Fractional Interest Appraisals in California: Valuing a Partial Share of Real Estate

This article is general information, not legal or tax advice. Talk to your attorney or CPA about your situation.

Partial interests are everywhere in California real estate. Parents leave a building to three children. Two families buy a strip center together as tenants in common. A trust holds 40 percent of an apartment complex. A couple divorcing owns half of a warehouse with a business partner. Sooner or later somebody needs a number for that piece, and the question is always the same: is a share of the property worth its percentage of the whole?

What is a fractional interest in real estate?

A fractional interest is any ownership share smaller than 100 percent of a property. The most common forms we see:

• Tenancy in common (TIC). Each co-owner holds an undivided share of the whole property. Nobody owns a particular unit or acre; everyone shares the whole.
• Joint tenancy. Similar shared ownership with a right of survivorship.
• Interests inherited through a trust or estate. A decedent’s partial share, or a building divided among several beneficiaries.
• Real estate held in an LLC or partnership. Here the owner holds an interest in the entity, and the entity owns the property. That is a different kind of asset, which matters for who values what (more on that below).

The property can be anything: an office building, a shopping center, an industrial park, apartments, a gas station, a hotel, vacant land or a vineyard. The ownership structure changes the assignment, not the property type.

When do you need a fractional interest appraisal?

• Estate and gift tax. Federal estate and gift tax regulations measure fair market value 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” (26 CFR 20.2031-1(b) for estates, 26 CFR 25.2512-1 for gifts). When the asset is a partial interest, that hypothetical buyer is buying the partial interest, not the whole building.
• Gifting shares to the next generation. Gifts of real estate interests are a common estate planning tool, and the gift tax return needs a supported value for what was given.
• Trust administration. A trust that owns part of a property needs a value for basis, accountings and distributions. See our guide to trust administration appraisals.
• Divorce. When a marital estate owns a share of a property with outside partners, the attorneys need a value for that share. See divorce appraisals.
• Buyouts and partnership splits. Co-owners buying each other out, families rebalancing, or partners going separate ways.
• Disputes. Litigation between co-owners, and the run-up to a partition action.

Is a partial interest worth its percentage of the whole?

Not automatically, and this is the heart of the assignment. Think about who would actually buy a 25 percent TIC interest in an apartment building from a stranger. That buyer would share decisions about leasing, repairs, refinancing and sale with the other owners. They may not be able to borrow against the interest the way they could against the whole building. They may have to live with a co-ownership agreement that restricts transfers. Many buyers would simply pass, and the ones who are interested may expect to pay less than a straight 25 percent of the building’s value.

The facts that typically drive the analysis include:

• The size of the interest and whether it carries any practical control
• The number of co-owners and how they get along
• Written agreements: a TIC agreement, operating agreement or partnership agreement, including rights of first refusal, buy-sell terms and limits on transfer
• The right to force a sale or division, which in California runs through the partition statutes
• The property itself: its income, condition, financing, and how easy it would be to sell or divide

None of this works without a solid number for the whole property first. That is the real estate appraisal, and it is where most fractional interest analyses succeed or fail.

Who values the discount: the real estate appraiser or a business valuation specialist?

This is the question to settle before anyone engages, and it is one we always raise on the first call.

We appraise real estate. For a fractional interest assignment, that means the market value of the entire property, supported by sales, income and cost analysis as the property calls for, plus a clear description of the interest and the facts that affect it. When the assignment needs a discounted value of the partial interest itself, CPAs and estate attorneys often bring in a qualified business valuation specialist for that step, and our appraisal becomes the foundation of their work. That is the norm when the interest is in an LLC, partnership or other entity, because then the asset being valued is the entity interest, not the real estate.

Be wary of any report that applies a large discount with little explanation. The IRS looks closely at discounted gifts and estate values, and the support behind the whole-property value and any discount is what holds up.

What does the IRS ask for on a gift of a partial interest?

