnership interests

worth only $6,675,156, decedent made taxable gifts upon the

formation of the partnerships equal to the difference in value.

     In Estate of Strangi v. Commissioner, 

, 489-490

(2000), a decedent formed a family limited partnership with his

children and transferred assets to the partnership in return for

a 99-percent limited partnership interest.    After his death, his

estate claimed that, due to lack-of-control and lack-of-

marketability discounts, the value of the limited partnership

interest was substantially lower than the value of the property

that was contributed by the decedent.   The Commissioner argued

that the decedent had made a gift when he transferred property to

the partnership and received in return a limited partnership

interest of lesser value.   The Court held that, because the

taxpayer received a continuing interest in the family limited

partnership and his contribution was allocated to his own capital
                               - 12 -


account, the taxpayer had not made a gift at the time of

contribution.

       In Shepherd v. Commissioner, 

, 379-381 (2000),

the taxpayer transferred real property and stock to a newly

formed family partnership in which he was a 50-percent owner and

his two sons were each 25-percent owners.    Rather than allocating

contributions to the capital account of the contributing partner,

the partnership agreement provided that any contributions would

be allocated pro rata to the capital accounts of each partner

according to ownership.    Because the contributions were reflected

partially in the capital accounts of the noncontributing

partners, the value of the noncontributing partners’ interests

was enhanced by the contributions of the taxpayer.    Therefore,

the Court held that the transfers to the partnership were

indirect gifts by the taxpayer to his sons of undivided

25-percent interests in the real property and stock.    See 

       The contributions of property in the case at hand are

similar to the contributions in Estate of Strangi and are

distinguishable from the gifts in Shepherd.    Decedent contributed

property to the partnerships and received continuing limited

partnership interests in return.    All of the contributions of

property were properly reflected in the capital accounts of

decedent, and the value of the other partners’ interests was not
                              - 13 -


enhanced by the contributions of decedent.    Therefore, the

contributions do not reflect taxable gifts.

     Because the contributions do not reflect taxable gifts, we

need not decide whether the period of limitations for assessment

of a deficiency due to a gift on formation has expired.

Section 2704(b)

     Respondent determined in the statutory notice, and argues in

the alternative, that provisions in the partnership agreements

constitute applicable restrictions under section 2704(b) and must

be disregarded when determining the value of the partnership

interests that were transferred by gift.

     Section 2704(b) generally states that, where a transferor

and his family control a partnership, a restriction on the right

to liquidate the partnership shall be disregarded when

determining the value of the partnership interest that has been

transferred by gift or bequest if, after the transfer, the

restriction on liquidation either lapses or can be removed by the

family.   Section 25.2704-2(b), Gift Tax Regs., provides that an

applicable restriction is a restriction on “the ability to

liquidate the entity (in whole or in part) that is more

restrictive than the limitations that would apply under the State

law generally applicable to the entity in the absence of the

restriction.”
                              - 14 -


     Respondent argues that both partnership agreements contain

provisions limiting the ability of a partner to liquidate that

are more restrictive than the default Texas partnership

provisions.   Specifically, respondent points to section 9.2 of

the partnership agreements, which provides that each partnership

shall continue for a period of 35 years.   Respondent also points

to section 9.3 of the partnership agreements, which prohibits a

limited partner from withdrawing from the partnership or from

demanding the return of any part of a partner’s capital account

except upon termination of the partnership.

     Respondent compares sections 9.2 and 9.3 of the partnership

agreements with section 6.03 of the Texas Revised Limited

Partnership Act (TRLPA).   TRLPA section 6.03 provides:

     A limited partner may withdraw from a limited
     partnership at the time or on the occurrence of events
     specified in a written partnership agreement and in
     accordance with that written partnership agreement. If
     the partnership agreement does not specify such a time
     or event or a definite time for the dissolution and
     winding up of the limited partnership, a limited
     partner may withdraw on giving written notice not less
     than six months before the date of withdrawal to each
     general partner * * *.

Tex. Rev. Civ. Stat. Ann. art. 6132a-1, sec. 6.03 (West Supp.

