                          T.C. Memo. 1997-116



                      UNITED STATES TAX COURT



       POPE & TALBOT, INC., & SUBSIDIARIES, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 530-93.                         Filed March 6, 1997.


     Grady M. Bolding, James E. Burns, Jr., Russell D. Uzes,

Kevin P. Muck, and D. Cameron Baker, for petitioner.

     Milton J. Carter, Jr., Terri Merriam, Henry T. Schaefer,

Christopher D. Hatfield, Randall E. Heath, and Robert F.

Geraghty, for respondent.


                          MEMORANDUM OPINION


     RUWE, Judge:   Respondent determined deficiencies in

petitioner's 1985 and 1986 Federal income taxes in the amounts of

$17,693,960 and $954,678, respectively.    In Pope & Talbot, Inc. &
                              - 2 -

Subs. v. Commissioner, 104 T.C. 574 (1995), we denied

petitioner’s motion for partial summary judgment and granted

respondent’s motion for partial summary judgment, holding that

under section 311(d),1 petitioner’s gain on the distribution of

appreciated property is to be determined as if petitioner sold

the property in its entirety for fair market value and not by

reference to the value of the property interest received by each

shareholder.

     The primary issue for decision herein is the fair market

value of the property distributed by petitioner.   After

concessions, the remaining issues for decision are:   (1) Whether

petitioner may offset fees in the amount of $1,364,071 in 1985,

which were incurred in connection with the distribution, against

its section 311(d) gain as costs of sale; (2) whether petitioner

may deduct investment banking fees in the amounts of $89,788.08

and $66,195.92 in 1985 and 1986, respectively, for advice

regarding potential hostile takeovers; and (3) whether petitioner

may deduct $1,465 paid to Depository Trust Co. in 1985 in

connection with holding petitioner’s stock.

     Some of the facts have been stipulated and are so found.

The stipulation of facts, first supplemental stipulation of

facts, and stipulations of exhibits are incorporated herein by

     1
      Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the taxable years in
issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
                               - 3 -

this reference.   For purposes of convenience, our findings of

fact with respect to respondent's specific determinations will be

combined with our opinion on each issue.

                            Background


     Petitioner is a publicly held Delaware corporation with its

principal place of business in Portland, Oregon.    Petitioner’s

shares are traded on the New York Stock Exchange.    During 1985,

petitioner engaged in several businesses, primarily in Oregon and

Washington, including timber, sawmill and pulp mill operations,

land development, and resort businesses.

     In October 1985, petitioner’s board of directors adopted a

Plan of Distribution (the plan).   Under the terms of the plan,

petitioner would transfer its timber and land development

properties and related assets located in the State of Washington

(collectively referred to as the "Washington properties") to Pope

Resources, a newly formed Delaware limited partnership (the

Partnership).   Upon transfer of the Washington properties to the

Partnership, the managing general partner was to make a pro rata

distribution of the interests in the Partnership (partnership

units or units), on the basis of one partnership unit for each

five shares of common stock.

     Petitioner’s board of directors believed the plan to be in

the best interests of petitioner’s shareholders for several

reasons.   First, the plan would provide certain tax benefits,
                                 - 4 -

including elimination of the double tax associated with the

corporate form and the passing through of net losses to the

unitholders.   Next, the plan would substantially improve

petitioner’s balance sheet by increasing the shareholder’s equity

by approximately $2.4 million and generating approximately $25.9

million in cash.   Finally, the plan would provide potential

increased economic returns from the Washington properties to the

unitholders.   The board of directors believed that the market

value of the Washington properties was not fully reflected in the

trading price of petitioner’s common stock, and, by placing these

properties in a separate entity, the board of directors could

achieve a higher overall value for the shareholders.

     Petitioner’s shareholders approved the plan at a special

shareholder’s meeting on December 4, 1985.   On December 6, 1985,

prior to the effective date of the plan, the partnership units

began trading on a "when issued"2 basis on the Pacific Stock

Exchange.   There were approximately 1.2 million partnership

units, and the weighted average trading price of the units for

the period December 6, 1985, through January 7, 1986, was

approximately $11.50 per unit.

     On December 20, 1985, pursuant to the terms of the plan,

petitioner (1) borrowed approximately $22.5 million from

     2
      "When issued" is a term used in connection with a security
not yet authorized for issuance. It refers to a conditional
transaction in which one indicates a desire to buy when the
security is authorized and available for sale.
                               - 5 -

Travelers Insurance Co., secured by approximately 71,363 acres of

its timberlands located in the State of Washington; (2)

transferred all its approximately 78,000 acres3 of Washington

timberlands to the Partnership, subject to the Travelers' loan;

(3) transferred all its Washington land development and resort

business to the Partnership;4 (4) transferred $1.5 million in

cash to the Partnership for working capital; and (5) sold certain

installment note receivables to the Partnership for approximately

$4.9 million in cash.

     The original general partners of the Partnership were Pope

MGP, Inc. (MGP), and Pope EGP, Inc. (EGP), both Delaware

corporations.   Initially, MGP and EGP were owned equally by two

of petitioner’s principal shareholders, Peter T. Pope and Emily

T. Andrews.   The corporate general partners held an aggregate

interest of approximately 1 percent in the capital, profits,

losses, and distributions of the Partnership.   Responsibility and

authority for management of the Partnership was vested

exclusively in MGP as the managing general partner.   Limited

partners had no management power and only limited voting rights.

MGP could be removed and replaced as managing general partner

only with the affirmative vote of partners of record holding at

least (1) 66-2/3 percent of the units issued upon distribution

     3
      Petitioner's proxy statement refers to 78,300 acres.
     4
      This included 4,400 acres in addition to the 78,000 acres
of timberlands.
                                - 6 -

that have been held by the unitholder or the unitholder’s family

continuously for at least 5 years, or (2) 90 percent of units

held by all partners.   Petitioner was not a partner in the

Partnership and received no partnership units.

     On December 20, 1985, descendants of the founding families

owned 34.36 percent of the outstanding stock of petitioner--the

Pope family owned 21.04 percent, and the Andrews family owned

13.32 percent.   They received corresponding percentages of

partnership units.   Peter T. Pope and Adolphus Andrews, Jr., were

members of the board of directors of petitioner, and Mr. Pope was

the chairman of the board and the chief executive officer.


                             Discussion


     The first issue we must decide is the fair market value of

the Washington properties transferred by petitioner to the

Partnership.   Fair market value is traditionally 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);

Buse v. Commissioner, 71 T.C. 1129, 1135 (1979).    The standard is

objective, using a purely hypothetical willing buyer and seller.

Propstra v. United States, 680 F.2d 1248, 1251-1252 (9th Cir.

1982); Estate of Newhouse v. Commissioner, 94 T.C. 193, 218

(1990).    However, the hypothetical sale should not be constructed
                                 - 7 -

in a vacuum isolated from the actual facts that affect value.

Estate of Andrews v. Commissioner, 79 T.C. 938, 956 (1982).

     The determination of fair market value is a question of

fact.     Hamm v. Commissioner, 325 F.2d 934, 938 (8th Cir. 1963),

affg. T.C. Memo. 1961-347; Estate of Newhouse v. Commissioner,

supra at 217.    In general, property is valued as of the valuation

date on the basis of market conditions and facts available on

that date--without regard to hindsight.    Subsequent events are

considered only to the extent that they were reasonably

foreseeable at the date of valuation.     Estate of Gilford v.

Commissioner, 88 T.C. 38, 52 (1987).     Moreover, valuation is

generally based on the highest and best use of the property to be

valued.    Buse v. Commissioner, supra at 1137.

