Estate of Harper v. Comm'r

T.C. Memo. 2002-121

UNITED STATES TAX COURT

ESTATE OF MORTON B. HARPER, DECEASED, MICHAEL A. HARPER,

EXECUTOR, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 19336-98. Filed May 15, 2002.

HFLP, a limited partnership, was established in

1994 and was capitalized by the contribution thereto by

D of the majority of his assets. D was initially named

as the sole limited partner and his children, M and L,

were designated as general partners. D subsequently

gave to M and L 24- and 36-percent limited partnership

interests, respectively. At his death in 1995, D

continued to hold a 39-percent limited partnership

interest in HFLP.

Held: The property contributed by D to HFLP is

includable in his gross estate pursuant to sec.

2036(a), I.R.C.

Held, further, value of the assets to be included

in the gross estate determined.

- 2 -

Warren J. Kessler and Joan B. Kessler, for petitioner.

Donna F. Herbert and Jonathan H. Sloat, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

NIMS, Judge: Respondent determined, as a primary position,

a Federal estate tax deficiency in the amount of $331,171 with

respect to the estate of Morton B. Harper (the estate). In the

alternative, respondent determined a Federal estate tax

deficiency of $150,496 and a Federal gift tax deficiency of

$180,675 for the 1994 calendar period. The principal issue for

decision is the proper treatment for estate and gift tax purposes

of interests in a limited partnership, some of which were

transferred by Morton B. Harper (decedent) prior to his death,

and another of which was held by decedent at his death.

Unless otherwise indicated, all section references are to

sections of the Internal Revenue Code in effect during the

relevant periods, and all Rule references are to the Tax Court

Rules of Practice and Procedure.

FINDINGS OF FACT

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

The stipulations of the parties, with accompanying exhibits, are

incorporated herein by this reference. Decedent was a resident

of Palm Springs, California, when he died testate in Portland,

Oregon, on February 1, 1995. No probate proceeding was ever

- 3 -

filed by or on behalf of the estate. Decedent is survived by his

two children, Michael A. Harper (Michael) and Lynn H. Factor

(Lynn). Decedent’s wife, Ruth Harper, died in 1988. Michael

serves as executor of the estate and provided a mailing address

in Lake Oswego, Oregon, at the time the petition in this case was

filed.

Decedent was born on September 1, 1908, in Cincinnati, Ohio.

He later attended law school, graduating in 1931, and began

practicing law in Chicago. His practice initially specialized in

corporate and “political” law and subsequently expanded to

include bankruptcy, tax, real estate, and wills and trusts law.

After World War II, decedent and his family moved to California

where decedent continued his legal practice, focusing in

particular on the entertainment industry. Decedent was a member

of the California bar from 1946 until his death. Decedent was

diagnosed with prostate cancer in 1983 and with cancer of the

rectum in 1989.

On December 18, 1990, decedent created a revocable living

trust entitled the Morton B. Harper Trust (the Trust). The trust

instrument designated decedent as the original trustee and as the

initial primary beneficiary. The document further provided:

“During the lifetime of the Trustor, the Trustee, in Trustee’s

sole discretion may pay or apply the net income and/or corpus, or

so much as Trustee chooses, to or for the benefit of the

- 4 -

Trustor”. Michael and Lynn were named as successor trustees and

were to receive the trust assets upon decedent’s death, with 60

percent thereof being distributed to Lynn and 40 percent to

Michael. The percentages were based on perceived need; Michael

has pursued a successful career in business as a real estate

professional, while Lynn has been less consistent in fiscal

matters.

At all relevant times, Lynn maintained a residence in

Hawaii. On December 18, 1990, a complaint was filed by the

Association of Apartment Owners of International Colony Club

(AOAO) against Lynn in the Circuit Court of the Second Circuit,

State of Hawaii. Lynn owned a home within the International

Colony Club condominium project, and the AOAO was the condominium

association overseeing that project. The complaint alleged that

Lynn had engaged in unauthorized and illegal construction and

renovation of her property and requested both injunctive and

monetary relief. Subsequently, in November of 1992, the AOAO

demanded arbitration of its claims. An arbitration award was

then entered against Lynn in December of 1993 and required

extensive reconstruction work as well as payment of fees, costs,

and expenses.