1993).

     Respondent’s argument is essentially the same as the

argument we rejected in Kerr v. Commissioner, 

, 469-

474 (1999).   In Kerr, the taxpayers and their children formed two
                               - 15 -


family limited partnerships with identical liquidation

restrictions.    Shortly after formation, the taxpayers transferred

limited partnership interests to their children by gift.      On

their Federal gift tax return, the taxpayers claimed substantial

discounts in the value of the interests compared to the value of

the underlying assets due to lack of control and lack of

marketability.   The partnership agreements provided that the

partnerships would continue for 50 years.

     The Court held:

     Respondent’s reliance on TRLPA section 6.03 is
     misplaced. TRLPA section 6.03 governs the withdrawal
     of a limited partner from the partnership--not the
     liquidation of the partnership. TRLPA section 6.03
     sets forth limitations on a limited partner’s
     withdrawal from a partnership. However, a limited
     partner may withdraw from a partnership without
     requiring the dissolution and liquidation of the
     partnership. In this regard, we conclude that TRLPA
     section 6.03 is not a “limitation on the ability to
     liquidate the entity” within the meaning of section
     25.2704-2(b), Gift Tax Regs.

  In sum, the Court concluded that the partnership

agreements in Kerr were not more restrictive than the limitations

that generally would apply to the partnerships under Texas law.

See 

   Respondent acknowledges that Kerr is

applicable to this issue but argues that Kerr was incorrectly

decided.   However, we find no reason to reach a result that is

different than the result in Kerr.      Thus, section 2704(b) does
                               - 16 -


not apply here.   See also Knight v. Commissioner, 

,

519-520 (2000); Harper v. Commissioner, T.C. Memo. 2000-202.

Valuation of Decedent’s Gifts of
Limited Partnership Interests

     A gift of property is valued as of the date of the transfer.

See sec. 2512(a).    The gift is measured by the value of the

property passing from the donor, rather than by the property

received by the donee or upon the measure of enrichment to the

donee.   See sec. 25.2511-2(a), Gift Tax Regs.   The fair market

value of the transferred property is the price at which the

property would change hands between a willing buyer and willing

seller, neither being under any compulsion to buy or to sell and

both having reasonable knowledge of relevant facts.    See United

States v. Cartwright, 

, 551 (1973); sec. 25.2512-1,

Gift Tax Regs.    The hypothetical willing buyer and the

hypothetical willing seller are presumed to be dedicated to

achieving the maximum economic advantage.    See Estate of Davis v.

Commissioner, 

, 535 (1998).     Transactions that are

unlikely and plainly contrary to the economic interests of a

hypothetical willing buyer or a hypothetical willing seller are

not reflective of fair market value.    See Estate of Strangi v.

Commissioner, 

, 491 (2000); Estate of Newhouse v.

Commissioner, 

, 232 (1990); Estate of Hall v.

Commissioner, 

, 337 (1989).
                               - 17 -


       As is customary for valuation issues, the parties rely

extensively on the opinions of their respective experts to

support their differing views about the fair market value of the

gifts of partnership interests.    The estate relies on Elliott, a

senior member of the American Society of Appraisers and a

principal in the business valuation firm of Howard Frazier Barker

Elliott, Inc.    Respondent relies on Francis X. Burns (Burns), a

candidate member of the American Society of Appraisers and a

principal in the business valuation firm of IPC Group, Inc.        Each

expert prepared a report.

       We evaluate the opinions of the experts in light of the

demonstrated qualifications of each expert and all other evidence

in the record.    See Estate of Davis v. 

at

536.    We are not bound by the formulae and opinions proffered by

expert witnesses, especially when they are contrary to our

judgment.    Instead, we may reach a determination of value based

on our own examination of the evidence in the record.      Where

experts offer contradicting estimates of fair market value, we

decide what weight to give those estimates by examining the

factors used by the experts in arriving at their conclusions.

