                         T.C. Memo. 1997-392



                       UNITED STATES TAX COURT



        ESTATE OF GEORGE A. LEHMANN, DECEASED, WALTER G.
       KEALY, JR. PERSONAL REPRESENTATIVE, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 1282-96.                       Filed August 26, 1997.



     James M. Kefauver and Lawrence L. Bell, for petitioner.

     Warren P. Simonsen and Susan T. Mosley, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     HAMBLEN, Judge:    Respondent determined a deficiency in

petitioner's Federal estate tax in the amount of $266,970.

Petitioner is the Estate of George A. Lehmann (decedent).     The

issue for decision is whether petitioner correctly valued the
                                - 2 -

partnership interests in LKB Associates for purposes of

decedent's gross estate.

     Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect as of the date of decedent's

death, 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 are found

accordingly.   The stipulation of facts and accompanying exhibits

are incorporated herein by this reference.

     The Decedent died testate on April 1, 1992 (valuation date).

Decedent resided in Montgomery County, Maryland.       At the time the

petition was filed, Walter G. Kealy, Jr., decedent's personal

representative, resided in Gaithersburg, Maryland.

     Decedent and his sister, Marie Louise Kealy, each owned, as

tenants in common, one-half interest in the land located at L

Street, in Washington, D.C. (property).       On December 21, 1962,

they agreed to lease the property for 99 years beginning as of

January 1, 1963.

     The lease required the lessee to construct any type of

office building or commercial structure having a value of at

least $500,000 in excess of the value of the land, but the

agreement gave the lessee sole discretion in the design and

subsequent demolition of the constructed structure during the

first 69 years of the lease term.    Thereafter, the lease required
                                     - 3 -

the lessee to seek permission before making any structural

changes.    The lease also permitted the lessee to sublet the

property.   During 1963 and 1964, the lessee improved the property

by constructing a hotel on the property.

     Decedent and Marie Louise Kealy and the lessee amended the

ground lease on March 29, 1963, October 28, 1963, June 2, 1964,

and November 4, 1964.    The ground lease included procedures for

resolving any disputes arising between the landlords and the

tenant, providing in pertinent part:

          14. The Lessors and the Lessee shall each appoint
     a disinterested real estate appraiser not related to
     any of them by consanguinity or affinity and who shall
     have knowledge of the value of commercial real estate
     in Washington, D.C. Written notice of such
     appointments by each party shall be given to the other
     on or before the twentieth (20th) day following the
     [designated] adjustments dates of the particular year,
     and the two appraisers so appointed shall on or before
     the tenth (10th) day thereafter appoint a third
     appraiser of like qualifications and non-interest who
     shall act as their chairman.

                         *   *   *    *   *   *   *

          18. In the event that for any reason, whether
     through failure to appoint appraisers, or failure of
     the appraisers to act, no report of the fair market
     value is made within the time or times, respectively, *
     * * either party may apply to the American Arbitration
     Association or its successor for the appointment of an
     appraiser or appraisers to the end that the fair market
     value as contemplated by this Lease shall be
     determined.

          19. In the event of a refusal or failure by the
     American Arbitration Association or its successor to
     appoint an appraiser or appraisers either party may
     apply to the president or senior office of the
     Washington Real Estate Board or its successor for the
     appointment of an appraiser. No appraisal shall be
                               - 4 -

     invalid by reason of having been delayed or not having
     been made within the time or times, respectively * * *.
     Whenever an appraisal is so delayed, it shall be
     effective and binding upon the parties as to the
     rentals to be paid by the Lessee to the Lessors
     commencing on the adjustment date that a new rental
     basis shall begin according to the terms [of the
     lease]. The cost of any such appraisal made under this
     paragraph shall be borne and paid by the parties hereto
     whose neglect or default had made such appraisal
     necessary.

     On December 19, 1983, decedent and his sister formed LKB

Associates, a limited partnership organized under the laws of the

District of Columbia (partnership).     After forming the

partnership, decedent and his sister conveyed the land subject to

the 99-year lease to the partnership.