     Both parties have submitted very extensive expert witness

reports and testimony relating to the fair market value of the

Washington properties.    While expert opinions can assist the

Court in evaluating a claim, we are not bound by the opinion of

any expert witness and may reach a decision based on our own

analysis of all the evidence in the record.       Helvering v.

National Grocery Co., 304 U.S. 282, 295 (1938); Silverman v.

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

1974-285; Estate of Newhouse v. Commissioner, supra at 217.
                                  - 8 -

Value of Timber, Timberlands, and Development Property


     The timberlands transferred to the Partnership consisted of

approximately 78,000 acres of timberland located in the Puget

Sound area of the State of Washington, within a 50-mile radius of

Seattle, Washington.      According to petitioner's proxy statement,

which describes this transaction, the timberlands included

approximately 650 million board feet5 of commercial softwood

stands, 75 percent of which were Douglas fir and the remainder of

which were hemlock and other species.        The proxy statement shows

the approximate age class distribution of petitioner’s softwood

stands in 1985 as follows:


                              Board Feet
           Age Class         (in millions)       Percentage

           0-39   years           41                6.2
          40-49   years          327               49.8
          50-59   years          127               19.3
          60-69   years           75               11.4
            70+   years           87               13.3

                                 657              100.0


In general, petitioner harvested softwood stands after they

attained 50 years of age.     According to the proxy statement, the

timberlands also included approximately 205 million board feet of

hardwood stands, consisting mostly of alder that had little



     5
      A board foot is a unit of measure for sawtimber and lumber
that is 12-inches square and 1-inch thick.
                               - 9 -

commercial value.   The market for timber and timberland was

depressed in 1985 but began to rise in mid-1986.

     Petitioner’s expert, Ray E. Granvall, Jr., of Cascade

Appraisal Services, Inc., appraised approximately 79,127 acres of

timberland6 containing about 796,729 thousand board feet (MBF) of

merchantable timber as of December 20, 1985, and concluded that

the market value of the property was $26,510,000.    Mr. Granvall

relied primarily on an economic approach, in which he separately

valued merchantable timber, reproduction timber (i.e.,

premerchantable timber that is less than 40 years of age), and

bare land and adjusted these indicated values to fair market

value by applying a comparable sales adjustment factor.

     Mr. Granvall considered merchantable timber to include

softwood and hardwood stands over 40 years old.    In estimating

the value of merchantable timber, Mr. Granvall utilized a

procedure known as "Conversion Return Analysis".    This approach

starts with the value of the end-product, generally the spot

market prices for logs, and then deducts logging costs to arrive

at an indicated value for the merchantable timber.    Mr. Granvall

started with an average delivered log price of $187/MBF.    He

arrived at this figure using published price lists for both




     6
      This figure includes acreage that petitioner described as
development properties in its proxy statement.
                               - 10 -

domestic and export markets.   He then subtracted the following

logging costs:


           Cost Component           Dollars Per MBF

           Fall and buck                 $17
           Yard and load                  58
           Haul                           45
           Road construction               7
           Road use/maintenance            2
           Slash                           1
           Scaling                         3
           Administrative                  5
           Excise tax                      9
           Reforestation                   7

             Total                      $154


Mr. Granvall also subtracted a profit and risk factor equal to

$4/MBF.7   Finally, Mr. Granvall applied a comparable sales

adjustment factor of .61, which is equivalent to a 39-percent

discount, to the net log value to arrive at an indicated value

for merchantable timber of $18/MBF, or $14,341,122 total.

     Mr. Granvall computed his comparable sales adjustment factor

by averaging the transaction prices for four comparable sales

that he selected and adjusted for size differences.   The four

comparable sales selected by Mr. Granvall occurred between July

1983 and March 1985 and ranged in size between 2,904 and 134,000

acres.


     7
      He estimated the profit and risk at 12.5 percent of the
delivered log value (net of logging costs) and adjusted that
amount for contract profit, which was already included within the
delivered log values.
                               - 11 -

     Mr. Granvall estimated the value of reproduction timber

using a discounted cash-flow analysis.   In applying this

analysis, Mr. Granvall considered any timber less than 40 years

of age to be reproduction timber.   Mr. Granvall projected the

value of the reproduction timber at 50 years, which he considered

to be the optimum harvest age, and discounted it to present value

using discount rates ranging from 4.7 percent for Site V (highly

productive) to 7.7 percent for Site I (poorly productive).   He

then applied the comparable sales adjustment factor of .61 to

arrive at a total value for reproduction timber of $4,937,389.

     Mr. Granvall estimated the value of bare land by site class

and then applied the comparable sales adjustment factor to the

total.   Using this approach, Mr. Granvall estimated the value of

the bare land at $7,233,807.

     Respondent’s expert, James W. Prochnau of Jackson &

Prochnau, Inc., appraised approximately 69,000 acres8 of



     8
      The difference in the number of acres appraised by each
expert as timberland is attributable to their differing opinions
as to how much of the land has a higher and better use as
something other than timberland. It is petitioner's contention
that, in addition to the 79,127 acres of undeveloped land
classified as timberland by Mr. Granvall, approximately 2,000
acres of land transferred to the Partnership had a higher and
better use as development land. Respondent, on the other hand,
argues that of the undeveloped land transferred to the
Partnership, only 69,000 acres should be classified as timberland
while 11,084 acres had a reasonable potential for development
and, accordingly, should be valued as such. The parties refer to
this "higher and better use" property as transitional or
development property.
                              - 12 -

timberland containing about 422,523 MBF of merchantable timber as

of December 20, 1985, and concluded that the market value of the

property was $63.5 million.   Mr. Prochnau first divided the

timberland into six smaller parcels based on geographic location

and market access.   His rationale for doing so was:   (1) To

attract buyers who are interested in specific income property or

may be incapable of financing the purchase of larger properties,

(2) to liquidate the property quickly, and (3) to maximize sales

revenue (smaller units reduce the discount related to the

wholesale nature of larger sales).     Mr. Prochnau then applied a

valuation methodology similar to that of Mr. Granvall.    He

estimated the value of each component (i.e., merchantable timber,

reproduction timber, and bare land) and multiplied the total by a

ratio to arrive at the total market value.

     In estimating the value of merchantable timber, which he

defined as softwood stands 50 years and older and hardwood stands

40 years or older, Mr. Prochnau used published price quotes and

contract sales prices to arrive at an average9 delivered log

price of $199.82/MBF.   He then subtracted the following average

logging costs:




     9
      The average amounts of delivered log prices and logging
costs are spread over only five of the six parcels of timberland,
because tract number six contained no merchantable timber.
                              - 13 -

          Cost Component              Dollars Per MBF

          Fall and buck                    $13.56
          Yard and load                     44.21
          Trucking                          30.72
          Road construction                  6.00
          Road maintenance/fees              1.00
          Excise tax                         6.00
          Contingency                        5.00

             Total                        $106.49


Mr. Prochnau thus determined that the gross value of the

merchantable timber (before applying any discount) was

$37,646,264.

     Mr. Prochnau then estimated the value of reproduction timber

using a growth-discount analysis that grows reproduction timber

(i.e., timber younger than 50 years) to age 50 and then discounts

the harvest value to present value.     The delivered log price is

determined in the same manner as for merchantable timber.     To

this price, Mr. Prochnau applied an appreciation rate of 1.5

percent and deducted carrying charges of $6 per acre.     This

future value was then discounted to present value using a rate of

7 percent.   Using this approach, Mr. Prochnau estimated the value

of reproduction timber at $36,252,683, before making a comparable

sales adjustment.