See 

valuation is necessarily an

approximation, it is not required that the value that we

determine be one as to which there is specific testimony,

provided that it is within the range of figures that properly may
                                - 18 -


be deduced from the evidence.    See Silverman v. Commissioner,

, 933 (2d Cir. 1976), affg. T.C. Memo. 1974-285.      The

experts in this case agree that, in ascertaining the fair market

value of each gift of interest in the partnerships, one starts

with the fair market value of the underlying assets of each

partnership and then applies discounts for factors that limit the

value of the partnership interests.

     A.   Nature of Interests Transferred

     The first argument of the estate is that the partnership

interests that were transferred by decedent were assignee

interests rather than limited partnership interests.   The estate

claims that decedent and the recipients of the gifts did not

fulfill the necessary requirements set forth in the partnership

agreements for transferring limited partnership interests.    The

JBLP agreement provides that, upon an exchange of an interest in

the partnership, the general partner and 100 percent of the

remaining limited partners must approve, in writing, of a

transferred interest becoming a limited partnership interest.

The AVLP agreement provides that the general partners and

75 percent of the limited partners must approve, in writing, of a

transferred interest’s becoming a limited partnership interest.

Because these written approvals were not carried out, the estate

contends that the recipients of the gifts are entitled only to

the rights of assignees.
                               - 19 -


     In Kerr v. Commissioner, 

, 464 (1999), the

taxpayers held greater than 99 percent of the partnership

interests of two family limited partnerships as general and

limited partners.    The taxpayers’ children held the remaining

partnership interests, totaling less than 1 percent of overall

ownership, as general partners.    The partnership agreements

provided that no person would be admitted as a limited partner

without the consent of all general partners.    In 1994, the

taxpayers transferred a large portion of their limited

partnership interests to trusts for which they served as

trustees.    At trial, the taxpayers argued that, although they

made these transfers to themselves as trustees, pursuant to the

family limited partnership agreement, their children as general

partners had to consent to the admission of the trustees as

limited partners.    The taxpayers argued that the interests held

by the trusts should be valued as assignee interests.     The Court

looked at all of the surrounding facts and circumstances in

holding that the interests that were transferred by the taxpayers

were limited partnership interests.     See 

     On review of the facts and circumstances of the case at

hand, decedent, like the taxpayers in Kerr, transferred limited

partnership interests to his children rather than assignee

interests.   The evidence shows that decedent intended for the

transfers to include limited partnership interests and that the
                                - 20 -


children consented to the transfer of limited partnership

interests, having waived the requirement of a writing.

     Pursuant to the AVLP agreement, Susan Jones Miller and

Elizabeth Jones as general partners would have had to consent in

writing to the transfer of the interests as limited partnership

interests.   Also, 75 percent of the remaining limited partners,

i.e., Elizabeth Jones, Susan Jones Miller, Kathleen Jones Avery,

Lorine Jones Booth, and decedent, would have had to consent in

writing.   Pursuant to the JBLP agreement, A.C. Jones as general

partner would have had to consent in writing to the transfer as a

limited partnership interest.    Also, all of the remaining limited

partners, i.e., A.C. Jones and decedent, would have had to

consent in writing.

     Although the estate argues that the absence of written

consents leads to the conclusion that the interests transferred

were assignee interests, it is difficult to reconcile that

position with the language that decedent, his children, and

Elliott used to document and characterize the transfers.    First,

the documents entitled “Gift Assignment of Limited Partnership

Interest”, created by decedent to carry out the transfers, state

that, after the transfers are complete, each child will hold his

or her newly acquired interest as a “limited partnership

interest”.   Second, in his 1995 Federal gift tax return, decedent

describes the gifts as “limited partnership interests” rather
                               - 21 -


than assignee interests.    Third, in an affidavit executed on

January 12, 1999, A.C. Jones states that the gifts that he and

his sisters received from decedent were “limited partnership

interests”.    Fourth, the 1995, 1996, 1997, and 1998 Federal

income tax returns for JBLP and AVLP, signed by A.C. Jones and

Elizabeth Jones, respectively, designate the interests as limited

partnership interests on the Schedules K-1.    Fifth, although he

claimed at trial that he was valuing assignee interests,

Elliott’s written report referred only to limited partnership

interests.    These factors lead to the conclusion that the

estate’s argument, that decedent transferred assignee interests,

was an afterthought in the later stages of litigation.