     During his lifetime, decedent made gifts of partnership

interests to various family members and to trusts, of which

family members were beneficiaries.     As of the valuation date,

decedent owned a 1-percent general partnership interest and a

23.965903-percent limited partnership interest (decedent's

interest).   The partnership agreement granted the partners a

right of first refusal, which required the selling partner to

offer his or her interest to the other partners on the same terms

before selling the interest to a third party.     The agreement

provided in pertinent part:

          The interest of any Limited Partner may be
     assigned, transferred, sold, exchanged or otherwise
     disposed of ( * * * collectively referred to as
     "assigned") in whole or in part, and each Limited
     Partner shall have a right to substitute an assignee as
     a Limited Partner in his place and stead, without in
     either case the consent of the General Partners, unless
                                 - 5 -

     such assignment would cause a termination of the
     Partnership for federal income tax purposes, but any
     such assignment shall not relieve the assigning Partner
     of his obligations hereunder, unless consented to by
     the other Partners; provided, however, that no such
     assignment to a person other than a person related by
     blood or marriage to Marie Louise Kealy, Walter G.
     Kealy or George A. Lehmann shall be effective unless
     the interest assigned is first offered to the Partners,
     both collectively and individually, on the same terms
     and conditions for a period of ninety (90) days
     [hereafter referred to as right of first refusal].

     The partnership agreement granted the general partners sole

discretion in setting the management fee that they were entitled

to receive from the partnership.    Historically, the rate had been

2 percent of the partnership's gross rental income.    In 1991, the

general partners raised the fee from 2 percent to 5 percent of

such income.

     During 1983, a lawsuit was filed regarding the

interpretation of certain terms of the ground lease.   To resolve

the dispute, the partnership and the lessee amended the terms of

the lease on January 30, 1984, to provide for, inter alia,

periodic rent adjustments during the life of the lease (fifth

amendment).    The lease and the fifth amendment directed that the

rent was to be adjusted every 10 years, beginning on January 1,

1993, to an amount equal to a specified percentage per annum

(rental rate) of the fair market value of the land on the first

day of the 10-year period as if the land were not encumbered by

the lease (unencumbered land).
                                - 6 -

     The fifth amendment specified that the rental rates for the

periods from January 1, 1993, through December 31, 1998, and from

January 1, 1999, through December 31, 2012, were 5.44 percent and

6.4 percent, respectively.    Thereafter, the partnership and the

lessee were to negotiate the rental rate for each 10-year period

beginning on January 1, 2013, through the end of the lease, but

in any event the negotiated rate was not to be less than 6.4

percent or more than 7.7 percent.    The fifth amendment also

required the partnership and the lessee to set the fair market

value of the unencumbered land as of the first day of the 10-year

period (adjustment date).

     The fifth amendment added additional procedures for

resolving disputes, providing in pertinent part:

     If the parties are unable to agree on the * * * Rental
     rate to be applicable in the following period prior to
     any decennial rent adjustment date from and after
     January 1, 2013, the appropriate [p]ercentage (not less
     than 6.4% or more than 7.7%) shall be determined by
     appraisers appointed to determine such * * * Rental
     rate consistent with the procedure for determining the
     fair market value of the unimproved land under the
     [ground lease].

     As of the valuation date, the principal assets of the

partnership were the leased fee interest in the property and a

cash balance of $64,339.    In addition, as of that date, the

lessee maintained a 99-room hotel with an occupancy rate of 65

percent.

     In connection with the preparation of the estate tax return,

petitioner obtained a valuation of decedent's interest from P.
                                - 7 -

Richard Zitelman of the Zitelman Group, Inc.    Zitelman determined

that, as of the valuation date, the fair market value of

decedent's interest was $399,000.    Petitioner included this

amount in the gross estate.    Respondent determined the fair

market value of the decedent's interest as of the date of death

was $1,070,000.    Subsequently, respondent conceded $262,000 of

that adjustment.

                               OPINION

     We must decide whether petitioner properly valued decedent's

interest in the partnership for purposes of section 2031(a).

Petitioner must prove that respondent's determination of value

set forth in the notice of deficiency is incorrect.    Rule 142(a);

Welch v. Helvering, 290 U.S. 111, 115 (1933); Estate of Gilford

v. Commissioner, 88 T.C. 38, 51 (1987).