     Mr. Prochnau estimated the value of bare land by site class

using a comparable sales analysis.     Mr. Prochnau utilized 21

comparable sales between December 1983 and March 1988, ranging in

size between 20 and 16,394 acres.    He adjusted these comparable
                              - 14 -

sales for differences in location (i.e., proximity to shipping or

delivery points and desirability of location) and concluded that

the total gross value (before discount) of the bare land was

$7,770,699.

     Mr. Prochnau took the sum of the gross values for each of

the components (i.e., merchantable timber, reproduction timber,

and bare land) and determined an indicated value under two

different approaches--the comparable sales approach and the

income approach.   Under the comparable sales approach, Mr.

Prochnau utilized 33 comparable sales of between 20 and 53,916

acres that occurred between December 1983 and September 1991.

For each comparable sale, Mr. Prochnau calculated a comparable

sales ratio equal to the actual sale price divided by the gross

value of the components as estimated by Mr. Prochnau.   The

comparable sales ratio is relative to the term "discount" or

"premium" commonly referred to in appraisals.   He then performed

a regression analysis to plot the variation of comparable sales

ratios over the range of comparable sale sizes.   The comparable

sales ratio chosen by Mr. Prochnau for each tract of the subject

property was between .7549 and .9957, indicating a discount of

between .43 and 24.51 percent.   Applying the appropriate

comparable sales ratio to the total gross value of each tract of

the subject property, Mr. Prochnau calculated an indicated value

of $63,980,100 for the subject property under the comparable

sales approach.
                              - 15 -

     Under the income approach, the gross values of reproduction

timber and bare land were determined as they were for the

comparable sales approach.   The merchantable timber component,

however, was adjusted for time (by applying an interest rate of

8.5 percent) and profit and risk (10 percent of net stumpage

value).   An income ratio was then calculated for each tract by

dividing the component value of merchantable timber as adjusted

for time and profit and risk by the gross component value of

merchantable timber.   The income ratios for each tract as

determined by Mr. Prochnau ranged from .7124 to .8618, indicating

a discount between 13.82 and 28.76 percent.     The income ratios

were then applied to the reproduction timber and bare land

components, and the product was added to the adjusted

merchantable timber value, yielding a total indicated value of

$63,092,357 under the income approach.

     Mr. Prochnau based his final conclusion of $63.5 million on

the indicated values under both the comparable sales and income

approaches.

     Overall, the parties’ experts used similar approaches in

valuing the timber and timberland.     Where the experts differ

primarily is in their calculation of logging costs, the discount

applied to the gross value of the subject property, the treatment

of reproduction timber, and the amount of property that has a

higher and better use, and thus a higher value, than timberland.
                              - 16 -

     In determining the logging costs, both experts included

contract logging and associated costs (i.e., the costs that would

be incurred by a landowner in harvesting the timber and

delivering it to the point of sale).   Specifically, these costs

include:   (1) Falling, or cutting the trees; (2) bucking, or

sectioning the trees into log lengths that maximize volume and

value; (3) yarding, or moving the bucked logs from the woods to a

roadside landing; (4) loading the logs onto trucks; (5) hauling,

or transporting the logs to the mill; (6) road construction and

maintenance; (7) excise taxes; and (8) contract administration,

or keeping track of the contractors hired to harvest the timber.

     Petitioner’s expert, however, included scaling,

reforestation, and slash disposal costs in addition to the

contract logging costs.   Scaling is the measuring and grading of

logs once they have arrived at the log dump or mill.   It is

generally performed by an independent third party, and the cost

is typically paid by the purchaser of the timber.   Slash burning

and reforestation involve cleaning the ground and replanting the

timber that has been removed from the timberland.   Reforestation

is required by Washington law in order to maintain the property’s

designation as forestland.   If the owner fails to reforest the

property, it will be converted to ad valorem land, which is taxed

at a higher rate.   In addition, upon conversion, the owner must

pay a conversion tax equal to the additional amount of tax that
                              - 17 -

the owner would have paid if the property had been subject to the

ad valorem tax rate for the preceding 10 years.

     In the present case, we are trying to determine what a

hypothetical buyer would pay for an entire tree farm, not just

the delivered logs.   Thus, we think that a buyer would consider

such costs as slash burning and reforestation, because those are

costs associated with operating a tree farm.   Petitioner has not

persuaded us, however, that a hypothetical buyer would consider

scaling costs, as those costs are normally incurred by the

purchaser of the timber, not the owner of the tree farm.

     Respondent also argues that petitioner’s expert has

overstated the contract logging costs.   The parties agree that

petitioner’s actual costs for 1985 are relevant in determining

the reasonableness of any cost estimate.   Petitioner claims that

its actual costs were approximately $161/MBF in 1985, which

establishes the reasonableness of Mr. Granvall’s estimate of

$154/MBF.   However, petitioner's actual cost records include a

substantial amount for general administrative costs that

significantly exceeds the amount of administrative costs that

even petitioner's expert includes in costs.    Respondent, on the

other hand, claims that petitioner’s actual costs, using only the

cost items listed by petitioner's expert, were approximately

$107/MBF, which confirms the reasonableness of Mr. Prochnau’s

estimate of $106.48/MBF.   However, this is partially attributable

to differences in the way the cost elements are described in the
                              - 18 -

expert report and petitioner's cost records.    Based upon our

analysis of petitioner’s cost records and giving due

consideration to all the evidence with respect to logging costs,

we find $130 to $140/MBF to be a reasonable cost estimate range.

     The next fact upon which the parties’ experts disagree is

the discount to be applied to the gross value of the subject

property.   Both of the parties’ experts discounted their initial

valuation estimate for the size of the parcel and agreed that the

larger the parcel, the larger the discount.    Both of the experts

derived their discounts from comparable sales.    However,

respondent’s expert, Mr. Prochnau, applied an average discount of

21.66 percent, while petitioner’s expert, Mr. Granvall, applied a

discount of 39 percent.   The difference results largely from

their differing assumptions about how the timberland should be

marketed.   Mr. Prochnau divided the property into six parcels,

while Mr. Granvall assumed that the property would be sold as a

single parcel.   Mr. Prochnau believed that partitioning the

property would maximize the sales revenue (because of the smaller

discount), result in a shorter liquidation period for the

property, and attract smaller buyers who would not be able to

finance the purchase of a larger parcel.    Mr. Granvall, on the

other hand, believed that operating large tracts of timberland

was more efficient and that the practice in the timber industry

in 1985 was to sell land in large blocks.
                               - 19 -

     While we agree that partitioning the land into smaller

parcels would reduce the overall discount, we do not think that

partitioning the land is appropriate in the present case.    Given

the depressed market and lack of demand for timberland in 1985,

we do not see how partitioning the land into smaller parcels

would significantly shorten the liquidation period for the

property.   Moreover, the owner would incur additional costs in

partitioning and selling multiple parcels of land.   The evidence

indicates that while smaller buyers were entering the timberland

market in 1986 and later, the most likely buyers in 1985 were

large, industrial buyers.   Accordingly, we shall consider the

value of the timberland as if it were sold as a single parcel.

Viewing the sale as such, we believe that a 39-percent discount

would be appropriate.

     The parties’ experts also disagree upon the classification

of reproduction timber.   The optimal harvest age for softwood

timber was 50 years.    Both parties' experts assumed for purposes

of applying their discounted cash-flow analyses that reproduction

timber would be held to age 50.   The difference lies in the

experts’ treatment of timber between the ages of 40 and 49 years.