     Also, after giving the gifts to his daughters, decedent was

left with a 20.518-percent limited partnership interest.      Section

5.4 of the AVLP agreement was modified so that consent of

85 percent of the partners was required in order for a general

partner to sell a real estate interest belonging to the

partnership.    With this modification, decedent could retain the

power to block unilaterally a sale of a real estate interest even

after giving the gifts.    This amendment would not have been

necessary if the daughters had received only assignee interests.

     This case is distinguishable from Estate of Nowell v.

Commissioner, T.C. Memo. 1999-15, relied on by petitioner.       In

Estate of Nowell, the partnership agreements specified that the
                               - 22 -


recipient of limited partnership interests would become an

assignee and not a substitute limited partner unless the general

partners consented to the assignee’s admission as a limited

partner.    The Court there decided that interests in the

partnerships should be valued for estate tax purposes as assignee

interests rather than as limited partnership interests.

     The transactions in Estate of Nowell differ from the gifts

in the case at hand in that the beneficiaries, the estate, and

the decedent in Estate of Nowell never treated the passing

interests in the partnerships as limited partnership interests.

The record was void of evidence that showed that a limited

partnership interest was in fact transferred.    Here, the conduct

of decedent, A.C. Jones, and the daughters reflects that limited

partnership interests were actually transferred by decedent.

     B.    Value of the Transferred Interest in JBLP

     Having concluded that decedent transferred an 83.08-percent

limited partnership interest in JBLP to A.C. Jones, the next

issue for decision is the value of the limited partnership

interest.    The estate relies on the conclusions of Elliott, who

opined that the value of the interest in JBLP is subject to a

secondary market discount of 55 percent, a lack-of-marketability

discount of 20 percent, and an additional discount for built-in

capital gains.    Respondent relies on the valuation of Burns, who

opined that no discounts apply.
                               - 23 -


     Section 9.4 of the JBLP agreement provides that a general

partner may be removed at any time by the act of the partners

owning an aggregate 51-percent interest in the partnership.

After removal, if no general partners remain, the limited

partners shall designate a successor general partner.    If the

limited partners fail to designate a successor general partner

within 90 days, the partnership will dissolve, affairs will be

wound up, and the partnership will terminate.

     Section 9.4 effectively gives ultimate decision-making

authority to the owner of the 83.08-percent limited partnership

interest.   Under the threat of removal of the general partner,

the 83.08-percent limited partner would have the power to control

management, to compel a sale of partnership property, and to

compel partnership distributions.    If the general partner

refused, the 83.08-percent limited partner could force

liquidation within 90 days.    Having the ability to force

liquidation also gives the 83.08-percent limited partner the

right to force a sale of the partnership assets and to receive a

pro rata share of the NAV.    Because the 83.08-percent limited

partner has the power to control the general partner or to force

a liquidation, the discounts proffered by Elliott are

unreasonable and unpersuasive.    The size of the interest to be

valued and the nature of the underlying assets make the secondary

market an improbable analogy for determining fair market value.
                              - 24 -


We do not believe that a seller of the 83.08-percent limited

partnership interest would part with that interest for

substantially less than the proportionate share of the NAV.

     Burns opined that no discount for lack of control should

apply for the reasons stated above.    We agree.   He also concluded

that “the size and the associated rights of the interest would

preclude the need for a marketability discount.”    He recognized

that section 8.4 of the partnership agreement purported to give

family members the power to prevent a third-party buyer from

obtaining an interest in the JBLP, but he maintained that “to

adhere to the fair market value standard, an appraiser must

assume that a market exists and that a willing buyer would be

admitted into the partnership.”   We believe that there is merit

to this position.   Self-imposed limitations on the interest,

created with the purpose of minimizing value for transfer tax

purposes, are likely to be waived or disregarded when the owner

of the interest becomes a hypothetical willing seller, seeking

the highest price that the interest will bring from a willing

buyer.   The owner of the 83.08-percent interest has the ability

to persuade or coerce other partners into cooperating with the

proposed sale.   Nonetheless, liquidation of a partnership and

sale of its assets, the most likely threat by which the owner of

such a controlling interest would persuade or coerce, would

involve costs and delays.   The possibility of litigation over a
                              - 25 -


forced liquidation would reduce the amount that a hypothetical

buyer would be willing to pay for the interest.      See Adams v.

