                     T.C. Memo. 1997-188



                UNITED STATES TAX COURT



         ESTATE OF BONNIE I. BARGE, DECEASED,
       C. RICHARD BARGE, EXECUTOR, Petitioner v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 230-92.                 Filed April 23, 1997.



     At issue is the valuation of a 25-percent
undivided interest in timberland that was the subject
of gifts made by donor. R determined a deficiency in
Federal gift tax based on her valuation of the
interest. Held: Value of interest determined by
discounting partition award to present value.



Harris H. Barnes III and John V. Eskrigge, for petitioner.

Robert W. West, for respondent.
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              MEMORANDUM FINDINGS OF FACT AND OPINION

     HALPERN, Judge:   Respondent determined deficiencies in

Bonnie I. Barge’s Federal gift tax for 1987 and 1988 in the

amounts of $5,547,988 and $4,000, respectively.   Respondent also

determined an addition to tax under section 6660 in the amount of

$1,664,396 for 1987.   Respondent has since conceded that no

addition to tax under section 6660 is due.   We accept that

concession.   The only issue remaining for decision is the value

of a 25-percent interest in certain timberland that was the

subject of gifts made by Bonnie I. Barge in 1987.    Respondent’s

determination of a deficiency in gift tax liability for 1988 is a

consequence of her determination with respect to 1987, and it

requires no separate analysis from us.

     Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the taxable periods in

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

Practice and Procedure.

                          FINDINGS OF FACT

     Some facts have been stipulated and are so found.   The

stipulation of facts filed by the parties with accompanying

exhibits is incorporated herein by this reference.   Bonnie I.

Barge filed the petition in this case on January 3, 1992.     At

that time, she resided in Macon, Mississippi.    Subsequently, she

died, and we ordered that Estate of Bonnie I. Barge, C. Richard

Barge, Executor, be substituted as petitioner.
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The Partnership

     In 1941, Bonnie I. Barge (decedent) and her husband, C.A.

Barge, formed a general partnership, eventually known as the C.A.

Barge Lumber Co. (the partnership), for the purpose of carrying

on a lumber business.   In that same year, decedent and C.A. Barge

purchased approximately 60,000 acres of timberland in Winston and

Noxubee Counties, Mississippi (the timberland).    They acquired

the timberland as tenants in common, and each owned an undivided

one-half interest.   The partnership operated the timberland as a

business for timber growth, harvesting, and sale on behalf of

decedent and C.A. Barge.

     Decedent and C.A. Barge had three children (the children):

Richard, Betty, and Charlene.   In 1959, C.A. Barge died.   He

devised his one-half interest in the timberland one-half to

decedent and one-half to the children, in equal shares (so that

each child received an 8.33-percent undivided interest in the

timberland).   After the death of C.A. Barge, decedent owned a

75-percent undivided interest in the timberland.

Decedent's Gifts

     In 1976, decedent gave a 25-percent undivided interest in

the timberland to the children in equal shares.    After the 1976

gift, decedent owned an undivided 50-percent interest in the

timberland, and each of the children owned an undivided interest

of 16.67 percent.
                                - 4 -

       Because of purchases and sales, in 1987, the timberland

totaled approximately 44,972 acres.     On or about February 6,

1987, decedent gave an undivided 25-percent interest (the

undivided interest) in the timberland to separate trusts

established for the benefit of her 10 grandchildren (the 1987

gifts).

Partnership's Management Philosophy

       Two management philosophies exist in the timber industry:

That which produces a majority of pulpwood, known as plantation

stand or even age management (pulpwood management), and that

which produces a majority of saw timber, known as natural stand

or uneven age management (saw timber management).     The objective

of saw timber management is to allow trees to grow to maturity,

which can take as long as 50 years, for use as lumber and poles.

Each tree to be harvested is specially selected and marked.

Pulpwood management, used by those who grow pulpwood for use by

paper companies, involves clear-cutting a certain number of acres

on a shorter rotation, before the trees reach their maturity.

Consequently, pulpwood management, which harvests younger trees,

accelerates the cash-flow from a given stand of timber.     Saw

timber management, on the other hand, reduces current cash-flow

by postponing the harvests and sales until later years, when the

trees reach maturity.    The risk of loss to trees on account of

pests, disease, and other factors increases, however, as they

age.
                              - 5 -

     The partnership’s management objective was the production of

large, mature trees for use as saw timber and poles, in line with

the saw timber management philosophy.   The management philosophy

adopted by the partnership did not maximize the current income

and profit from the timberland.   Operating the timberland under

the pulpwood management philosophy would have greatly increased

the cash-flow available from the timberland.