     The parties agree that decedent's interest should be valued

as a limited partnership interest notwithstanding the fact that

decedent held a 1-percent general partnership interest as of the

valuation date but do not agree upon the value of that interest

or upon the method by which decedent's interest should be valued.

Respondent's expert used the fractional discount method, whereas

petitioner's expert used the discounted cash-flow (DCF) method.

     The parties primarily rely upon their experts' testimony and

reports to support their respective positions.    Expert testimony

sometimes aids the Court in determining valuation.    Other times,

it does not.   See Laureys v. Commissioner, 92 T.C. 101, 129
                               - 8 -

(1989).   We evaluate such opinions in light of the demonstrated

qualifications of the expert and all other evidence of value.

Estate of Newhouse v. Commissioner, 94 T.C. 193, 217 (1990);

Parker v. Commissioner, 86 T.C. 547, 561 (1986); Johnson v.

Commissioner, 85 T.C. 469, 477 (1985).   We are not bound,

however, by the opinion of any expert witness when that opinion

is contrary to our judgment.   Estate of Newhouse v. Commissioner,

supra at 217; Parker v. Commissioner, supra at 561.    Although we

may accept the opinion of an expert in its entirety, Buffalo Tool

& Die Manufacturing Co. v. Commissioner, 74 T.C. 441, 452 (1980),

we also may be selective in the use of any portion of such an

opinion, Parker v. Commissioner, supra at 562.    Consequently, we

will take into account expert opinion testimony to the extent

that it aids us in arriving at the fair market value of the

property.

     The value of decedent's gross estate is the fair market

value of property includable in the gross estate.    Sec. 2031.

Fair market value is defined as "the price at which the property

would change hands between a willing buyer and a willing seller,

neither being under any compulsion to buy or to sell and both

having reasonable knowledge of relevant facts."     United States v.

Cartwright, 411 U.S. 546, 551 (1973); Estate of Newhouse v.

Commissioner, supra at 217; sec. 20.2031-1(b), Estate Tax Regs.

Because valuation is necessarily an approximation, the figure at

which the Court arrives need not be one as to which there is
                                 - 9 -

specific testimony, if it is within the range of figures that may

properly be deduced from the evidence.     Silverman v.

Commissioner, 538 F.2d 927, 933 (2d Cir. 1976), affg. T.C. Memo.

1974-285; Alvary v. United States, 302 F.2d 790, 795 (2d Cir.

1962).

       The willing buyer-willing seller standard generally is used

in valuing transferred property.     United States v. Cartwright,

supra.    The standard is an objective test using hypothetical

buyers and sellers in the marketplace, and is not a personalized

one which envisions a particular buyer and seller.        Estate of

Andrews v. Commissioner, 79 T.C. 938, 956 (1982); Kolom v.

Commissioner, 71 T.C. 235, 244 (1978), affd. 644 F.2d 1282 (9th

Cir. 1981).     Generally, for estate tax purposes, property is

valued at its fair market value based on its highest and best

use.     Sec. 2031(a); sec. 20.2031-1(b), Estate Tax Regs.

A.     Respondent's Expert

       Respondent relies upon the report and testimony of an

expert, Richard L. Parli.     Parli is a certified general real

property appraiser.

       Parli considered two methods of estimating the value of

decedent's partial interest in the partnership:     (1) The income

discounting method and (2) the fractional discounting method.

Ultimately, Parli concluded that the fractional discounting

method was the appropriate method because, in his view, land is

not inherently income producing.
                               - 10 -

     Parli first determined the present value of the rents due

pursuant to the terms of the ground lease and from the

partnership's reversionary interest in the land and then

calculated decedent's pro rata share of those amounts.   Under

Parli's calculations, the present value and decedent's pro rata

share were $4,680,000 and $1,154,043, respectively.

     Parli next considered factors affecting the value of

decedent's pro rata share including, inter alia:   (1) Relative

risk of the partnership's assets; (2) historical consistency of

the partnership's earnings; (3) condition of the partnership's

assets; (4) market growth potential; (5) portfolio

diversification; (6) strength of management; (7) size of

decedent's interest; (8) liquidity; (9) potential ability to

influence management and (10) relative ease of analyzing the

partnership's assets.   Parli assigned individual discounts for

each factor and calculated an aggregate discount factor of 30

percent.   Based upon such a discount factor, he assigned a value

to decedent's interest of $808,000.