Lynn and Michael testified that following entry of the above

award, Lynn told Michael about her litigation versus the AOAO and

the concomitant award, which Michael then communicated to

- 5 -

decedent. Thereafter, in approximately February of 1994, Michael

and decedent met in California with John G. Coulter, Jr., an

experienced real estate developer familiar with the Hawaii

market. Michael had previously contacted Mr. Coulter, asking him

to review documents relating to the Hawaii lawsuit and to offer

his advice. After reviewing the documents and speaking to a

gentleman involved in management of the condominium, Mr. Coulter

expressed his concern that Lynn had gotten herself into “deep

water”; that is, into a situation where “if she takes additional

steps which could injure her further, her loss could go beyond

the judgment”. He also recommended that they evaluate her legal

counsel and suggested that “they get involved with her in the

management of her assets through a trust or some other form of

involvement.” Several weeks after the meeting, Michael

accompanied Mr. Coulter to Hawaii for the purpose of being

introduced to other potential representatives for Lynn. On March

23, 1994, the attorney who had represented Lynn in the AOAO

proceeding filed a complaint against her alleging unpaid legal

fees in the amount of $18,153.92.

At a time not entirely clear from the record, decedent made

the decision to form a limited partnership and to contribute

thereto the majority of his assets. An Agreement of Limited

Partnership for Harper Financial Company, L.P. (HFLP), was

prepared and sets forth the governing provisions for the entity.

- 6 -

The document begins with language stating that the Agreement was

made “as of the 1st day of January, 1994”, but later recites that

the partnership shall commence its existence upon the date a

certificate of limited partnership is duly filed with the

California Secretary of State. The primary purpose for HFLP’s

formation, according to the Agreement, was as follows:

The acquisition, including by purchase of, sale

of, management of, holding, investing in and

reinvesting in stocks (both common and preferred),

options with respect thereto, bonds, mutual funds, debt

instruments, money market funds, notes and deeds of

trust and similar instruments and investments (the

“Portfolio”).

Michael and Lynn were named as the general partners of HFLP

and the Trust as the sole limited partner, with interests of .4

percent, .6 percent, and 99 percent, respectively. Michael was

also designated to serve as the managing general partner. As

regards his authority, the Agreement provides:

Subject to the provisions of Paragraph 7.3, the

Managing General Partner shall have the full, exclusive

and complete authority and discretion in the management

and control of the business of the Partnership for the

purposes stated herein and shall have the right to make

any and all decisions affecting the business of the

Partnership. Subject to the provisions of this

Agreement, the Managing General Partner shall have full

and exclusive authority with respect to the Portfolio,

including rights of sale, reinvesting and voting. * * *

The referenced Paragraph 7.3 then specifies the following

limitations:

Notwithstanding the provisions of this Paragraph

7, neither General Partner shall have any right, power

or authority to:

- 7 -

(a) Do any act in contravention of this

Agreement, without first obtaining the written consent

thereto of a “Majority in Interest of the Limited

Partners” * * * [defined as limited partners holding

more than 50 percent of the interest in the ordinary

income of the partnership held by limited partners].

(b) Do any act * * * which would (i) make

it impossible to carry on the ordinary business of the

Partnership, or (ii) change the nature of the

Partnership’s business, without first obtaining the

written consent thereto of a Majority in Interest of

the Limited Partners.

(c) Confess a judgment against the

Partnership, without first obtaining the written

consent thereto of a Majority in Interest of the

Limited Partners.

(d) Possess Partnership property, or assign

the Partnership’s right in such property, for other

than a Partnership purpose without first obtaining the

written consent thereto of a Majority in Interest of

the Limited Partners.

(e) Admit a person as a limited partner,

otherwise than as permitted by this Agreement, without

first obtaining the written consent thereto of a

Majority in Interest of the Limited Partners.

(f) Elect to dissolve and wind up the

Partnership, without first obtaining the written

consent thereto of a Majority in Interest of the

Limited Partners.

(g) Sell or reinvest 5% or more of the

Portfolio (based on their fair market value) in a

single transaction or in a related series of

transactions, other than in the ordinary course of

business, without first obtaining the written consent

thereto of a Majority in Interest of the Limited

Partners.

(h) Issue or sell new interests in the

Partnership (or admit new partners in connection

therewith) or permit the contribution of new capital to

- 8 -

the Partnership, without first obtaining the written consent

thereto of a Majority in Interest of the Limited Partners.

(i) Enter into any transactions, other than

those transactions contemplated by Paragraph 7, in

which a General Partner has an actual or potential

conflict of interest with the Trust or the Partnership,

without first obtaining the written consent thereto of

a Majority in Interest of the Limited Partners.

(j) Admit a person as a general partner,

without first obtaining the written consent thereto,

and to any related transactions with such person, of a

Majority in Interest of the Limited Partners.

