                          T.C. Memo. 2011-141



                      UNITED STATES TAX COURT



               ESTATE OF NATALE B. GIUSTINA, DECEASED,
         LARAWAY MICHAEL GIUSTINA, EXECUTOR, Petitioner v.
            COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 10983-09.                Filed June 22, 2011.



     D. John Thornton and Kevin C. Belew, for petitioner.

     Kelley A. Blaine, for respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


     MORRISON, Judge:     The IRS issued a notice of deficiency

determining (1) a $12,657,506 deficiency in estate tax and (2) a

$2,531,501 accuracy-related penalty under section 6662 of the

Internal Revenue Code.1    The notice of deficiency was issued to


     1
      Unless otherwise indicated, all citations of sections refer
                                                   (continued...)
                                -2-

Laraway Michael Giustina (“Larry Giustina”), the executor of the

estate of his deceased father, Natale B. Giustina.   Larry

Giustina brings this case pursuant to section 6213(a), asking

this Court to redetermine the deficiency.   We refer to Larry

Giustina as “the estate” when referring to him in his capacity as

a party to this case.   The two issues for decision are:

     (1) the value of the 41.128-percent limited partner interest

in Giustina Land & Timber Co. Limited Partnership owned by Natale

Giustina at his death on August 13, 2005 (the estate contends the

value is $12,995,000, but the IRS contends the value is

$33,515,000);2 and

     (2) whether the estate is liable for the section 6662

accuracy-related penalty.3




     1
      (...continued)
to the Internal Revenue Code (26 U.S.C.) as in effect for the
date of death, and all citations of Rules refer to the Tax Court
Rules of Practice and Procedure.
     2
      Although the 41.128-percent limited partner interest was
owned by a trust, rather than by Natale Giustina directly, the
estate concedes that the value of the partnership interest must
be included in the gross estate. For convenience, we sometimes
discuss the partnership interest as if it was held by Natale
Giustina rather than through the trust.
     3
      The parties have stipulated that the marital deduction at
issue is a computational issue and that the amount of the
allowable marital deduction will depend on the value of the
41.128-percent limited partner interest in Giustina Land & Timber
Co. owned by Natale Giustina at his death on Aug. 13, 2005. The
parties also stipulated that administrative expenses incurred by
the estate shall be allowable to the extent substantiated.
                                 -3-

We find that the value of the partnership interest is $27,454,115

and that the estate is not liable for the penalty.

                          FINDINGS OF FACT

1.   Introduction

     The parties stipulated some facts; those facts are so found.

Larry Giustina resided in Eugene, Oregon, when the petition was

filed.    The decedent, Natale Giustina, was born in 1918 and died

on August 13, 2005, at the age of 87.    He was a resident of

Eugene, Oregon, when he died, and his estate is administered in

the State of Oregon.

     Natale Giustina was the trustee of the N.B. Giustina

Revocable Trust.4    The trust owned a 41.128-percent limited

partner interest in Giustina Land & Timber Co. Limited

Partnership.   This partnership is sometimes referred to here as

“the partnership”.

2.   History of the Giustina Family and Its Business:    1917 to
     1989

     Erminio Giustina was the father of Natale Giustina, the

decedent.   In the summer of 1917, Erminio Giustina and two of his

brothers entered the lumber industry.    The three brothers bought

a lumber mill in Molalla, a small town in Clackamas County,

Oregon.   In the 1920s the brothers moved their base of operations

to Lane County, Oregon, where they were joined by another



     4
      Natale Giustina’s middle initial was “B”.
                                 -4-

brother, Anselmo.   Over time, the Giustina family bought land and

mills around Eugene, the largest town in Lane County.     The family

business was operated through several entities.

     Until the 1960s the family timberlands were held by Giustina

Bros., a partnership.   In the 1960s the timberlands that

contained young trees were transferred from Giustina Bros. to a

newly formed partnership called Giustina Timber Co.     The shares

of Giustina Timber Co. were then transferred to heirs of the

original four brothers.   The mills, meanwhile, were owned by

Giustina Bros. Lumber & Plywood, a corporation that employed 200

people.

     For many years the family business was run by Natale

Giustina and his brother, Ehrman Giustina.     The Giustina family

eventually sold all of its mills.      By 1988 the Giustina family’s

business holdings consisted primarily of timberlands owned by

Giustina Bros. and by Giustina Timber Co.

3.   Formation of Giustina Land & Timber Co. in 1990

     By the time the mills closed, the family business was

managed by two family members:   Larry Giustina, who was the son

of Natale Giustina, and Dan Giustina, who was the son of Ehrman

Giustina.   The two cousins found that their managerial roles were

redundant and that they had conflicting ideas about how to run

the business.   They therefore proposed to divide the family

properties so that they each would manage separate properties.
                                  -5-

Their proposal was adopted by the other members of the family.