Mr. Prochnau, respondent’s expert, treated the timber falling in

the 40-49 age group as reproduction timber.10   Mr. Granvall,


     10
      Actually, Mr. Prochnau classified softwood timber under 50
years into two categories--timber between 30 and 49 years was
classified as "immature", and timber less than 30 years was
                                                   (continued...)
                                - 20 -

petitioner’s expert, treated such timber as merchantable.     We

note that almost 50 percent of petitioner’s timber fell within

the 40-49 age classification.

     We find Mr. Granvall’s approach to be inconsistent.     For

timber up to 39 years old, Mr. Granvall "grew" it to age 50 and

discounted it to present value, but for timber between 40 and 49

years, he harvested it immediately.      This timber, if held to age

50, would net a higher profit.    We think that a hypothetical

buyer would consider this economic opportunity and value the

timber accordingly.

     Finally, the parties agree that some portion of petitioner’s

undeveloped land had a higher and better use as something other

than timberland; however, they disagree as to the amount of such

property.   The parties refer to this "higher and better use"

property as transitional, or development, property.

     In 1968, petitioner formed Pope & Talbot Development for the

purpose of dealing in real estate sales.     Petitioner often sold

or contributed property to Pope & Talbot Development that

petitioner’s management had determined was potentially

developable and was more valuable as development property than as

timberland.   In 1985, Pope & Talbot Development held

approximately 17,000 acres.   The most recent transfer of 13,500


     10
      (...continued)
referred to as "reproduction". To simplify the comparison of the
reports of the two experts, we refer to all premerchantable
timber as "reproduction".
                               - 21 -

acres occurred in June 1984.   Pursuant to the plan, petitioner

transferred all the property held by Pope & Talbot Development to

the Partnership.   However, as set forth in the notice and proxy

statement that petitioner sent to its shareholders describing the

plan, petitioner classified only 4,400 acres of this property as

development property; the remainder was classified as timberland.

     Respondent’s expert, Bruce C. Allen of Bruce C. Allen &

Associates, Inc., determined that approximately 11,084 acres (31

parcels) of land held by Pope & Talbot Development had

development potential in the reasonably foreseeable future (i.e.,

5-10 years).11   A majority of this property was located in Kitsap

and Jefferson Counties.   Kitsap County is the more developed of

the two counties, with a broad economic base and well-established

cities.   Jefferson County is more rural with lower values and

lower levels of development.

     In appraising the land, Mr. Allen utilized a sales

comparison approach.   He analyzed roughly 200 sales spanning the

period from 1981 through 1987.   He adjusted the comparable sales

for differences in size, location, topography, access, zoning,

view, and forested appearance.   Mr. Allen opined that due to the

generally flat market conditions, only those sales in 1987



     11
      Most of the acreage Mr. Allen valued was classified as
"Timberlands" in petitioner's proxy statement. In the proxy
statement, petitioner classified only 4,400 acres of land
transferred to Pope Resources as "Development Properties"; 78,300
acres were classified as "Timberlands".
                              - 22 -

required a time adjustment to 1985.    Mr. Allen assumed that some

timber would remain on the subject property because of the

difficulty in marketing completely bare, or clear-cut, land.      In

cases where the parcels were large and comparable sales were not

available, Mr. Allen utilized a development approach.    The

approach involved an analysis of the potential segregation of a

parcel, less the costs to segregate and sell the lots.     Mr. Allen

retained a planning firm specializing in the subdivision of land

to assist in the estimation of the development costs.    To the

extent that a typical buyer would recognize the value of

merchantable timber in excess of a light forested cover, Mr.

Allen relied on Mr. Prochnau for the value of such excess timber.

     Mr. Allen then applied a bulk discount of 10 percent to the

total appraised value of the subject properties to recognize

several potentially offsetting factors:   (1) The ability to sell

scattered parcels individually, (2) the near-term development

potential of property in Kitsap County, (3) the long-term holding

prospect of property in Jefferson County, and (4) the moderate

activity in Pierce County.   Mr. Allen estimated the total market

value of the development properties (after discount) to be $20.9

million.

     Petitioner’s expert, Byron Slack of National Appraisal Co.,

determined that approximately 2,000 acres (10 parcels) had

development potential.   Mr. Slack utilized a market, or

comparable sales, approach to valuing these parcels, making
                                 - 23 -

adjustments to the comparable sales prices where necessary.        One

parcel, however, the Gold Mountain broadcast site, was valued

using an income approach, capitalizing net income at 17

percent.12

     The parties agree that eight parcels had a higher and better

use than timberland.     A comparison of the estimated values of

these properties is as follows:


          Property          Mr. Allen           Mr. Slack

     Bucklin Ridge          $3,600,000          $2,400,000
     Poulsbo 80                112,500             130,000
     Everett                   765,000             707,000
     Gamblewood                247,500             285,000
     Pete’s Mountain           792,000           1,247,000
     Discovery Bay           1,080,000             623,600
     Camano Hill               180,000             246,000
     Brown’s Point             558,000             697,000

          Total             $7,335,000          $6,335,600


     Like the market for timberland, the real estate market was

depressed in 1985.     As such, we do not agree with Mr. Allen's

determination that 11,084 acres of real estate held by Pope &

Talbot Development were potentially developable in the reasonably

foreseeable future.     Moreover, we note that upon conversion of

designated forestland into ad valorem property, the owner must

pay a conversion tax equal to the additional amount of tax that

the owner would have paid if the property had been subject to the

ad valorem tax rate for the preceding 10 years.     While this cost


     12
          Mr. Slack valued the Gold Mountain parcel at $126,500.
                                - 24 -

is not incurred until actual conversion, we think that a

hypothetical buyer would consider this potential cost.     Mr. Allen

did not account for conversion costs in his analysis.     Upon

consideration of the experts’ reports and testimony and other

evidence relating to the development potential of the property,

we believe that approximately 6,000 acres of the property held by

Pope & Talbot Development should be classified as development

property having a higher and better use than timberland.

     In sum, we have considered each expert’s report and

testimony with respect to timber, timberland, and development

property and have determined that we cannot accept or reject

either party’s experts in full.     Based upon the record before us

and the conclusions we have reached above, we believe that the

collective value of the timber and timberland was between $30 and

$40 million, and the value of the development property was

between $10 and $12 million.


Port Ludlow Community


     The Port Ludlow community is a resort and residential

development project located in Port Ludlow, Washington, on the

Puget Sound.   Prior to the transfer of Port Ludlow to the

Partnership, approximately 500 acres of land had been developed,

and approximately 750 lots had been sold at prices ranging from

$10,000 to $75,000.     As of December 20, 1985, approximately 68

developed lots remained available for sale, and about 2,500
                                - 25 -

additional acres in the Port Ludlow area were available for

future development.13    Facilities at the Port Ludlow community

include a marina, a full-service restaurant, a convention center,

a sales office, and an 18-hole golf course.    In 1985, Village

Resorts, Inc., a resort management company, leased these

facilities.   The property transferred to the Partnership remained

subject to this lease.

     By 1984, the wastewater treatment plant at Port Ludlow was

operating well in excess of capacity.    The Department of Ecology

imposed a moratorium on new sewer hookups until certain interim

improvements were made and an expansion plan was approved.    The

Department of Ecology dropped the moratorium in May 1985;

however, sales of petitioner’s existing lots were still not

permitted until expansion of the sewer was completed.    In 1985,

petitioner estimated that the expansion project would be

completed by the end of 1988 at a cost of between $2 and $5

million.   Phase I of the sewer expansion project was completed in

1989 at a cost of approximately $2.5 million.