B.   Petitioner's Expert

     Petitioner relies upon the report and testimony of its

expert, P. Richard Zitelman.   Zitelman is the president of The

Zitelman Group, a firm providing investment advisory and

investment services.

     Zitelman also considered two methods of evaluating the fair

market value of decedent's interest:    (1) The liquidation method,
                               - 11 -

and (2) the DCF method.   Ultimately, Zitelman selected the DCF

method because, in his view, a "potential buyer" of decedent's

interest would be an individual or entity seeking long-term cash-

flows but having no expectation of receiving the return of its

invested capital.

     Under the DCF method, Zitelman estimated the fair market

value of decedent's interest by calculating the present value of

decedent's pro rata share of the partnership's expected net cash-

flows.   He calculated the net income due pursuant to the lease

and the net reversionary interest in the land.

     For purposes of calculating the annual rent, Zitelman

assumed that the fair market value of the unencumbered land, as

of the valuation date and as of January 1, 1993, was $5,479,883.

Thereafter, Zitelman assumed the value increased annually at a

rate of 2.6 percent.    He also assumed the rental rate for the

lease period of January 1, 2013, through March 31, 2062, was 7.05

percent.

     In estimating all of the expenses for 1992 except for the

management fees and the franchise tax, Zitelman averaged the

deductions reported upon the partnership's Federal income tax

returns for taxable years 1989 through 1991.   See appendix A.

Thereafter, he treated the expenses as increasing at a rate of

2.6 percent per year.

     Zitelman estimated the management fee as equal to 5 percent

of the gross rental income and the franchise tax expense as equal
                               - 12 -

to the product of the estimated net income and the tax rates in

effect as of the valuation date.

     Zitelman made several assumptions regarding the rate of

return a hypothetical buyer would demand.    He initially noted

that, as of the valuation date, the rate of return of 30-year

Treasury bonds was 7.9 percent and assumed that the applicable

discount rate would have to be at least between 9.9 percent and

11.9 percent.   Zitelman assumed that the discount rate necessary

to achieve an acceptable rate of return required that such a

discount rate should be increased for each of the following

perceived risks:    (1) The partnership agreement permits the

general partners to make loans at (a) the prime rate to the

partners for estate taxes, estate administrative expenses, and

medical expenses or (b) the rate at which petitioner borrowed the

funds; (2) there is a likelihood of a disagreement between the

lessee and the partnership as to the future rental rates or the

value of the property; (3) a potential buyer would have to invest

substantial time, energy, aggravation, and cost to evaluate

decedent's interest; (4) the partnership agreement granted the

other partners a right of first refusal; and (5) the potential

buyer did not have control over the partnership's management.

Zitelman concluded that a hypothetical buyer would demand a

purchase price based upon a discount rate between 15.3 percent

and 22.6 percent.   Ultimately, Zitelman averaged the present

values calculated based upon these rates and assigned a fair
                               - 13 -

market value to decedent's interest in the partnership of

$399,000.

       The divergent methodologies of the experts that testified in

this case reveal that the determination of the value of a

minority interest in a partnership holding real estate is a

matter of judgment to be resolved on the basis of the entire

record.    See Estate of Lauder v. Commissioner, T.C. Memo. 1994-

527.    Parli failed to explain adequately how he derived the

individual discounts.    Rather, Parli summarily concluded that

each individual discount is "typical" without providing any

evidence, e.g., comparables or market data, establishing the

basis of these conclusions.    Giving due consideration to each of

the expert reports, and weighing all of the facts and

circumstances presented, we conclude that Zitelman's methodology

provides the most reliable basis for valuing the decedent's

interest as of the valuation date.      The value of any interest in

real property that has an income stream can be estimated by the

DCF method.    See Estate of Bennett v. Commissioner, T.C. Memo.

1993-34; Estate of Hatchett v. Commissioner, T.C. Memo. 1989-637.

The evidence before the Court shows that the property had a

determinable income stream.