As a result, the assets of the family business entities, Giustina

Bros., Giustina Timber Co., and Giustina Bros. Lumber & Plywood,

were transferred to three new partnerships, each of which was

owned by a separate set of Giustina family members.

     The first new partnership was Giustina Land & Timber Co.

Limited Partnership.    This partnership received 51.875 percent of

the assets of (1) Giustina Bros. and (2) Giustina Timber Co.         The

parties have stipulated that this partnership was owned by “the

Natale Giustina and Anselmo Giustina families, as well as another

relative named Dolores Fruiht”.    The value of a 41.128-percent

limited partner interest in this partnership is the major issue

in this case.

     The second new partnership was Giustina Resources.       This

partnership received 30.625 percent of the assets of (1) Giustina

Bros. and (2) Giustina Timber Co.       The parties have stipulated

that this partnership was owned by “members of the Ehrman

Giustina family”.   It was operated by Dan Giustina.

     The third new partnership was Giustina Woodlands.       It

received 17.5 percent of the assets of (1) Giustina Bros. and (2)

Giustina Timber Co.    The parties have stipulated that this

partnership was owned by “the Greg Giustina family”.

     The extended Giustina families made every effort to ensure

not only that the assets were divided according to each family’s
                                -6-

proportionate ownership interests in Giustina Bros. and Giustina

Timber Co., but also that the timber species, revenues, and

income were divided in the same manner.    Even though

substantially all of its assets were distributed, the Giustina

Bros. partnership remained in existence.    All of the assets of

Giustina Timber Co. were distributed.

4.   Operations and Ownership of Giustina Land & Timber Co.

     Giustina Land & Timber Co. was formed effective January 1,

1990.   The partnership was governed by a written partnership

agreement from the day the partnership was formed.    The agreement

has been amended several times since then.    Unless otherwise

noted, all provisions of the partnership agreement that we

discuss were in effect when Natale Giustina died in August 2005.

     The partnership agreement provides that the general partners

have full control over the business of the partnership.    The

general partners have the power to sell the partnership’s timber,

land, and other property.   The general partners also have the

power to make distributions of cash or property to the partners

in proportion to each partner’s respective interest in the

partnership.   All decisions of the general partners must be made

with the concurrence of a majority of the general partners.

     The partnership agreement initially provided that the

general partners were Larry Giustina and Ansel James Giustina,

their survivors, and any other person admitted to the partnership
                                 -7-

as an additional general partner in accordance with the

provisions of the agreement.    Ansel James Giustina is the son of

Anselmo Giustina.   We refer to him as James Giustina.

     The partnership agreement allows a general partner to

voluntarily resign.   A general partner can be removed by the

concurrence of limited partners owning two-thirds of the

interests in the partnership.   If a general partner resigns or is

removed, a successor general partner may be designated by the

limited partners owning two-thirds of the interests in the

partnership.   An additional general partner can be admitted to

the partnership if all the partners consent to the admission.

     The partnership agreement allows a limited partner interest

to be transferred to (1) another limited partner, (2) a trust for

the benefit of a limited partner, or (3) any other person

approved by the general partners.      A limited partner may not

withdraw from the partnership unless all of the limited partner’s

interests have been transferred.

     The partnership agreement provides that the partnership will

continue to exist until December 31, 2040, unless the partnership

is terminated earlier pursuant to section 12.2 of the partnership

agreement.   Section 12.2 provides that the partnership shall be

dissolved:   (1) automatically on December 31, 2040, (2) if the

limited partners fail to designate a successor general partner

within 90 days after the resignation or removal of the sole
                                   -8-

general partner, or (3) if the limited partners owning two-thirds

of the interests in the partnership vote to dissolve the

partnership.    If the partnership is dissolved, its affairs must

be wound up, its assets may be sold, and its assets and any

proceeds from the sale of assets must be distributed to its

partners in accordance with their capital accounts.

     Schedule A of the original partnership agreement listed the

limited partners when the partnership was formed in 1990:

                 Limited Partner            Number of Units
           N.B. Giustina                         44.128
           Anselmo Giustina                      31.940
           Dolores Giustina Fruiht                4.809
           Natalie Giustina Newlove               4.198
           L.M. Giustina                          3.195
           Irene Giustina Goldbeck                4.198
           Sylvia B. Giustina                     3.266
           A.J. Giustina                          2.266
             Total                               98.000

Each general partner owned one unit in his capacity as a general

partner.    N.B. Giustina refers to Natale Giustina, the decedent.