     As a result of the sewer problems, Port Ludlow experienced

heavy financial losses and was forced to close the resort during

the winter of 1984-1985.



     13
      The 2,500 acres of undeveloped property were not appraised
by the parties’ experts in connection with the Port Ludlow
community. Instead, this property was valued either as
timberland or development property, which was previously
discussed.
                              - 26 -

     Petitioner’s expert, Byron Slack, separately valued the

developed lots, each resort improvement, and the bare land.     He

assumed that the most likely buyer would be a timber company who

would purchase the resort along with the surrounding timberland.

In estimating the value of the developed lots, Mr. Slack utilized

a subdivision approach, wherein he capitalized the net income

expected to be generated from sales of the lots.   First, Mr.

Slack estimated the current market value of the lots based on

previous lot sales by petitioner in the Port Ludlow area.   He

then estimated the reasonably expected absorption rate (i.e., the

rate and period over which the lots would be sold).   Because of

the sewer moratorium, Mr. Slack assumed that lot sales would not

recommence until 1988.   He further estimated that lot sales would

average approximately 10 per year from 1988 through 1993 and that

the lots would be entirely disposed of in 1994.

     Next, Mr. Slack deducted the estimated costs associated with

selling the lots.   He estimated the costs of sale at 55 percent

of the sales price of the lots.   These costs would include site

preparation, sales costs, property taxes, utilities, and roads.

Mr. Slack then estimated an additional cost of $40,000 per year

for general overhead, administrative expenses, marketing,

supplies, etc.   Mr. Slack also apportioned part of the expected

costs for the sewer upgrade (which he estimated at a total of $3

million) to the developed lots.
                               - 27 -

     Finally, Mr. Slack capitalized the net income from the lots

at a rate of 29.41 percent to arrive at the fair market value of

the lots.   This capitalization rate has both debt and equity

components as well as adjustments for risk and illiquidity.

     According to Mr. Slack, the income flow from the lots as

determined under this subdivision approach was negative.       Thus,

Mr. Slack determined that residential use of these lots was not

the highest and best use.    Rather than consider other potential

uses for the lots, Mr. Slack thought that it was more reasonable

to estimate the value of the lots at $50 each, or $3,400 total.

     In estimating the value of the improvements at Port Ludlow,

Mr. Slack utilized a cost approach.     He rejected the market

approach as a reliable indicator of value because of the lack of

good comparable sales.   He also rejected the income approach,

because there was insufficient data from which to precisely

determine revenue and costs.    In addition, in most cases, the

income approach yielded extremely low or negative values.      Mr.

Slack utilized the market approach, however, to estimate the

value of the land underlying the improvements.     Mr. Slack

determined the following fair market values for the land and

improvements at Port Ludlow:


            Land and Improvement                  Value

            Golf course and
              related improvements              $1,571,661
            Convention center                      117,422
            Restaurant, sales office, and
                               - 28 -

              information center                1,525,106
            Marina and related improvements     1,314,653
            Miscellaneous                         112,194

              Total                            $4,641,036


     Finally, Mr. Slack estimated the value of approximately 959

acres of bare, undeveloped land at $2,129,003 using the market

approach.    In arriving at this value, Mr. Slack considered the

wastewater treatment problems at Port Ludlow to be a particularly

significant factor.    Even after the planned sewer expansion

project, some of the land would be left without access to the

wastewater treatment system.    Moreover, most of the land had soil

characteristics that did not allow for on-site sewer systems.

Mr. Slack apportioned part of the $3 million expected costs for

the sewer upgrade to the bare and improved land.    Mr. Slack also

made adjustments to his comparable sales to account for

differences in access and view.    No time adjustment was made,

however, because land values remained stable in Jefferson County

during the time period.

     In sum, Mr. Slack estimated the value of the Port Ludlow

community, including the developed lots, the undeveloped land,

and all the improvements, less total estimated sewer expansion

costs of $3 million, at $3,945,000.

     Respondent’s experts, Christopher K. Monger and Michael F.

Griffin of Palmer, Groth & Pietka, Inc., determined that the

highest and best use of the property is its current use as a
                              - 29 -

resort and that the most likely buyer would be a single developer

or investor, who would continue to operate it as a resort.

Messrs. Monger and Griffin valued the Port Ludlow community in

the aggregate as opposed to in bulk (with the exception of the

developed lots).   In other words, they summed the values of the

individual components, rather than determining the value of the

individual components as if offered and sold on the market to a

single buyer in one transaction.

     In estimating the value of the developed lots, Messrs.

Monger and Griffin utilized a sales comparison, or market,

approach to arrive at the value of each lot.   They then adjusted

the aggregate of these values to arrive at a bulk value.   The

bulk value reflects the subject’s value if sold as a single

entity to one buyer in one transaction, and it reflects the

purchaser’s acceptance of the marketing risk and holding costs.

Messrs. Monger and Griffin assumed an absorption rate of 5 lots

per year for the first 2 years increasing gradually up to 25 lots

per year (for an overall average of 15 lots per year).   They

deducted selling and holding costs equal to approximately 18.5

percent of sales from the aggregate value of the lots.   Then, a

total discount of 22 percent (i.e., 12 percent attributable to

the time value of money and 10 percent expected profit) was

applied to arrive at the bulk value of the lots.   Messrs. Monger

and Griffin arrived at a final bulk value of $400,000 for the

developed lots.
                              - 30 -

     Messrs. Monger and Griffin estimated the value of the

improved portions of Port Ludlow using a cost approach.      An

income approach was also used for those properties for which

there was sufficient revenue and expense data (i.e., the

restaurant, marina, and golf course).   The sales comparison

approach was not considered a reliable value indicator, since

individual resort components sell infrequently, and they derive

their value mostly in connection with the larger resort property.

Messrs. Monger and Griffin utilized the sales comparison

approach, however, to estimate the value of the land underlying

the improvements.   That method is discussed below.   Messrs.

Monger and Griffin determined the following fair market values

for the land and improvements at Port Ludlow:


          Land and Improvement                    Value

          Golf course                           $2,350,000
          Convention center and sales
            office                                 270,000
          Restaurant                               500,000
          Marina                                 1,080,000

            Total                             $4,200,000


In addition, Messrs. Monger and Griffin utilized the cost

approach to estimate the value of certain retail and commercial

facilities that were under construction in 1985 at $130,000.

     Finally, in estimating the value of the vacant, undeveloped

land, Messrs. Monger and Griffin divided the parcels into

functional units, or a smaller number of property groups with
                                - 31 -

similar higher and best uses.    They then valued each functional

unit by using the comparable sales method.   Adjustments were made

for size, location, access, topography, view, and access to

utilities.    No adjustment was made for the time of the comparable

sale, because Messrs. Monger and Griffin concluded that land

values in Jefferson County remained relatively stable throughout

the period.    Messrs. Monger and Griffin concluded that the value

of the vacant land was $3,670,000.

     Messrs. Monger and Griffin deducted $2.15 million from the

aggregate values of the individual components as a reserve to

cover future estimated sewer expansion costs.   They concluded

that the Port Ludlow community had fair market value of

$6,270,000.

     In evaluating the expert opinions with respect to the value

of the Port Ludlow community, we found several problems that seem

to account for much of the difference between the experts’ value

conclusions.   First, we believe that Mr. Slack overstated the

costs associated with the developed lots, thus underestimating

the value of the developed lots.    Mr. Slack estimated the costs

of sale at 55 percent of the sales price of the lots and

determined an additional cost of $40,000 per year for general and

administrative expenses.    We note that petitioner’s actual costs

of sale for each of the years 1982 through 1985 were

approximately 25 percent of the sales price.
                              - 32 -

     Next, we believe that Messrs. Monger and Griffin were

inconsistent in determining that the most likely buyer would be a

single developer or investor, who would continue to operate the

Port Ludlow community as a resort and then apply an aggregate

value approach rather than a bulk value.   We believe that the

bulk value approach that Messrs. Monger and Griffin used to value

the developed lots should be extended to the entire resort.