For a gift to be “adequately disclosed” on the gift tax return, which matters for how long the IRS has to assess additional gift tax, Treasury Regulation 301.6501(c)-1(f) asks for, among other things, a description of the method used to value the gift and “a description of any discounts, such as discounts for blockage, minority or fractional interests, and lack of marketability, claimed in valuing the property.”

A donor can meet that part of the rule by submitting an appraisal instead. The regulation says the appraiser must hold themselves out to the public as an appraiser or appraise regularly, be qualified to appraise that type of property, and not be the donor, the donee, a member of either’s family or someone they employ. The appraisal must state the date of the transfer, the date of the appraisal and its purpose, describe the property and the appraisal process, state the assumptions and limiting conditions, explain the valuation method and its rationale, and give the specific basis for the value, such as specific comparable sales.

That is a description of a real narrative report, not a broker’s opinion or a one-page letter. Your CPA decides how to report the gift and which professionals to use.

How does a fractional interest affect California property tax?

Differently than you might expect. Under Revenue and Taxation Code Section 65.1, when an interest in a portion of real property is purchased or changes ownership, generally only the interest or portion transferred is reappraised. There is also a small de minimis rule: an interest worth less than 5 percent of the whole property is not reappraised if its value is under $10,000, with transfers during an assessment year added together. Joint tenancy interests have their own rules.

For property tax, the assessor values the transferred share of the property, which is a different question from what a buyer would pay for a fractional interest on the open market. If the county’s new value looks wrong, a supported appraisal is the evidence an assessment appeal is built on. Ask your CPA or property tax advisor how the rules apply to your transfer.

Is a partition appraisal the same thing?

No, and attorneys mix these up. In a California partition action under the Partition of Real Property Act, Code of Civil Procedure Section 874.316 has the court-appointed appraiser value the property “assuming sole ownership of the fee simple estate,” and a cotenant’s buyout price is that whole value multiplied by the cotenant’s fractional ownership. In other words, the partition statute deliberately does not discount the fractional interest. The same 25 percent share can be valued one way for a gift tax return and another way in a partition buyout, because the purpose and the rules are different. See partition action appraisals.

What should you send the appraiser?

• The purpose of the appraisal (gift, estate, trust, divorce, buyout, dispute) and who will rely on it
• The effective date: a date of death, date of gift, date of separation or a current date
• The vesting deed, and the exact interest being valued (for example, a 33.3 percent TIC interest)
• Any TIC, operating or partnership agreement, and any buy-sell or right of first refusal terms
• Leases, rent rolls and operating statements for income property, as of the effective date
• Loan documents if the property is financed
• Prior appraisals, purchase documents and property tax bills
• The CPA and attorney on the file, and whether a business valuation specialist is involved

Your appraiser will confirm the list on the first call. A simple two-owner building needs less than a multi-property family partnership.

How do CPAs, attorneys and co-owners work with PM Appraisal?

Call or text (805) 990-9700. You talk directly to the appraiser on your assignment, not a coordinator or an appraisal management company. We pick up the phone, and we are your ears and eyes on the property. We confirm the interest, the purpose, the effective date and who else is on the valuation team before anyone engages, so the real estate appraisal fits cleanly with the CPA’s or valuation specialist’s work.

Rush commercial appraisals take 5 to 7 business days. Standard timing depends on the property and scope. Our opinions are independent: we never take an assignment that requires a predetermined value, and our fees are never tied to the result.

Fractional interest work is one example of what we do. Our team writes every kind of commercial appraisal, including estate and trust, date of death, retroactive, divorce, litigation, eminent domain, tax appeal, hard money lending and multi-property portfolios, for every commercial property type: office, retail, industrial and warehouse, multifamily, mixed-use, gas stations, hotels and motels, land, vineyards and agricultural property, medical, care facilities, religious facilities and special-use property. See the full list of property types and our statewide coverage, from San Diego to the Oregon border.

Keep reading

• Estate and trust appraisals
• Partition action appraisals
• Trust administration: when a successor trustee needs an appraisal
• Date of death appraisals
• Divorce appraisals
• Multi-property portfolio appraisals

This article is general information, not legal or tax advice. Talk to your attorney or CPA about your situation.