Anselmo Giustina died in 1993.       Dolores Giustina Fruiht’s exact

relationship to the other partners is not revealed by the record.

Natalie Giustina Newlove is a daughter of Natale Giustina.      L.M.

Giustina, we infer, refers to Larry Giustina, i.e., Laraway

Michael Giustina.    Irene Giustina Goldbeck is a daughter of
                                 -9-

Natale Giustina.    Sylvia B. Giustina, we infer, is the sister of

James Giustina and the daughter of Anselmo Giustina.     A.J.

Giustina refers to James Giustina, i.e., Ansel James Giustina.

     A buy-sell agreement, dated November 21, 1994, bars a

limited partner from transferring a partnership interest unless

(1) the transfer is to a member of the transferring partner’s

family group, or (2) the transferring partner offers the other

limited partners the right of first refusal.   For these purposes,

there are three family groups:

     •     “Sylvia B. Giustina, A.J. Giustina, children of Sylvia

           B. Giustina, and children of A.J. Giustina.”

     •     “N.B. Giustina, Natalie Giustina Newlove, L.M.

           Giustina, Irene Giustina Goldbeck, and children of

           Natalie Giustina Newlove, L.M. Giustina, and Irene

           Giustina Goldbeck.”

     •     “Dolores Giustina Fruiht, her children, and

           grandchildren.”

The provisions of the buy-sell agreement were in effect in August

2005.

     On January 1, 2002, Larry and James Giustina resigned as

general partners.   Each was replaced by a limited liability

company.   LMG, LLC, is controlled by Larry Giustina.    AJG, LLC is

controlled by James Giustina.
                                -10-

     Some transfers of limited partner interests occurred after

formation of the partnership.   The parties stipulated that as of

August 13, 2005, the partnership had the following owners:

              Ownership of Giustina Land & Timber Co.
                         as of Aug. 13, 2005
                                             Percentage
          General Partners:                   Interest
            LMG, LLC                            1.000
           AJG, LLC                             1.000
          Limited Partners:
            N.B. Giustina, Trustee of          41.128
              the N.B. Giustina
              Revocable Trust
           Sylvia B. Giustina                  17.236
           A.J. Giustina                       16.236
           Natalie Giustina Newlove             5.198
           Irene Giustina Goldbeck              5.198
           Dolores Giustina Fruiht              4.809
           L.M. Giustina                        4.195
           Anselmo Giustina Family              4.000
             Trust
             Total                            100.000

     Under the terms of the N.B. Giustina Revocable Trust

agreement, Natale Giustina had the right to revoke the trust or

to withdraw the principal and accumulated income of the trust

estate.   The terms of the trust agreement required that the

trust’s 41.128-percent limited partner interest be distributed as

follows at Natale Giustina’s death:     17 percent to Natalie
                                 -11-

Giustina Newlove, 17 percent to Larry Giustina, 17 percent to the

Irene Giustina Goldbeck Trust, and 49 percent to the N.B.

Giustina Marital Trust.

     By August 13, 2005, Giustina Land & Timber Co. owned 47,939

acres of timberland in the area of Eugene, Oregon.     It employed

approximately 12 to 15 people.    Three or four worked in forestry;

four worked on the roads crew; and six worked at administrative

tasks.   Although James Giustina and Larry Giustina both

controlled general partners of the partnership (their respective

LLCs), the primary decisions regarding the management of the

timber were made by Larry Giustina.     James Giustina provided

assistance to Larry Giustina in the decisionmaking.

5.   Tax Reporting, Notice of Deficiency, and Positions of the
     Parties

     Natale Giustina died on August 13, 2005.    He was survived by

his spouse, Jacqueline L. Giustina, and his three children:

Natalie Giustina Newlove, Larry Giustina, and Irene Giustina

Goldbeck.   On the estate tax return, the value of the 41.128-

percent limited partner interest was reported to be $12,678,117.

On April 3, 2009, the IRS issued the notice of deficiency

determining a $12,657,506 deficiency and a $2,531,501 accuracy-

related penalty under the provisions of section 6662.    The notice

of deficiency determined that the value of the 41.128-percent

limited partner interest was $35,710,000.    The notice made a

computational adjustment to the marital deduction claimed on the
                               -12-

return.   At trial, the IRS contended that the value of the

limited partner interest was $33,515,000 (a lesser amount than it

had earlier determined).   The estate contended that the value of

the limited partner interest was $12,995,000 (a greater amount

than it had reported on its return).

                             OPINION

     Generally, the taxpayer has the burden of disproving the

determinations in the IRS notice of deficiency.   Rule 142(a)(1).