     Accounting for these differences and considering all the

evidence with respect to the Port Ludlow community, we conclude

that the appropriate value for the Port Ludlow community is

between $4.2 and $4.7 million.


Port Gamble Townsite and Tree Nurseries


     The Port Gamble townsite, located in Port Gamble,

Washington, was founded in 1853.   Since then, it has remained a

genuine company town and has been designated as a National

Historic Landmark.   The Port Gamble sawmill is one of the oldest

operating sawmills in the United States, and it still remains the

employment center and focal point of Port Gamble.   Petitioner

transferred to the Partnership the land on which the Port Gamble

sawmill and related town are located, the town buildings, and the

log dump site.   Petitioner retained all the physical mill

facilities and leased back the land underlying the mill, the log

dump site, and the town from the Partnership.
                               - 33 -

     The townsite improvements consist of 35 single-family homes,

1 duplex, and 8 nonresidential buildings, including a country

store, company offices, community hall and post office building,

Masonic temple, church, gas station, fire hall, and carpenter

shop.   The town’s structures are wood and were built between 1853

and 1929.   The style, quality, and condition of these structures

vary widely.   They lack functional heating systems but have

chimney systems for occupants to install wood-burning stoves.

Plumbing and electrical fixtures are minimal.   Although

sufficient spring water was available to supply Port Gamble’s

needs, the water system was not in compliance with State and

Federal regulations in terms of water quality on December 20,

1985.   The sewer treatment plant was operating at or above

capacity on a regular basis.   It was sufficient for existing

improvements, but additional development would likely require

additional treatment capacity.   The homes in Port Gamble were

generally rented to mill workers at an average rent of

approximately $170 per month, less than the cost to operate the

townsite.

     Petitioner also transferred to the Partnership the land,

buildings, and inventory associated with its Cyrus T. Walker Tree

Nursery and its 40-acre Hansville Transplant Nursery.    The

nurseries grow Douglas fir seedlings for reforestation of cut-

over timberlands and have the capacity to produce 2.5 to 3
                               - 34 -

million seedlings annually.    This seedling production had

historically been used to reforest petitioner’s timberlands.

     Mr. Slack, petitioner’s expert, concluded that the

structures at Port Gamble were substantially deteriorated and

that the townsite had been operating at an ongoing loss.

According to Mr. Slack, any alternative use of the Port Gamble

townsite land and improvements that would entail additional

development or additional use of the existing structures was not

financially feasible due primarily to the poor quality and

condition of the sewer treatment and water systems and to

limitations on potential uses as a result of the historical

designation.   As a result, Mr. Slack concluded that the highest

and best use of the townsite was to vacate the structures and use

the excess land as a tree farm.    Mr. Slack determined that

because of the negative income stream produced by the property in

its current state and the infeasibility of any alternative uses,

the cost and market methods were not appropriate.    Mr. Slack

believed that the income approach was the best method, because

the houses were all rented, and the property was never

subdivided.    Utilizing the income approach, Mr. Slack determined

the value of the townsite and related properties to be equal to

the salvage value of the improvements plus the value of the land

as a tree farm, or $202,000.

     Respondent’s expert, Christopher S. Eldred of Lamb Hanson

Lamb Appraisal Associates, Inc., determined that the highest and
                              - 35 -

best use of the townsite was reasonably reflected in most

instances by its current mixed use.    He believed that the houses

were in fair to average condition and assumed separate sales with

no additional development.

     Mr. Eldred estimated the value of the townsite using a

combination of the cost and comparative sales approaches.     In

valuing the millsite and log dump property, he used only the

comparative sales approach.   Mr. Eldred determined that the

income approach was inappropriate, because structures like the

subject structures are generally not purchased for the purpose of

receiving rental income.   He found that most of the

nonresidential buildings, such as the church, fire station,

community hall, and Masonic temple, were special purpose

facilities for which no meaningful rental, expense, and income

data are available.   He believed that the actual rents charged by

petitioner in 1985 were not reflective of market rents.

     Mr. Eldred determined that the fair market value of the Port

Gamble townsite and related properties was as follows:


          Land and Improvement              Value

          Millsite industrial land       $1,400,000
          Log dump property                 770,000
          Townsite-residential            1,952,000
          Townsite-nonresidential           882,000

            Total                        $5,004,000
                              - 36 -

     We agree with Mr. Eldred that the highest and best use of

the townsite was its current mixed use and that the income

approach was generally inappropriate for the subject property.14

However, we believe that a couple of factors would result in a

lower market value than that determined by Mr. Eldred.    First,

Mr. Eldred utilized a sales comparison approach to value the

millsite as industrial property.   The mill itself, however, was

still owned by petitioner.   Thus, while a hypothetical buyer

could purchase the land, it would be severely constrained in its

use of the land.   Since the land was subject to a 20-year lease

in favor of petitioner, we believe that a capitalized income

approach would be more appropriate.    Next, Mr. Eldred did not

factor in any cost with respect to the water system.    Although a

hypothetical buyer of one of the houses would not incur costs to

improve or correct the entire system, we believe that a buyer

would consider the problems with the water system and factor it

into the price it is willing to pay for the house.    Finally, Mr.

Eldred did not factor in any selling expenses with respect to the

properties, even though he indicated at trial that such costs

would probably be approximately 10 percent of the selling price.




     14
      Mr. Slack subsequently appraised the Port Gamble townsite
as of Jan. 1, 1991, and although that appraised value is not
controlling for purposes of the present case, we note that in the
subsequent appraisal, he, too, concluded that the highest and
best use was a historical townsite and that the income approach
was inappropriate.
                              - 37 -

     In estimating the value of the nurseries, Mr. Slack

determined that an income approach was the best indicator of

value.   He rejected use of the market approach due to lack of

comparable sales.   Both nurseries were operating at a continual

loss, and the losses were forecasted to continue into the future.

Based on these losses and the absence of reasonable and probable

alternative uses, Mr. Slack determined that the value of the

nurseries was equal to the estimated salvage value of the

improvements plus the value of the vacant land.    Mr. Slack

concluded that the highest and best use of the vacant land was

for residential use, as opposed to agricultural use.    He also

considered the lack of water rights at the Hansville Transplant

Nursery to be a limiting factor.   Accordingly, Mr. Slack

concluded that the fair market value of the Cyrus Walker Nursery

was $161,000 and the Hansville Transplant Nursery was $69,631.

     Mr. Eldred utilized a cost approach to estimate the values

of the nursery improvements, as no comparable sales were

discovered, and he used a comparable sales approach to value the

land underlying and surrounding the nurseries.    In valuing the

land, Mr. Eldred assumed a highest and best use as residential

property.   Mr. Eldred concluded that the fair market value of the

Cyrus Walker Nursery was $570,000 and the value of the Hansville

Transplant Nursery was $450,000.

     We agree with Mr. Eldred that a cost approach is appropriate

in valuing the nurseries and that an income approach artificially
                                - 38 -

undervalues them.    The evidence indicates that petitioner

operated these nurseries for the purpose of providing seedlings

to petitioner for reforestation.    We believe that the most likely

buyer would be the owner of a tree farm and similarly operate the

nurseries as a source of supply rather than a profit center.