United States, 

(5th Cir. 2000); Estate of Newhouse

v. Commissioner, 

, 235 (1990).    A marketability

discount would apply, but we believe that, under the

circumstances of this case, an 8-percent discount more accurately

reflects reality.   This amount approximates the discount for lack

of marketability proposed by Burns with respect to AVLP, as

discussed below.

     The experts also disagree about whether a discount

attributable to built-in capital gains to be realized on

liquidation of the partnership should apply.    The parties and the

experts agree that tax on the built-in gains could be avoided by

a section 754 election in effect at the time of sale of

partnership assets.   If such an election is in effect, and the

property is sold, the basis of the partnership’s assets (the

inside basis) is raised to match the cost basis of the transferee

in the transferred partnership interest (the outside basis) for

the benefit of the transferee.    See sec. 743(b).   Otherwise, a

hypothetical buyer who forces a liquidation could be subject to

capital gains tax on the buyer’s pro rata share of the amount

realized on the sale of the underlying assets of the partnership

over the buyer’s pro rata share of the partnership’s adjusted

basis in the underlying assets.    See sec. 1001.    Because the JBLP
                               - 26 -


agreement does not give the limited partners the ability to

effect a section 754 election, in this case the election would

have to be made by the general partner.

     Elliott opined that a hypothetical buyer would demand a

discount for built-in gains.   He acknowledged in his report a 75-

to 80-percent chance that an election would be made and that the

election would not create any adverse consequences or burdens on

the partnership.   His opinion that the election was not certain

to be made was based solely on the position of A.C. Jones,

asserted in his trial testimony, that, as general partner, he

might refuse to cooperate with an unrelated buyer of the

83.08-percent limited partnership interest (i.e., the interest he

received as a gift from his father).    We view A.C. Jones’

testimony as an attempt to bootstrap the facts to justify a

discount that is not reasonable under the circumstances.

     Burns, on the other hand, opined, and respondent contends,

that a hypothetical willing seller of the 83.08-percent interest

would not accept a price based on a reduction for built-in

capital gains.   The owner of that interest has effective control,

as discussed above, and would influence the general partner to

make a section 754 election, eliminating any gains for the

purchaser and getting the highest price for the seller.    Such an

election would have no material or adverse impact on the

preexisting partners.   We agree with Burns.
                                - 27 -


     Petitioner relies on Eisenberg v. Commissioner, 

(2d Cir. 1998), revg. T.C. Memo. 1997-483, and Estate of Davis v.

Commissioner, 

, 546-547 (1998).    Those cases,

however, are distinguishable.    In the contexts of those cases,

the hypothetical buyer and seller would have considered a factor

for built-in capital gains in determining a price for closely

held stock in a corporation.    In Eisenberg, the Court of Appeals

emphasized that earlier Tax Court cases declining to recognize a

discount for unrealized capital gains were based on the ability

of the corporation, under the doctrine of General Utilities &

Operating Co. v. Helvering, 

(1935), to liquidate and

distribute property to its shareholders without recognizing

built-in gain or loss and thus circumvent double taxation.     The

Court of Appeals went on to explain that the tax-favorable

options ended with the Tax Reform Act of 1986, Pub. L. 99-514,

sec. 631, 100 Stat. 2085, 2269.    In reversing our grant of

summary judgment on this issue and remanding the case for

determination of gift tax liability, the Court of Appeals cited

and quoted from Estate of Davis v. 

, in

support of its reasoning.

     In Estate of Davis, the Court rejected the Government’s

argument that no discount for built-in capital gains should apply

because of the possibility that the corporation could convert to

an S corporation and avoid recognition of gains on assets
                               - 28 -


retained for 10 years.    Applying the hypothetical buyer and

seller test, the Court, based on the record presented, including

the testimony of experts for both parties, concluded that a

discount for tax on built-in gains would be applied.