The IRS has the burden of proof regarding any factual issue for

which the taxpayer has presented credible evidence and met other

requirements.   Sec. 7491(a)(1).   Our conclusions, however, are

based on a preponderance of the evidence, and thus the allocation

of the burden of proof is immaterial.   See Martin Ice Cream Co.

v. Commissioner, 110 T.C. 189, 210 n.16 (1998).

1.   Introduction

     Each party called an expert witness to opine on the value of

the 41.128-percent limited partner interest.   Of the methods used

by the expert witnesses, we believe that there are two

appropriate methods that are helpful in valuing that interest.

The first method (the cashflow method) is based upon how much

cash the partnership would be expected to earn if it had

continued its ongoing forestry operations.   The operations, which

consisted of growing trees, cutting them down, and selling the

logs, have historically generated almost all of the partnership’s
                                   -13-

cashflows.     The second valuation method (the asset method) is

based upon the value of the partnership’s assets if they were

sold.     The value of the timberlands, which constitute most of the

partnership’s assets, is agreed to be $142,974,438.       The value

includes a 40-percent discount for the delays attendant to

selling the partnership’s approximately 48,000 acres of

timberland.

2.   The Cashflow Method

     a.     The Expert Witnesses

     Both expert witnesses relied in part on the cashflow method

to determine the value of Natale Giustina’s interest in the

partnership.    John Thomson, the IRS expert, estimated that the

partnership’s annual cashflow would be $9,979,969 in the first

year after Natale Giustina’s death.       He estimated that the total

future cashflows, once discounted to present value, would be

$65,760,000.    Robert Reilly, the estate’s expert, estimated that

annual cashflow would be $4,560,000 in the first year after

Natale Giustina’s death.    He estimated that the total future

cashflows, once discounted to present value, would be

$33,800,000.

     b.     Calculation of Cashflows

     Thomson’s cashflow estimates were not persuasive.      First, as

Reilly explained on pages 17-18 of his rebuttal report, there was

an internal inconsistency between Thomson’s cashflow estimates
                                 -14-

and his calculation of the effect of lack of control on the value

of the 41.128-percent limited partner interest.     The

inconsistency led Thomson to overvalue it.     Second, Thomson

unrealistically assumed that the partnership’s operating expenses

would remain fixed, even though he projected that its revenues

would increase 3 percent annually.      Third, Thomson’s estimate of

annual cashflows was extrapolated from the actual cashflow

results of the most recent year.    By contrast, Reilly

extrapolated from the cashflow results of five consecutive years.

Reilly’s use of five years of data is sounder because it reduces

the effect of a temporary variation in cashflow.     But Reilly’s

application of the cashflow method to value the partnership

interest has its own problems.    As we explain, however, his

computations can be adjusted.

     One problem with Reilly’s computations is that he reduced

each year’s predicted cashflows by 25 percent to account for the

income taxes that would be owed by the owner of the partnership

interest on that owner’s share of the partnership’s income.      The

25-percent reduction is inappropriate because the rate at which

Reilly discounted the cashflows to present value was a pretax

rate of return, not a posttax rate of return.     An appraiser

should not reduce cashflows by income tax while simultaneously

using a pretax rate of return to discount the cashflows to

present value.   Gross v. Commissioner, T.C. Memo. 1999-254, 78
                                -15-

T.C.M. (CCH) 201, 209, affd. 272 F.3d 333 (6th Cir. 2001).        Thus,

Reilly’s cashflow estimates must be recomputed to eliminate the

25-percent discount for income tax liability.

     c.   The Discount Rate

     Another problem with Reilly’s application of the cashflow

method is that the rate at which he discounted the cashflows to

present value--18 percent--was too high.      As we explain below,

the discount rate should be 16.25 percent.

     Reilly’s 18-percent discount rate had four components.       Only

the fourth needs to be corrected.      The first component was the

risk-free rate.   Reilly assumed that the risk-free rate was the

4.5-percent rate of return earned by owners of 20-year U.S.

Treasury bonds.

     The second component of Reilly’s discount rate was a beta-

adjusted equity risk premium.   According to Reilly, beta is a

“measure of the systematic risk (i.e., risk relative to returns

in a measure of the overall equity market, such as the S&P 500

index) inherent in a company’s investment returns.”      Reilly

determined that the risk premium for an equity investment in the

S&P 500 common stock index was 7.2 percent.      Reilly estimated

that the beta for an investment in companies in the timber

industry was 0.56.   He then estimated that a beta of 0.5 was

appropriate for the partnership because it had less debt than
                                 -16-

other timber companies.    He therefore calculated a beta-adjusted

risk premium of 3.6 percent (7.2 percent x 0.5).