     After considering the above factors and the other evidence

before us, we conclude that the value of the Port Gamble townsite

and related properties (including the nurseries) was between $2.5

and $3 million.

     In sum, we have reviewed the voluminous valuation evidence

with respect to the individual assets, introduced through both

the testimony and reports of seven different experts.      All the

experts were qualified, but we are aware of the bias reflected in

their assessments.    Given the vastly disparate values assigned to

the various assets by each party’s experts, we have narrowed

these values to a reasonable range of values based upon all the

evidence.   Our valuation ranges are as follows:

                                           Approximate
            Asset                        Fair Market Value

     Timber & timberland                  $30-40 million
     Development property                  10-12 million
     Port Ludlow community                 4.2-4.7 million
     Port Gamble townsite and
       tree nurseries                      2.5-3 million

       Total                             $46.7-59.7 million
                              - 39 -

Valuation by Reference to the Partnership Units


     The partnership units were publicly traded on the Pacific

Stock Exchange.   There were approximately 1.2 million partnership

units outstanding.   During the first 20 days following

commencement of "when issued" trading, the aggregate trading

volume was 116,892 units, or 9.7 percent of the number of units

outstanding, and the weighted average trading price of the units

was approximately $11.50 per unit.

     Petitioner argues that the value of the Washington assets

held by the Partnership must be determined by reference to the

partnership unit prices set by the market.   Thus, according to

petitioner, the Partnership's assets had an aggregate fair market

value on December 20, 1985, of approximately $41.5 million based

on the sum of (1) the aggregate public trading price of the units

(i.e., 1.2 million units x $11.50 per unit, or $13.8 million) and

(2) the initial indebtedness of the Partnership ($27.7 million).

Furthermore, petitioner argues that the unit price does not

represent a discount from the liquidation value of the

partnership, because with a publicly traded company, there is no

difference between the aggregate trading value of the units and

the amount produced by subtracting the entity's liabilities from

the fair market value of its individual assets.

     To support its position, petitioner introduced the reports

and testimony of two expert witnesses, Professor Michael Bradley,
                               - 40 -

who holds a chair professorship at the Fuqua School of Business

at Duke University and a joint appointment at the Duke Law

School, and Gilbert E. Matthews of Bear, Stearns & Co.

     Professor Bradley described the Efficient Market Hypothesis,

which provides that, in an efficient capital market, security

prices constitute unbiased estimates of the value of the

underlying assets.   More specifically, security prices are

unbiased estimates of the value of the future cash-flows that

will accrue to the holder of that security, and the ultimate

source of these cash-flows is the productivity of the underlying

assets.   Professor Bradley determined that the units were

efficiently valued by the market as evidenced by the relationship

between the pricing of the units and the Douglas fir stumpage

prices.   He noted that the $4.5 million decrease in the aggregate

market value of petitioner’s stock on the exdividend date15

confirmed the efficiency of the market’s valuation of the

Partnership.16   Professor Bradley concluded that the market price


     15
      "Exdividend" refers to the situation where a dividend has
been declared but not paid. When stock is sold exdividend, the
seller, and not the buyer, has the right to the next dividend.
     16
      Professor Bradley attributed the difference between the
observed $4.5 million decrease and the $13.8 million aggregate
value of the partnership units to the "wealth effect of
spinoffs". According to Professor Bradley, there are two
explanations for this effect. First, a spinoff may lead to
better valuation of each entity, because the two businesses may
be followed by different analysts and may attract different
investors. In addition, transaction costs may provide incentives
for sellers to sell their stock before the exdividend date and
                                                   (continued...)
                              - 41 -

of the units fairly represented the value of the underlying

assets of the Partnership and that any potential control premium

that may have been associated with the units was incorporated in

the market price of the units.   Mr. Matthews generally supported

Professor Bradley.

     Respondent, on the other hand, argues that the trading value

of the partnership units is irrelevant in determining the value

of the assets in petitioner’s hands.   Respondent contends that

the Efficient Market Hypothesis relates to the valuation of an

entity’s securities, not the underlying assets, and that in the

timber industry, the value of an entity’s assets will greatly

exceed its trading value because of the long time period it takes

to generate cash-flows.

     We disagree with respondent that the trading value of the

units is irrelevant to a determination of the value of the

underlying assets.   However, we do not accept petitioner’s

contention that the aggregate value of the partnership units at

the $11.50 trading price should be used to mathematically

determine the value of the partnership's assets.17


     16
      (...continued)
for buyers to wait until after the exdividend date.
     17
      Petitioner argues that two prior Tax Court opinions stand
for the proposition that when valuing the assets of a publicly
traded company, there is no difference between the freely traded
minority stock value and the value of the underlying assets.
Philip Morris, Inc. and Consol. Subs. v. Commissioner, 96 T.C.
606 (1991), affd. without published opinion 970 F.2d 897 (2d Cir.
                                                   (continued...)
                               - 42 -

     A minority discount reflects a minority shareholder’s

inability to compel liquidation and realize a pro rata share of

the net asset value.    Estate of Jung v. Commissioner, 101 T.C.

412, 434 (1993); Harwood v. Commissioner, 82 T.C. 239, 267

(1984), affd. without published opinion 786 F.2d 1174 (9th Cir.

1986).    Generally, the trading price of securities in a free and

active market represents the value of marketable minority



     17
      (...continued)
1992); Estate of Brownell v. Commissioner, T.C. Memo. 1982-632.
We disagree.

     In Philip Morris, Inc. and Consol. Subs. v. Commissioner,
supra, Philip Morris, Inc., acquired the stock of Seven-Up Co.
through its wholly owned subsidiary. We were called on to
determine the value of the intangible assets of Seven-Up Co. In
doing so, we determined that the residual method was
inappropriate, because a control premium had been paid. We noted
that the control premium represented a payment for voting
control, over and above the value attributable to the underlying
assets. We concluded that the amount of the control premium was
the price paid in excess of the trading price prior to the
announcement of the acquisition. Id. at 628-632. We found that
Philip Morris, Inc., was an over-anxious purchaser who had not
obtained adequate information about Seven-Up Co. or conducted a
due diligence investigation of Seven-Up Co. However, we went on
to value the intangibles using the excess earnings approach,
which yielded a value slightly different from the aggregate
trading value. Although we used the aggregate trading value to
validate the reasonableness of our determination under the excess
earnings approach, we did not hold that the aggregate trading
value was determinative of the aggregate value of the underlying
assets. Id. at 638-639.

     In Estate of Brownell v. Commissioner, supra, we were called
on to determine the value of unregistered stock of Pope & Talbot,
Inc., for estate tax purposes. We did not determine the value of
the underlying assets and expressed no opinion as to the
relationship between the trading value of the stock and the value
of the underlying assets. Accordingly, we find this case
inapposite.
                                - 43 -

interests.     Estate of Jung v. Commissioner, supra at 442-443

n.11.     Limited partnership interests may be analogized to a stock

interest in this respect.     Harwood v. Commissioner, supra.

Similarly, courts have recognized a fractional interest discount

in valuing undivided interests, particularly when valuing real

property.     Estate of Bonner v. United States, 84 F.3d 196, 197-

198 (5th Cir. 1996); Estate of Fawcett v. Commissioner, 64 T.C.

889, 900-901 (1975).    The discount is an acknowledgment of the

restrictions on sale or transfer of property, when more than one

individual or entity holds undivided fractional interests.

Estate of Bonner v. United States, supra; Estate of Fawcett v.

Commissioner, supra.