       Respondent concedes that the DCF method is an appropriate

appraisal method in some contexts but argues that, based upon

Parli's testimony, the method is not appropriate when the current

use of the property is not its highest and best use.     Respondent
                              - 14 -

relies upon Parli's view that the highest and best use of the

property is as office space rather than as a hotel.1

     Respondent's contention ignores the fact that the property

was encumbered by a long-term lease.   The lessee, possessing a

leasehold interest, occupies the land on which its particular

hotel is located.   Such an interest reduces the value of the

partnership's interest in the land because the lessee's

contractual right to occupy the land prevents the partnership

from re-leasing the property at a higher rate or from demolishing

the hotel and using the land for another, perhaps more

profitable, purpose.   The lessee, not the partnership, has the

option to use the land to construct an office building or to

sublet the property at a profit.   Consequently, it is unrealistic

to contend that the value of the partnership's interest in the

land is equivalent to the value of the land at its highest and

best use as though the land were vacant.   See Marks v.

Commissioner, T.C. Memo. 1985-179; Appraisal Institute, The

Appraisal of Real Estate, 280 n.5, 282 (10th ed. 1992).

Respondent's assertions fail to consider reality as it existed on



     1
      Petitioner does not argue that it made an election pursuant
to sec. 2032A. Sec. 2032A permits an estate to elect to value
qualified real property used for farming and small business
purposes on the basis of income capitalization rather than on the
basis of highest and best use. Sec. 2032A(e)(7); Williamson v.
Commissioner, 93 T.C. 242, 244 (1989), affd. 974 F.2d 1525 (9th
Cir. 1992); Estate of Heffley v. Commissioner, 89 T.C. 265, 271
(1987), affd. 884 F.2d 279 (7th Cir. 1989).
                               - 15 -

the valuation date.    We are satisfied that the DCF method is a

viable means of determining the value of decedent's interest.

     Although we accept that the DCF method is an appropriate

approach in the instant case, we have found weaknesses in

Zitelman's analysis.   The DCF method generally requires

assumptions regarding the future revenue, operating costs, and

trends, see generally Estate of Cartwright v. Commissioner, T.C.

Memo. 1996-286, but some of Zitelman's assumptions are

unreasonable.

     We are not convinced that the perceived risks cited by

Zitelman would depress the hypothetical purchase price as

significantly as petitioner would have us believe.    Zitelman

correctly notes that the partnership agreement permits the

general partners to lend money to the estate of a deceased

partner, and obviously, in making such loans, the general

partners would be motivated in part by their family ties to the

deceased partner, but the partnership agreement also provides

that the deceased partner's interest in the partnership must

secure such a loan, and the loan must be at the prime rate or the

rate at which the partnership borrows the funds.    Accordingly, we

do not see such lending as particularly jeopardizing the

partnership's cash-flow.

     Nor do we find that the risk of future litigation over

determining the rental rates or the fair market values of the

unencumbered land substantially affected decedent's potential
                               - 16 -

share of the cash-flows.   To a large extent, the ground lease and

the amendments eliminated these risks by setting forth a

mechanism for settling such disputes through the use of

appraisers.

     Similarly, we disagree with Zitelman's view that the

hypothetical buyer would demand a higher rate of return because

of the "substantial amount of time, energy, aggravation, and

cost" required to value decedent's interest.   Although such an

interest is not as easy to value as other investments, such as a

30-year Treasury bond or annuity, the present value of the cash-

flows is, nevertheless, not so difficult or inconvenient to

calculate as to justify a significant increase in such a rate of

return.   The partnership principally owns only one income-

producing asset.   Zitelman's own analysis evidences the relative

ease by which decedent's interest may be valued.

     We are not convinced that the right of first refusal

significantly affected the value of decedent's interest.    The

partnership agreement does not provide a price or a formula for

determining the fair market value of a transferred partnership

interest.   The absence of a fixed price clearly has a less

dramatic effect than fixed-price restrictions, see, e.g.,

Worcester County Trust Co. v. Commissioner, 134 F.2d 578, 581-582

(1st Cir. 1943), revg. Estate of Smith v. Commissioner, 46 B.T.A.

337 (1942); Estate of Reynolds v. Commissioner, 55 T.C. 172,

188-190 (1970);    Mandelbaum v. Commissioner, T.C. Memo. 1995-255,
                                - 17 -

affd. without published opinion 91 F.3d 124 (1996).     Indeed, a

right of first refusal without a fixed price does not limit the

buyers to whom a seller could sell the interest or the price for

the interest, but merely governs the order in which prospective

buyers must stand in line to purchase.      Mandelbaum v.