     The third component of Reilly’s discount rate was a small

stock equity risk premium.    Reilly estimated that this component

was 6.4 percent.    Reilly calculated that an investment in a small

company, defined as a company with a total equity capitalization

between $1.4 million and $263 million, had an annual return of

6.4 percent above the overall equity risk premium exhibited by

the S&P 500 common stock index.

     The fourth component of Reilly’s 18-percent discount rate

was a partnership-specific risk premium of 3.5 percent.    Reilly

explained that this risk premium was justified because the

partnership’s timberlands were not geographically dispersed.     All

were in Oregon.    He also explained that the partnership’s

operations were nondiversified.    The partnership’s sole source of

revenue was timber harvesting.    Thus, it is apparent that a

portion of the 3.5-percent premium reflects the unique risks of

the partnership.    But unique risk does not justify a higher rate

of return.   Investors can eliminate such risks by holding a
                               -17-

diversified portfolio of assets.5     We conclude that the

partnership-specific risk premium should be only 1.75 percent.

     After this adjustment is made, the correct discount rate is

16.25 percent.   This is equal to the sum of 4.5 percent, 3.6

percent, 6.4 percent, and 1.75 percent.6

     Reilly reduced his 18-percent discount rate by 4 percent to

reflect his assumption that cashflows would increase by 4 percent

each year.   After making this reduction, his “direct

capitalization rate” was 14 percent.     We have no dispute with the



     5
      Richard A. Brealey and Stewart C. Myers explain:

     The risk that potentially can be eliminated by
     diversification is called unique risk. Unique risk
     stems from the fact that many of the perils that
     surround an individual company are peculiar to that
     company and perhaps its immediate competitors. But
     there is also some risk that you can’t avoid,
     regardless of how much you diversify. This risk is
     generally known as market risk. Market risk stems from
     the fact that there are other economywide perils that
     threaten all businesses. * * *

Brealy & Myers, Principles of Corporate Finance 168 (7th ed.
2003) (fn. refs. omitted); see also Booth, “The Uncertain Case
for Regulating Program Trading”, 1994 Colum. Bus. L. Rev. 1, 28
(“Because diversification can eliminate the unique risks
associated with investing in individual companies, the market
pays no additional return to those who assume such risks.”).
     6
      The discount rate Thomson used in his cashflow method,
16.22 percent, is almost equal to the 16.25-percent rate that we
find to be the appropriate discount rate. Thomson’s discount
rate was equal to: (1) a 4.52-percent risk-free rate, plus (2)
an 11.7-percent equity risk premium paid for small stocks (i.e.,
stocks in the fifth capitalization quintile of companies traded
on the New York Stock Exchange for 1926-2004). We did not use
Thomson’s method of determining a discount rate.
                                     -18-

4-percent assumption.        Therefore, the 16.25-percent discount rate

should be reduced by 4 percent, resulting in a direct

capitalization rate of 12.25 percent.

     d.     Value of Marketable Noncontrolling Interests in the
            Partnership

     Using the cashflow method, Reilly determined that the value

of 100 percent of the interests of the partnership (on a freely

marketable basis) is equal to the discounted present value of the

cashflows.     Reilly estimated that the discounted present value of

the cashflows was $33,800,000, but our adjustments result in an

estimate of $51,702,857.        The adjustments are set forth in the

table below:

          Valuation of All Partnership Interests on a Marketable Basis
                            Using the Cashflow Method
                                                     Reilly’s
                                                   Calculations
                                                    in Exhibit
                                                     10 of His    As Adjusted
                                                      Report       by Court
Normalized pretax income                             $6,120,000    $6,120,000
Normalized net income (normalized pretax income      $4,590,000    $6,120,000
  reduced 25% by Reilly for income taxes)
Total adjustments to estimated cashflow                -$30,000      -$30,000


Normalized net cashflow                              $4,560,000    $6,090,000
Projected normalized net cashflow (normalized        $4,743,000    $6,333,600
  net cash flow, increased by long-term growth
  rate of 4%)
Direct capitalization rate                                  14%          12.25%
Total equity value on a marketable,                 $33,800,000   $51,702,857
  noncontrolling ownership interest basis
  (Reilly’s estimate is rounded)
                               -19-

     e.   Discount for Marketability

     Reilly discounted the cashflows in order to reflect the

inability of the owner of the 41.128-percent limited partner

interest to easily sell it.   This discount for lack of

marketability is 35 percent in Reilly’s view.7   Thomson’s lack-

of-marketability discount was only 25 percent.   Both Reilly and

Thomson formed their opinions from two types of studies:     (1)

restricted-stock studies and (2) pre-IPO studies.    Thomson relied

more on the restricted-stock studies because, he testified, the

pre-IPO studies “tend to overstate their discount for just lack

of marketability”.   In particular, Thomson relied on the SEC

Institutional Investor Study, a restricted-stock study that

showed an average discount of 26.4 percent.   Reilly relied more

on the pre-IPO studies than the restricted-stock studies.     Reilly

did not rebut Thomson’s testimony that the pre-IPO studies

overstated the discount for lack of marketability.   We therefore

adopt Thomson’s marketability discount of 25 percent.