     We believe that such a discount was reflected in the trading

price of the partnership units.    The units that were being traded

were limited partnership units.    Limited partners in the

Partnership had no management power, limited voting rights, and

significant limitations on their power to remove the managing

general partner.    Moreover, the units were newly issued.   The

value of the assets that had just been transferred to the

Partnership was uncertain as evidenced by the large variance in

the values assigned to them by the various experts in this

case.18    In addition, most of the underlying assets consisted of



     18
      This uncertainty is also reflected in the value estimates
that were made for petitioner prior to transferring the
Washington properties.
                                 - 44 -

timberland and other real property, which generally take a long

time to generate cash-flows.19

     We recognize that our previously stated value range for the

specific Washington properties is significantly greater than the

asset value that one would arrive at through petitioner's

mathematical use of the trading price of the partnership units.

On the other hand, as indicated above, we believe that the market

price of the partnership units is relevant to our ultimate

determination.   Taking this into consideration, we conclude that

figures in the lower range of our approximate valuations are a

better indication of true value.     Based upon all the evidence, we



     19
      The Washington properties were transferred to the
Partnership because petitioner's board believed that the market
value of the properties was not fully reflected in the trading
price of petitioner's stock. At trial, when petitioner's chief
executive officer was asked if he believed that the market value
of the properties had been fully reflected in the trading price
of petitioner's stock, he stated:


          I think that the market value is reflected in the
     price, just like Weyerhaeuser. You know it's like
     saying, the timber value in Weyerhaeuser is reflected
     in its market value. It is reflected in the market
     value. But if you were to take the timber value of
     Weyerhaeuser and appraise it, it would be greatly in
     excess of the market value of Weyerhaeuser. And so why
     is that the case? The cash-flows in timberland, you
     know, take many, many years to turn out. And so that--
     and the returns on timber are very low. They don't--
     timber only grows about five percent a year. So the
     values in this, in our industry, in any of our publicly
     traded companies, if you appraise the timberland, it's
     going to appraise higher than the market value of the
     stock. So this is sort of a general statement that you
     would make about any company in our industry.
                                - 45 -

conclude that the Washington properties had the following fair

market values on December 20, 1985:


                Timberland           $31.0   million
                Development           10.5   million
                Port Ludlow            4.5   million
                Port Gamble            2.5   million

                                     $48.5 million


Deductibility of Expenses


     The next issue we must decide is whether petitioner may

offset certain expenses incurred in connection with the

distribution against its section 311(d) gain.     In 1985,

petitioner incurred $1,364,071 of legal, accounting, investment

banking, and other fees relating to the formation of the

Partnership, the transfer of the Washington properties, and the

distribution of the partnership units.    Petitioner agrees that

these expenses are capital in nature and, therefore, not

deductible under section 162.    Rather, petitioner argues that

such sales expenses may be used to offset its gain on the taxable

distribution.

     It is well settled that costs connected with the sale of a

capital asset are capital expenditures to be used to offset

against the sales price.    Woodward v. Commissioner, 397 U.S. 572,

576 (1970); Kirschenmann v. Commissioner, 488 F.2d 270, 273 (9th

Cir. 1973), revg. 57 T.C. 524 (1972); Spangler v. Commissioner,

323 F.2d 913, 921 (9th Cir. 1963), affg. T.C. Memo. 1961-341;
                              - 46 -

Davis v. Commissioner, 151 F.2d 441 (8th Cir. 1945), affg. 4 T.C.

329 (1944); Stokely-Van Camp, Inc. v. United States, 21 Cl. Ct.

731, 753, (1990), affd. 974 F.2d 1319 (Fed. Cir. 1992).

     Section 311(d)(1) provides that if a corporation distributes

appreciated property to a shareholder, then gain shall be

recognized as if the property distributed had been sold at the

time of the distribution.   See also Pope & Talbot, Inc., & Subs.

v. Commissioner, 104 T.C. 574 (1995).   Thus, where appreciated

assets are distributed by a corporation, section 311(d)(1) treats

such a distribution as a deemed sale.   We see no reason why

transaction costs should be treated differently in a deemed sale

than they are in an actual sale.   Accordingly, we hold that

petitioner may offset its expenses incurred in connection with

the distribution against its section 311(d) gain.

     The next issue is whether petitioner may deduct investment

banking fees for advice regarding potential hostile takeovers

under section 162.   Petitioner retained Bear, Stearns & Co. (Bear

Stearns) in October 1984 to advise its board of directors

regarding potential unfriendly proposals to purchase the company.

Pursuant to this arrangement, Bear Stearns agreed to review

petitioner’s strategies, financial position, charter documents,

etc., in order to obtain a level of understanding that would

allow Bear Stearns to evaluate instantly any future proposal to

acquire petitioner, as well as recommend any changes that would

strengthen management’s negotiating position in such an event.
                                - 47 -

Petitioner paid Bear Stearns $89,788.08 in 1985 and $66,195.92 in

1986 with respect to this advice.    No takeover was ever

threatened or attempted.

     Section 162(a) permits taxpayers to deduct all the ordinary

and necessary expenses paid or incurred during the taxable year

in carrying on any trade or business.     An expense is ordinary if

it is of common or frequent occurrence in the type of business

involved.   Deputy v. du Pont, 308 U.S. 488, 495 (1940); Welch v.

Helvering, 290 U.S. 111, 114 (1933).     An expense is necessary if

it is appropriate or helpful to the development of the taxpayer’s

business.   Commissioner v. Tellier, 383 U.S. 687, 689 (1966);

Welch v. Helvering, supra.

     In contrast, section 263(a)(1) disallows a deduction for

capital expenditures.   Expenditures that give rise to a long-term

benefit or are incurred for the purpose of changing the corporate

structure are capital expenditures.      INDOPCO, Inc. v.

Commissioner, 503 U.S. 79 (1992); A.E. Staley Manufacturing Co.

v. Commissioner, 105 T.C. 166 (1995).     In determining whether

fees paid for business advice and counsel are capital, we look to

the nature of the services performed by the adviser rather than

their designation or treatment by the taxpayer.      Honodel v.

Commissioner, 76 T.C. 351, 365 (1981), affd. 722 F.2d 1462 (9th

Cir. 1984); Cagle v. Commissioner, 63 T.C. 86, 96 (1974), affd.

539 F.2d 409 (5th Cir. 1976).    Our inquiry thus focuses on

whether the services were performed in the process of giving
                                - 48 -

business advice or whether the services were performed in the

process of effecting a change in corporate structure for the

benefit of future operations.     INDOPCO, Inc. v. Commissioner,

supra at 89; Honodel v. Commissioner, supra.

     In the present case, the nature of the services performed by

Bear Stearns was business planning or advice.    The amounts paid

to Bear Stearns did not result in any change in corporate

structure or long-term benefit.    We believe that this case

differs from INDOPCO, Inc. v. Commissioner, supra and A.E. Staley

Manufacturing Co. v. Commissioner, supra, both of which involved

acquisitions of the corporate taxpayer’s stock that gave rise to

long-term benefits.   Here, no acquisition or takeover was ever

threatened or attempted.   Accordingly, we hold that the fees

petitioner paid to Bear Stearns were not capital expenditures

and, therefore, are deductible pursuant to section 162(a).

     The final issue is whether petitioner may deduct fees paid

to Depository Trust Co. in connection with holding petitioner’s

stock "in street name" pursuant to section 162(a).      Petitioner

has introduced no evidence regarding the specific nature or

purpose for this expenditure.    Therefore, we find that petitioner

has not met its burden of proving that it is entitled to a

deduction under section 162, and we uphold respondent’s

determination that the expenditure must be capitalized.


                                           Decision will be entered

                                      under Rule 155.
