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Latest IRS Tactic - Minority Premium Model

In the last two years, we have confronted the IRS on their application of a Minority Premium Model (MPM). It is being used to minimize discounts for tenant-in-common interests in excess of 50% of an asset or entity.

Historically, the valuation community has utilized several models to value TIC interests. These models include: (a) actual guideline transactions of similar TIC interests, (b) real estate partnership data, (c) cost of partition, (d) IPO / Restricted stock studies, and (e) court cases. The Mentor Group typically considers all of these models, and selects the most appropriate ones based on the specific facts and circumstances of the TIC interest. However, when the TIC interest being valued is a majority interest, we believe the new Minority Premium Model should be considered.

The Minority Premium Model primarily focuses on concept of the "willing hypothetical seller." This model takes into consideration what a "willing seller" will accept when faced with the prospect of selling his majority TIC interest at a significant discount.

An example illustrates the theory of the "willing seller." Assume that a property is worth $100,000. We are asked to value a 90% TIC interest in the property; the pro rata value is $90,000 ($100,000 x 90% = $90,000). By using the many valuation methods historically used to value a TIC interest, let's assume the fractional interest discount was computed to be 20%. Therefore, we would apply the 20% discount to the pro rata $90,000 value to compute the fair market value of the 90% TIC interest. The discounted value would be computed at $72,000 ($90,000 less the 20% discount of $18,000 = $72,000.)

The IRS posits that 90% majority TIC "willing seller" would not be willing to accept an $18,000 discount for the majority TIC interest; rather, he would be willing to pay a premium to the minority 10% TIC owner in the property to buy out that minority owner. The theory is that the 90% TIC owner can pay a premium (assume a 50% or $5,000) to the 10% TIC owner and gain control of the property for less than it would cost the 90% TIC owner to sell the majority interest at an $18,000 discount. By gaining control and owning 100% of the property, the 90% TIC owner could then sell the property for $100,000 and realize more from the sale than if the 90% TIC owner sold the majority TIC interest for an $18,000 discount.

We believe this new model is an interesting addition to the various models we consider, because it takes into consideration the thoughts of a "willing seller" and makes economic sense from a financial prospective. However, we believe keys to the use of this model are: (1) an assumption as to what the premium should be that a minority TIC owner is willing to accept; and, (2) whether the majority TIC owner has the resources to make such a purchase. Even based upon sound financial logic, if the "willing seller" does not have the economic resources to purchase the minority TIC interest at a premium, then this model may not be reasonable. We believe that various scenarios must be analyzed in an effort to apply this model in a proper manner.

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