     f.   Weight Given to the Cashflow Method

     Reilly gave a 30-percent weight to the cashflow method.8

Thomson gave the cashflow method a weight of 20 percent.     In our

view, the cashflow method is appropriate to reflect the value of



     7
      Reilly testified that 25 percent was also reasonable.
     8
      Reilly referred to the cashflow method as the direct
capitalization method.
                               -20-

the partnership if it is operated as a timber company, and the

asset method is appropriate to reflect the value of the

partnership if its assets are sold.   Accordingly, the percentage

weight to be accorded the cashflow method should be equal to the

probability that the partnership would continue to be operated as

a timber company.

     We believe that there was a 75-percent probability that the

partnership would have continued its operations rather than

liquidating its assets.   The Giustina family had a long history

of acquiring and retaining timberlands.   We take this into

account, but we also assume that the owner of the 41.128-percent

limited partner interest is a hypothetical third party, see sec.

25.2512-1, Gift Tax Regs., who seeks the maximum economic

advantage from the asset.9   As Reilly testified, the optimal

strategy to maximize the value of the partnership would be to

sell the timberland and “get $143 million today.”   Selling the

timberlands would generate about $143 million; continuing to

operate the partnership would generate only about $52 million.


     9
      As we said in Estate of Davis v. Commissioner, 110 T.C.
530, 535 (1998) (citations omitted):

     The willing buyer and the willing seller are
     hypothetical persons, rather than specific individuals
     or entities, and the individual characteristics of
     these hypothetical persons are not necessarily the same
     as the individual characteristics of the actual seller
     or the actual buyer. The hypothetical willing buyer
     and the hypothetical willing seller are presumed to be
     dedicated to achieving the maximum economic advantage.
                                 -21-

Reilly opined that the value of the timberlands is irrelevant

because a holder of Natale Giustina’s interest could not

unilaterally force the sale of the partnership’s assets.    It is

true that the owner of a 41.128-percent limited partner interest

could not alone cause the partnership to sell the timberlands.

However, there are various ways in which a voting block of

limited partners with a two-thirds interest in the partnership

could cause the sale.   The members of such a voting block could

replace the two general partners, who have the power to sell

assets and make distributions.    Alternatively, a two-thirds

voting block could dissolve the partnership, an act that must be

followed by the distribution of the partnership’s assets.     We are

uncertain how many partners would share the view that the

timberland should be sold.   The uncertainty does not prevent us

from estimating the probability of the sale:

     The entire valuation process is a boundless subjective
     inquiry: To value an asset the court has to make
     guesses or assumptions about the future. These
     inquiries require speculation about the composition of
     management * * *

Repetti, “Minority Discounts:    The Alchemy in Estate and Gift

Taxation”, 50 Tax L. Rev. 415, 445 (1995).    Some of these family

members would perhaps prefer that the partnership remain in

operation.   But people also tend to prefer $143 million to $52

million, or, in this case, a share of $143 million to a share of

$52 million.   We believe that there is a 25-percent probability
                                 -22-

that a sufficient number of limited partners would cause the sale

of the partnership’s assets.

     Conversely, there was a 75-percent probability the

timberlands would not be sold.    We assign a weight of 75 percent

to the value of the partnership as measured by the cashflow from

its continued operations.

3.   Asset Method

     a.   Significance of Value of Timberlands and Other Assets

     The timberland assets of the partnership were worth

approximately $143 million.    The total assets of the partnership

were worth $150,680,000, according to an estimate by Thomson that

is essentially unchallenged by the estate.   Therefore, we assume

that if the partnership had liquidated its assets and distributed

the proceeds to the partners, the amount of the distribution

would have been $150,680,000.    This figure should be weighted by

the 25-percent probability that the partners would have caused

the sale of the timberlands and other assets.

     b.   No Discount for Lack of Control

     In determining the value of the 41.128-percent limited

partner interest if the timberland assets were sold, it is not

appropriate to subtract a discount for the inability of the owner

to control the affairs of the partnership.   The IRS expert,

Thomson, applied a lack-of-control discount of 12 percent.