Decedent's 1987 Gift Tax Return and Respondent’s Notice of
Deficiency

     Decedent reported the 1987 gifts on a U.S. Gift (and

Generation Skipping Transfer) Tax Return, Form 709, for 1987.

She reported the value of the 1987 gifts to be $2,450,002.   In

her notice of deficiency for 1987, respondent explained that she

had determined the value of the undivided interest to be

$12,847,252.

Fair Market Value of the 44,972 Acres

     As of the date of the 1987 gifts, the fair market value of

the fee simple ownership of the timberland, including land and

timber, was $40 million.

Fair Market Value of the Undivided Interest

     The fair market value of the undivided interest was

$7,404,649 on February 6, 1987.
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                              OPINION

I.   Introduction

      This case involves the value of certain gifts made in 1987

(the 1987 gifts) by Bonnie I. Barge (decedent) in trust for the

benefit of her 10 grandchildren.   The 1987 gifts were of portions

of a 25-percent undivided interest in certain timberland (the

timberland).   The parties agree that the question for decision by

the Court is the fair market value of the 25-percent undivided

interest in the timberland (the undivided interest) as of

February 6, 1987.   Petitioner argues that the fair market value

of the undivided interest in February 1987 was between $4,200,000

and $4,888,600 and on February 6, 1987, it was $4,750,000.

Respondent argues that the fair market value of the undivided

interest on February 6, 1987, was at least $8,413,050.    The

parties have stipulated that, as of the date of the 1987 gifts,

the fair market value of the timberland was $40 million.

      The standard for determining fair market value for purposes

of the gift tax is the price at which the property would change

hands between a willing buyer and seller, neither being under any

compulsion to buy or sell, and both having knowledge of relevant

facts.   Sec. 25.2512-1, Gift Tax Regs.   Valuation is an issue of

fact, and petitioner bears the burden of proof.    Rule 142(a).   We

have found that the fair market value of the undivided interest

was $7,404,649 on February 6, 1987.     We will explain our reasons

for making that finding.
                                - 7 -

II.   Valuation of the Gift

      In part, to support their respective valuations, the parties

have relied on the testimony of experts.    We have considered that

testimony and, in part, have relied on it in reaching our own

conclusion.

   A.   Method of Valuation

      Based on expert testimony, petitioner requests that we value

the undivided interest in one of two ways:    (1) apply a discount

(50 percent) to 25 percent of the value of the timberland

($40 million) to take into account various problems relating to

the ownership of an undivided fractional interest, or (2) use an

income capitalization approach.    Because of the possibility that,

by way of an action for partition, the undivided interest could,

in a reasonable amount of time, be liquidated or turned into a

fee interest in some portion of the timberland, we believe that a

capitalization approach is a reasonable way to arrive at a value

for the undivided interest.    At the end of the partition period,

a hypothetical owner of the undivided interest would receive

either cash payment or a fee interest in certain acreage (a

payment in kind).   During the pendency of the action, she would

(as will be shown) receive certain cash payments.    We believe

that we can value all of those payments and determine an

appropriate discount rate.    With such data, we can determine a

present value for the undivided interest.    But cf. Harwood v.

Commissioner, 82 T.C. 239, 265 (1984) (declining to accept an
                               - 8 -

income capitalization approach to value limited partnership

interests in a family partnership engaged in the forest products

business), affd. without published opinion 786 F.2d 1174 (9th

Cir. 1986).

     Petitioner’s expert, Thomas J. Ebner (Ebner), a forest

consultant, relied heavily on an income capitalization approach.

Petitioner’s expert, Richard H. Pinkowski, Jr. (Pinkowski), a

registered forester, considered an income capitalization

approach, among other approaches.   Respondent’s expert, Earl

Flowers (Flowers), a registered forester, did not rely on an

income capitalization approach and relied exclusively on a market

comparison approach.   Nevertheless, on brief, respondent argues

that the value of the undivided interest is to be determined by

considering the present value of the benefit to be received on

partition.

     We do not find Pinkowski's income capitalization analysis

persuasive.   He had little experience with that type of analysis,

and he merely applied an income capitalization methodology that

he obtained from a journal article.    Moreover, he projected

future income based only on past income from one year, 1987, a

year which produced abnormally high income due to the Barges’

excessive harvesting, which was done in order to raise cash to

pay gift taxes.