     In the cases in which the discount was allowed, there was no

readily available means by which the tax on built-in gains would

be avoided.    By contrast, disregarding the bootstrapping

testimony of A.C. Jones in this case, the only situation

identified in the record where a section 754 election would not

be made by a partnership is an example by Elliott of a publicly

syndicated partnership with “lots of partners * * * and a lot of

assets” where the administrative burden would be great if an

election were made.    We do not believe that this scenario has

application to the facts regarding the partnerships in issue in

this case.    We are persuaded that, in this case, the buyer and

seller of the partnership interest would negotiate with the

understanding that an election would be made and the price agreed

upon would not reflect a discount for built-in gains.

     C.   Value of Interests in AVLP

     The estate relies on the conclusions of Elliott, who opined

that the value of each transferred interest in AVLP is subject to

a secondary market discount of 45 percent, a discount for lack of

marketability equal to 20 percent, and an additional discount for

built-in capital gains.    Burns opined that the transferred
                              - 29 -


interests are entitled to a secondary market discount of

38 percent, a discount for lack of marketability equal to

7.5 percent, and no discount for built-in capital gains.

     An owner of a 16.915-percent limited partnership interest in

AVLP does not have the ability to remove a general partner.     As

such, a hypothetical buyer would have minimal control over the

management and business operations.    Also, a 16.915-percent

limited partnership interest in AVLP is not readily marketable,

and any hypothetical purchaser would demand a significant

discount.   In calculating the overall discount for the AVLP

interests, both experts use data from different issues of the

same publication regarding sales of limited partnership interests

on the secondary market.   The publication was the primary tool

used by both experts.

     Burns, using the May/June 1995 issue, opined that interests

in real estate-oriented partnerships with characteristics similar

to AVLP traded at discounts due to lack of control equal to

38 percent on January 1, 1995.   The May/June 1995 issue contained

data regarding the sale of limited partnership interests during

the 60-day period ended May 31, 1995.    Burns classified AVLP as a

low-debt partnership making current distributions.

     Elliott, using the May/June 1994 issue, opined that similar

partnerships traded at a secondary market discount of 45 percent.

The secondary market discount is an overall discount encompassing
                              - 30 -


discounts for both lack of control and lack of marketability for

minority interests in syndicated limited partnerships.   The

May/June 1994 issue contained data regarding the sale of limited

partnership interests during the 60-day period ended May 31,

1994.

     The estate argues that Burns’ conclusion, which is based on

data found in the May/June 1995 issue, is flawed because such

information was not available on January 1, 1995, the date the

gift was made.   The estate contends that, since a gift of

property is valued, pursuant to section 2512(a), as of the date

of the transfer, posttransfer data cannot affect our decision.

However, Burns does not use the posttransfer data to prove

directly the value of the transferred interests.   Instead, he

uses the May/June 1995 issue to show what value would have been

calculated if, on January 1, 1995, decedent had looked at

transactions involving the sale of interests in similarly

situated partnerships occurring at that point in time.   Data

regarding such transactions involving similarly situated

partnerships were available on the valuation date.   Therefore,

the data available in the May/June 1995 issue are relevant as

they provide insight into what information would have been found

if, on January 1, 1995, decedent had looked at transactions

occurring on or near the valuation date.
                              - 31 -


     The data on which Burns relied show that interests in

similarly situated partnerships were trading at a 38-percent

discount from April 2 to May 31, 1995.    The data on which Elliott

relied show that interests in similarly situated partnerships

were trading at a 45-percent discount from April 2 to May 31,

1994.   Therefore, transfers of interests on or around January 1,

1995, would have been trading at a discount somewhere between 38

and 45 percent.   Because the data on which Burns relied are

closer in time to the transfer date of the 16.915-percent AVLP

interests, we give greater weight to his determination.