However, our calculations already assume that there was a
                                 -23-

75-percent chance that the owner of the interest would have been

unable to garner enough support from the other limited partners

to sell the timberland.    The inability to cause the sale of the

timberland is an aspect of the lack of control.10    Thus, lack of

control is already reflected by the 75/25 percentage weighting.

No additional discount is needed.

     c.     No Discount for Lack of Marketability

     In calculating the value of the partnership interest if the

assets were sold, it is not appropriate to subtract a discount

for lack of marketability.     A discount for lack of marketability

reflects the inability of the owner of a business enterprise to

quickly sell the interest.11    But in valuing the partnership

interest as if there were a sale of the timberlands, we have



     10
          James R. Repetti writes:

     Additional benefits of control, however, become
     available only as the percentage of stock ownership
     increases. For example, many state statutes require a
     two-thirds vote of shareholders to liquidate a
     corporation, sell substantially all the corporation’s
     assets, merge the corporation or amend the certificate
     of incorporation. The ability to compel liquidation of
     a corporation or sale of its assets may be valuable if
     the value of the corporation’s assets exceeds the value
     of its ongoing business. * * *

“Minority Discounts: The Alchemy in Estate and Gift Taxation”,
50 Tax L. Rev. 415, 426-427 (1995) (fn. refs. omitted).
     11
      As Reilly testified: “The concept of investment
marketability relates to the liquidity of an investment--that is,
how quickly and certainly the investment can be converted into
cash at the owner’s discretion.”
                               -24-

assumed that the timberland could be sold for $143 million, a

stipulated value that includes a 40-percent discount to reflect

the delays in selling the land.     It would be a double discount to

reduce the value further to reflect the delays in selling the

partnership interest.

4.   Value of the 41.128-Percent Limited Partner Interest

     In our view, the value of all interests in the partnership

is equal to (75% x $51,702,857) + (25% x $150,680,000), or

$76,447,143.   The discount for lack of marketability (which is

applicable only to the value of the partnership interest as if

the partnership continued operations, not to the value as if the

timberland is sold, see supra Opinion parts 2.e and 3.c) is equal

to 25% x (75% x $51,702,857), or $9,694,286.     This discount

reduces the value to $66,752,857.     Multiplying $66,752,857 by

41.128 percent equals $27,454,115, which we conclude is the

correct value of the partnership interest in question.     These

calculations can be compared to the approaches taken by the two

expert witnesses as set out in the following chart:
                                        -25-

            Valuation of the 41.128-Percent Limited Partner Interest:
                            Comparison of Approaches
                        Reilly                Thomson
                    (Estate Expert)        (IRS Expert)               Court
Methods and
  adjustments
Asset-              10% x $51,100,000           --                     --
  accumulation
  method
Cashflow method     30% x $33,800,000     20% x $65,760,000     75% x $51,702,857
Capitalization-     30% x $52,100,000           --
  of-
  distributions
  method
Price-of-           30% x $59,100,000     20% x $99,550,000            --
  shares-of-
  other-
  companies
  method
   Asset method                          60% x $150,680,000     25% x $150,680,000
Total                     $48,610,000          $123,470,000           $76,447,143
Discount for                      35%                     25%     25% (applied to
  lack of                                                        value from cash-
  marketability                                                 flow method only,
                                                                   for a weighted
                                                                      discount of
                                                                      $9,694,286)
Discount for                       0%                     12%                  0%
  lack of
  control
Total after               $31,597,000          $81,490,200            $66,752,857
  discounts
X 41.128%                 $12,995,000          $33,515,000            $27,454,115
                                 -26-

5.   Valuation Methods That We Did Not Adopt

     a.     Reilly’s Capitalization-of-Distributions Method

     The estate’s expert witness, Reilly, attributed a 30-percent

weight to the value given by the capitalization-of-distributions

method.     Using this method, Reilly estimated the present value of

the distributions that he expected the partnership to make to the

partners.     We did not attribute independent weight to this method

for two reasons.     First, the cash earned by the partnership is a

more reliable indicator of value than the cash distributed to the

partners.12    Second, the capitalization-of-distributions method

and the cashflow method share the assumption that the partnership

would remain in operation and not liquidate its timberland

holdings.     In this respect the methods are duplicative.

     b.     Reilly’s Asset-Accumulation Method

     Reilly also ascribed a 10-percent weight to what he called

the asset-accumulation method.     Applying this method, Reilly

first aggregated the distributions that he predicted the

partnership would make to the partners from 2005 until 2040, the

end of the term of the partnership agreement.     Reilly then

discounted these distributions to present value.     To this sum

Reilly added the value of the timberlands, $143 million, as

discounted to present value from the year 2040.     The asset-


     12
      Undistributed cash that is used by the partnership to
increase the value of the partnership assets increases the value
of the limited partner interests.
                               -27-

accumulation method is effectively a hybrid of the

capitalization-of-distributions method and the asset method.

