| Phil Jones' IRA was invested in Denver Rehab, LLC | | | | the value of this stock, undiscounted, would be |
| (DR), a privately held and profitable apartment building | | | | $200,000. Discounted, this value could actually be in the |
| rehab company in Denver. DR had been in business | | | | neighborhood of $130,000 to $140,000. Splitting the |
| for over 5 years and consisted of a group of 25 | | | | difference to $135,000 for the sake of illustration, Phil |
| investors, some of which were IRAs. Phil was very | | | | would be paying $41,850 in taxes as opposed to |
| satisfied with both the quality of the work and the | | | | $56,000 on the distribution of the IRA shares based on |
| earnings of DR, but was now contemplating the tax | | | | a personal income tax rate of 31%. This is a substantial |
| impact of distributing his IRA shares to himself and the | | | | tax savings and it is tempting to stop at this point and |
| consequent tax impact. The question loomed: what | | | | go no further with the valuation. |
| was the value of these shares for tax purposes? | | | | What are the cautions in the application of DLOM? In |
| Unlike the distribution of publicly traded stock with a | | | | some cases, because of lack of thorough analysis on |
| daily market value, or real estate, which can rely on an | | | | the part of the taxpayer or his/her experts, the |
| appraisal, the value of stock in a privately held | | | | standard 30% to 35% has been challenged. |
| company is a completely different story. Why? Here | | | | In McCord v. Commissioner, 120 T.C. 38 (203), a family |
| are a few reasons: | | | | limited partnership (FLP) 2, the business valuation |
| · Unlike public stock, there is no effective way | | | | expert used the DLOM of 35%. The IRS expert |
| to market the shares. | | | | thought differently and estimated the discount at 7.2%. |
| · A less-than-majority ownership leaves the | | | | Ultimately the court decided that the discount should be |
| share owner with no substantial control over the | | | | 20%. The argument, in this case, was the applicability |
| company, and therefore the stock has less value to a | | | | of the restricted stock model to a FLP. |
| prospective purchaser. | | | | In other cases such as Peraccio v. Commissioner TC |
| · Lastly, because there are likely no competing | | | | Memo 2003-280 and Lappo v. Commissioner TC |
| potential buyers due to lack of marketing for the | | | | Memo 2003-258, both FLP entities, similar valuations |
| shares (above), there may be only one "take it or | | | | were at issue, both resolving in a lower DLOM than |
| leave it" offer on the shares. | | | | expected. The decisions resulted in a DLOM of 25% |
| CPAs and business valuation experts frequently are | | | | and 24% respectively. |
| required to answer the question: What is the value of | | | | What do these numbers mean to Phil or any other |
| minority shareholder stock in a privately held company | | | | individual with regards to the valuation of stock being |
| for tax purposes? | | | | distributed from their IRA? The lesson is, although there |
| This is referred to as the "Discount for Loss of | | | | are some "industry accepted" standards for valuing |
| Marketability", DLOM for short, and would apply to Phil's | | | | private stocks, it pays to do your homework when |
| IRA's share distribution in Denver Rehab LLC. | | | | taking advantage of DLOM. |
| In general, valuation of this type of stock has only been | | | | It is nearly certain that there is a discount in Phil's and |
| extensively evaluated in the following two | | | | maybe your IRA's stock valuation for taxable |
| circumstances: | | | | distribution purposes, but how do you make use of |
| · Pre-public offering stock or IPO stock, which | | | | DLOM and still stay on the right side of the IRS? To |
| will eventually be offered to the public | | | | take advantage of DLOM, you and your experts need |
| · Restricted stocks, which may not, because | | | | to answer the questions, "What is the discount and |
| of SEC rules, be offered to the public for a certain | | | | how can I support this?" before jumping into the |
| period of time | | | | "industry standard" trap. |
| These are the two types of stock that require | | | | SUMMARY |
| valuations and may be discounted. Historically, IPO | | | | An IRA can take advantage of the DLOM when |
| stock has had a discount in value of 45% while | | | | valuing its shares for taxable distributions. Although the |
| restricted stock may vary between 30% to 35% 1. | | | | industry has historically used 30% to 35% as the |
| Although private stock is not the same as restricted | | | | discount, caution should be exercised when applying |
| stock, the two are still somewhat analogous when | | | | this discount randomly. Always seek the guidance of a |
| looking at valuation discount scenarios. | | | | qualified tax or legal expert in this area to avoid running |
| Phil's IRA's stock would fall into the private stock | | | | into a dispute on applying the discount without |
| category. It would be more prudent to use the DLOM | | | | supporting evidence of its validity. |
| evaluation for restricted stock (above) when evaluating | | | | References: |
| the stock in DR. This means that if the value of DR is | | | | 1 "Understanding the Valuation Discount for Lack of |
| $5 million and the IRA owns 1/25 of the issued stock, | | | | Marketability" by Russell T. |