     Ebner’s report and testimony, on the other hand, did

influence our analysis.   He determined a future income stream
                               - 9 -

based upon the cash-flow of the years 1983 through 1986.   Using

the partnership's tax returns and income and expense statements,

he first calculated that an average cash-flow applicable to a

25-percent interest was $341,000 a year.   He then concluded that,

because the partners received distributions of only 86 percent of

that cash-flow, a purchaser of a 25-percent interest would

receive $293,000 a year.   He thought that a private investor (as

opposed to a forest products company or an institutional

investor) would be the most likely purchaser of the undivided

interest.   He concluded that a private investor would capitalize

the estimated $293,000 annual cash-flow at 10 percent and add the

unrealized gain on the buildup of inventory resulting from the

Barges’ saw timber management policies to make a maximum offer of

$3,340,000.

     Ebner did not consider that a potential purchaser

unsatisfied with the Barges’ saw timber management philosophy

could force a partition of the property and, thus, escape the

Barge management philosophy.   Petitioner agrees that Mississippi

law provides for partition of real property.   See Miss. Code Ann.

sec. 11-21-3 (Supp. 1996).   If the timberland were partitioned, a

purchaser would pay an amount equal to the present value of

(1) the cash-flow expected under Barge management for the period

until partition (minus the costs of partition, which would be

divided equally over the partition period), and (2) the value of
                               - 10 -

the interest on partition (which, if she received a payment in

kind, would not be subject to the Barge management philosophy).

Accordingly, in order to determine the price that the purchaser

would pay, we must figure (1) the length of the partition process

and its costs, (2) the proper interest rate a buyer would demand,

and (3) the value of a 25-percent fee simple after partition.

     B.   What a Purchaser Would Pay

            1.   Partition

     In partition suits, Mississippi courts tend to favor

equitable partition-in-kind over an outright sale of the entire

property.    Shaw v. Shaw, 603 So.2d 287, 290 (Miss. 1992).

Petitioner's expert, William C. Smith, Jr. (Smith), was of the

opinion that a contested partition would take from 2 to 5 years

to resolve at a total cost of about $1,150,000 to $1,500,000,

which would be borne equally by the parties.     Members of the

Barge family testified that they would resist any attempt to

partition the timberland.    We are not convinced that such

resistance would be undertaken just for the sake of delay, since

it would not be cost free.    Resistance might be mounted to obtain

an advantageous partition, however.     We judge that a partition

action would take 4 years, and that the party initiating such

action would bear one-half of total partition costs of

$1,325,000.
                                 - 11 -

          2.     Discount Rate

     Respondent argues that a capitalization rate of 9 to

10 percent is applicable in this case.     In support of that

argument, she points to Ebner’s testimony and to the testimony of

her own expert, Flowers.    Petitioner argues for a discount rate

of 14 percent:

     the rate of return which a potential investor would
     require from the type of investment involved herein is
     considered a minimum of 10% exclusive of investment
     risks. The evidence in this case clearly indicates
     that there are many risks inherent with the ownership
     of this type property. Therefore, it is reasonable for
     the court to accept 14% as a required rate of return on
     this type of investment. * * *

Petitioner points only to the expert testimony of Pinkowski to

support a rate of return of 14 percent.     We do not find Pinkowski

particularly helpful with respect to the capitalization approach.

Petitioner has failed to prove that a discount rate of greater

than 10 percent is appropriate.     We shall use 10 percent.




          3.     Value of Interest After Partition

     The parties have stipulated that the timberland had a fair

market value of $40 million as of the date of the 1987 gifts.

Respondent argues, however, that because of the Barges’ saw

timber management philosophy, the value of the timberland would

increase during the period of any action to partition.     We think
                                     - 12 -

that that is correct.        Petitioner’s expert, Ebner, was of the

opinion that the increase would be $363,000 a year.                  We reach a

figure close to that and conclude that the timberland would be

worth $41 million at the end of a 4-year partition period.

Accordingly, we believe that the partition award to a 25-percent

owner of the timberland at the end of a 4-year partition action

would be worth $10,250,000

III.     Fair Market Value

        Accordingly, using a 10-percent rate of return, a partition

period of 4 years, future income of $293,000 per year during the

partition period, partition costs of $662,500 (the purchaser’s

50-percent share of $1,325,000) allocated equally over the

partition period, and a value of $10,250,000 after partition, we

find that the fair market value of the 1987 gift to be $7,404,649

under the following calculation:

Year       Income        Partition            Partition      Total        Present
                         Costs                Payment                     Value
  1       $293,000   -   $165,625     +         $0           $127,375     $115,795
  2        293,000   -    165,625     +          0            127,375     105,268
  3        293,000   -    165,625     +          0            127,375      95,699
  4        293,000   -    165,625     +   10,250,000       10,377,375    7,087,887
Total                                                                   $7,404,649




                                                     Decision will be entered

                                          under Rule 155.