Because we reject the capitalization-of-distributions method for

the reasons given in Opinion part 5.a, and because we adopt the

asset method (as weighted by the probability of an asset sale),

we accord no independent weight to the asset-accumulation method.

     c.   Prices of Stock of Similar Companies

     Reilly ascribed a 30-percent weight to what he called the

“guideline publicly traded company” method.    Applying this

method, Reilly used the value of two publicly traded businesses

to derive the value of the interest in the partnership.    The

first business was Plum Creek Timber Co., Inc., which is a real

estate investment trust.   Plum Creek owned 7.8 million acres of

timberlands and 10 wood product conversion facilities.    It

derived only 52 percent of its revenue from timber sales.      The

second business was Pope Resources LP, a partnership.    This

business derived 81 percent of its revenue from timber sales.

The remaining revenue was earned from two other operations:

timberland consulting and a multifaceted real estate operation.

     Like Reilly, Thomson used the value of other businesses to

value the interest in the partnership.    He relied on four

businesses:   Plum Creek Timber Co., Inc., Pope Resources LP,

Deltic Timber Corp., and Potlatch Corp.    Both Deltic and Potlatch
                               -28-

have substantial operations other than owning timberland and

selling timber.

     In our view, neither expert appropriately considered that

the other companies have assets other than timberland assets and

that they earn income from sources other than timber sales.

Because of this failure, and because other methods are available,

we accord no weight to the “guideline publicly traded company”

method used by Reilly or the similar method used by Thomson.

6.   The Accuracy-Related Penalty Under Section 6662

     If there is an underpayment of tax, the penalty imposed is

equal to 20 percent of the portion of the underpayment that is

attributable to a “substantial estate * * * tax valuation

understatement.”   Secs. 6662(a), (b)(5), 6664(a).   For estate-tax

returns filed before August 17, 2006, like the return in this

case, there is a substantial estate-tax valuation understatement

if the value of property shown on the estate-tax return is 50

percent or less of the correct value.    Sec. 6662(g)(1) (effective

for tax returns filed before the August 17, 2006, amendment by

the Pension Protection Act of 2006, Pub. L. 109-280, sec.

1219(a)(1)(B), 120 Stat. 1083).   On its estate-tax return, the

estate claimed that the value of the 41.128-percent limited

partner interest was $12,678,117.     This is less than 50 percent

of the correct value of $27,454,115.    Therefore there was a

substantial estate-tax valuation understatement.
                                 -29-

     However, no penalty is imposed with respect to an

underpayment if there was reasonable cause for the underpayment

and the taxpayer acted in good faith.    Sec. 6664(c)(1).     Whether

an underpayment of tax is made in good faith and due to

reasonable cause will depend upon the facts and circumstances of

each case.    Sec. 1.6664-4(b)(1), Income Tax Regs.   In determining

whether a taxpayer acted reasonably and in good faith with regard

to the valuation of property, factors to be considered include:

(1) the methodology and assumptions underlying the appraisal; (2)

the appraised value; (3) the circumstances under which the

appraisal was obtained; and (4) the appraiser’s relationship to

the taxpayer.    Id.   Although the IRS bears the burden of

production under section 7491(c) that the section 6662 penalty is

appropriate, the taxpayer bears the burden of proof in

demonstrating reasonable cause.    See Higbee v. Commissioner, 116

T.C. 438, 446-448 (2001).

     The executor of the estate is the decedent’s son, Larry

Giustina.    Larry Giustina hired a lawyer, Steven Lane, to prepare

the estate-tax return.    Lane hired Columbia Financial Advisors to

appraise the 41.128-percent limited partner interest.    Larry

Giustina relied on the Columbia appraisal in filing the return.
                                 -30-

     The Columbia appraisal, like the Reilly report, valued the

limited partner interest on the basis of capitalized cashflows,

capitalized distributions, and the market values of other

companies.   Even though the Columbia appraisal did not

incorporate the asset method, it was reasonable for the executor

to rely on the Columbia appraisal.      The partnership had been in

operation for 15 years.   It was reasonable to conclude that the

partnership would continue to maintain its timberland assets

without liquidating them.

     The underpayment of tax on the estate’s tax return resulted

from its valuation of the 41.128-percent limited partner

interest.    The valuation was made in good faith and with

reasonable cause.   The estate is not liable for the section 6662

penalty.

     To reflect the foregoing,


                                             Decision will be entered

                                        under Rule 155.