Commissioner, supra.    Given the fact that such a right actually

protects and benefits the other partners, the depressant effect

(if any) upon the value of a privately held partnership interest

subject to a right of first refusal is not necessarily

substantial.

     Overall, from our perspective, Zitelman's report lacks a

wholly objective analysis of the willing buyer/willing seller

standard.   Consequently, we do not find the report as compelling

as petitioner suggests.   Rather, Zitelman focuses exclusively

upon the hypothetical willing buyer.     Zitelman failed to consider

whether a hypothetical seller would sell his or her interest in

the partnership for $399,000.    The test of fair market value

rests upon the concept of a hypothetical willing buyer and a

hypothetical willing seller.    We find incredible the proposition

that any partner, limited or general, would be willing to sell

his or her interest for such a low amount as to generate an

internal rate of return of approximately 15 percent to 22

percent.    Ignoring the views of a willing seller is contrary to

this well-established rule.     Id.   In this regard, Zitelman's
                              - 18 -

failure to consider a hypothetical willing seller of an interest

in the partnership weakens his analysis.

     Zitelman's assertion at trial that the fact the lessee is

not a major hotel chain also depresses the value and accordingly

increases the discount rates lacks merit.   In light of the

lessee's other options for developing the property, we do not see

the financial success or lack thereof in the hotel business as a

significant risk.

     Zitelman's calculations are also inaccurate.    First, we

found several errors in the calculations of the partnership's

rental income.   Zitelman ignored the appreciation in the fair

market value of the unencumbered land between the valuation date

and January 1, 1993, for purposes of calculating the expected

rent due.   Zitelman claimed to be treating the fair market value

of the unencumbered land as appreciating at a rate of 2.6 percent

per year, yet he estimated the value of that land, as of the

valuation date, to be $5,479,883 and used that amount without

adjustment for estimating the rental income for the period of

January 1, 1993, through December 31, 2002.   Moreover, Zitelman

calculated the net cash-flow to be received during the period

after decedent's death through December 31, 1992, but he failed

to include any part of that cash-flow in the total values

assigned to decedent's interest.   See appendix B.   In addition,

Zitelman treated the net cash-flows arising from the lease as

being received upon the last day of the year.   The lease
                                - 19 -

agreement, however, specifically provides that the lessee is to

pay the rent on the first of each month.     Further, the

partnership had a cash balance of $64,339 as of the valuation

date.     Zitelman's analysis does not provide adequate support or

explanation of treatment of that cash or his assumptions

regarding the projected interest income.

     Second, we find Zitelman's estimate of the expected expenses

is likewise flawed.     For example, Zitelman assumed that the

management fees equal 5 percent of the gross rentals each year.

These fees, however, are subject to the discretion of the general

partners.     We see no reason to assume that the fee will always be

5 percent rather than 2 percent, as it was in taxable years 1989

and 1990.     Zitelman included expense amounts and reductions in

the expected cash-flows for which he offered no explanation.      We

have disregarded those amounts.     Zitelman's calculation of the

franchise taxes appears to be too low, but the record does not

provide adequate information by which to recalculate those

amounts.

     Finally, Zitelman estimated the liquidation costs at the end

of the lease term in 2062.     We find these amounts to be too

speculative, conjectural, and remote.     See Estate of Bennett v.

Commissioner, T.C. Memo. 1993-34.

        Despite our concerns, Zitelman's analysis makes several

valid conclusions.     With the weaknesses discussed above in mind,

we have estimated the value of decedent's interest by modifying
                              - 20 -

Zitelman's analysis.   See appendices C and D.   Under our

calculation, we conclude that the value of decedent's interest,

as of the valuation date, was $699,853.   We have considered all

of the other arguments made by the parties and, to the extent we

have not addressed them, find them to be without merit.

     To reflect the foregoing,

                                          Decision will be entered

                                    under Rule 155.




[REPORTER'S NOTE:   THE APPENDICES IN LOTUS FORMAT HAVE NOT BEEN

REPRODUCED.]