Recognizing that the valuation process is always imprecise, a

40-percent discount is reasonable.     This discount is a reduction

in value for an interest trading on the secondary market and

encompasses discounts for lack of control and lack of

marketability.

     Elliott opines that an additional 20-percent discount for

lack of marketability is applicable because the partnerships that

are the subject of the data in the publication are syndicated

limited partnerships.   He believes that, although there is a

viable market for syndicated limited partnership interests, a

market for nonsyndicated, family limited partnership interests

does not exist.   The additional 20-percent discount opined by

Elliot is also attributable to sections 8.4 and 8.5 of the AVLP

agreement, which attempt to limit the transferability of
                              - 32 -


interests in AVLP.   In calculating the additional discount,

Elliott relied on data found in various restricted stock and

initial public offering studies.

     Elliott acknowledges that the secondary market for

syndicated partnerships is not a strong market and that a large

discount for lack of marketability is already built into the

secondary market discount.   Although Elliott adjusts his analysis

of the data found in the restricted stock and initial public

offering studies to take into consideration the lack-of-

marketability discount already allowed, his adjustment is

inadequate.   His cumulation of discounts does not survive a

sanity check.

     Sections 8.4 and 8.5 of the AVLP agreement do not justify an

additional 20-percent discount.    An option of the partnership or

the other partners to purchase an interest for fair market value

before it is transferred to a third party, standing alone, would

not significantly reduce the value of the partnership interest.

Nevertheless, the right of the partnership to elect to pay the

purchase price in 10 annual installments with interest set at the

minimum rate allowed by the rules and regulations of the Internal

Revenue Service would increase the discount for lack of

marketability.   Texas courts have been willing to disregard

option clauses that unreasonably restrain alienation.     See

Procter v. Foxmeyer Drug Co., 

, 859 (Tex. App.
                               - 33 -


1994).   We express no opinion whether this election is

enforceable under Texas law.   Because this clause would cause

uncertainty as to the rights of an owner to receive fair market

value for an interest in AVLP, a hypothetical buyer would pay

less for the partnership interest.      See Estate of Newhouse v.

Commissioner, 

, 232-233 (1990); Estate of Moore v.

Commissioner, T.C. Memo. 1991-546.      We believe that an additional

discount equal to 8 percent for lack of marketability, to the NAV

previously discounted by 40 percent, is justified.

     For the reasons set forth in the built-in capital gains

analysis for JBLP, an additional discount for lack of

marketability due to built-in gains in AVLP is not justified.

Although the owner of the percentage interests to be valued with

respect to AVLP would not exercise effective control, there is no

reason why a section 754 election would not be made.      Elliott

admits that, because AVLP has relatively few assets, a section

754 election would not cause any detriment or hardship to the

partnership or the other partners.      Thus, we agree with Burns

that the hypothetical seller and buyer would negotiate with the

understanding that an election would be made.      Elliott’s

assumption that Elizabeth Jones and Susan Jones Miller, as

general partners, might refuse to cooperate with a third-party

purchaser is disregarded as an attempt to bootstrap the facts to

justify a discount that is not reasonable under the
                              - 34 -


circumstances.   Therefore, a further discount for built-in

capital gains is not appropriate in this case.

     D.   Conclusion

     The schedules below summarize our conclusions as to fair

market value for the transferred JBLP and AVLP limited

partnership interests:

     83.08-Percent Interest in JBLP

           NAV of limited partnership           $ 7,704,714
                                                     83.08%
           Pro rata NAV                           6,401,076
                Lack of marketability (8%)         (512,086)
           Fair market value                    $ 5,888,990

     16.915-Percent Interest in AVLP

           NAV of limited partnership           $11,629,728
                                                    16.915%
           Pro rata NAV                           1,967,168
                Secondary market (40%)             (786,867)
                                                  1,180,301
                Lack of marketability (8%)          (94,424)
           Fair market value                    $ 1,085,877

     We have considered all remaining arguments made by both

parties for a result contrary to those expressed herein, and, to

the extent not discussed above, they are irrelevant or without

merit.

     To reflect the foregoing,

                                           Decision will be entered

                                      under Rule 155.