(k) Amend this Agreement, without first

obtaining the written consent thereto of a Majority in

Interest of the Limited Partners.

In addition, Paragraph 12.5 provides explicitly that “The Trust

is entitled to vote, prior to any such action being taken to”

approve any of the above-enumerated actions.

Regarding capital accounts and contributions, the Agreement

states that capital accounts were to be established and

maintained in accordance with section 704(b) and the regulations

promulgated pursuant thereto; namely, section 1.704-1(b)(2)(iv),

Income Tax Regs. In general, Paragraph 10.2 of the document

requires that profits and losses be allocated 0.6 percent, 0.4

percent, and 99 percent to the capital accounts of Lynn, Michael,

and the Trust, respectively. The Agreement also sets forth the

following with respect to contributions: “Concurrently with the

execution of this Agreement (or as soon thereafter as is

reasonably possible), the Trust shall make an initial capital

- 9 -

contribution to the Partnership consisting of the Portfolio. The

General Partners shall have no obligation to make any

contribution to the capital of the Partnership.”

Although “the Portfolio” is not defined in the Agreement,

there appears to be no dispute between the parties that it

consisted of: (1) Securities held in a brokerage account at M.L.

Stern & Co., Inc., (2) securities held in a Putnam Investments

account, (3) securities held in two Franklin Fund accounts, (4)

2,500 shares of Rockefeller Center Properties, Inc., and (5) a

$450,000 note receivable from Jack P. Marsh. The parties value

these assets at between $1.6 and $1.7 million (rounded), an

amount representing approximately 94 percent of decedent’s total

assets. The Trust’s capital account in HFLP was credited with 99

percent of the value of the property contributed. Decedent

retained, personally or through the Trust, his personal effects,

a checking account, an automobile, and his Palm Springs

condominium.

As regards distributions, Paragraph 11.1 of the Agreement

states: “Subject to all of the provisions of this Agreement,

funds of the Partnership from any source shall be distributed to

the Partners at such times and in such amounts as are determined

in the sole and absolute discretion of the Managing General

Partner.” Paragraph 11.2 then goes on to recite:

Funds of the Partnership shall be distributed as

follows:

- 10 -

(a) First, to any Partner, the amount then due on

any Advances [loans to the entity] * * *

(b) Ordinary Net Cash Flow [revenues from

dividends, interest, and other items of ordinary income

in excess of ordinary and necessary operating expenses]

shall be distributed 0.6% to Lynn, 0.4% to Michael and

99% to the Trust.

(c) Extraordinary Net Cash Flow [revenues from

capital gains in excess of capital losses, less

consequent expenses] shall be distributed to the

Partners with positive Capital Account balances, pro

rata to the extent thereof.

The Agreement also specifies that “No distribution of funds of

the Partnership shall be made until the allocations described in

Paragraph 10 hereof [regarding the allocation of profits and

losses to the partners’ capital accounts] have first been made.”

The Agreement prohibits transfer, sale, assignment, or

encumbrance of a limited partnership interest without the consent

of all partners. Any transfer attempted in violation of this

restriction is declared by the Agreement to be null and void ab

initio. Under provisions of the Agreement, the entity is to be

dissolved upon the earlier of: (1) January 1, 2034; (2) the

retirement, withdrawal, death, or insanity of any general partner

or any other event or condition, other than removal, which

results in a general partner’s ceasing to be a general partner,

unless (i) at the time there is at least one remaining general

partner to continue the business of the partnership and such

remaining general partner chooses to do so, or (ii) all partners

agree in writing within 60 days thereof to continue the business

- 11 -

and, if necessary, to the admission of one or more general

partners; (3) an election to dissolve the partnership made in

writing by the general partners and the limited partners; or (4)

the failure to elect a successor general partner within 60 days

after the removal of the last general partner.

Although the Agreement contains no express provision

regarding the removal of a general partner, it specifies that

rights and duties of the partners are governed by the California

Revised Limited Partnership Act except to the extent the

Agreement states otherwise. This Act includes the following:

“The limited partners shall have the right to vote on the removal

of a general partner, and that action shall be effective without

further action upon the vote or written consent of a majority in

interest of all partners”. Cal. Corp. Code sec. 15636(f)(2)

(West 1991).

The Agreement was signed by decedent on behalf of the Trust,

by Michael, and by Lynn. Although the signatures are undated,

the document was executed by Michael in May or June of 1994.

Lynn could not remember when she signed the Agreement and did not

read it prior to signing. A certificate of limited partnership

was filed on behalf of HFLP with the California Secretary of

State on June 14, 1994.

- 12 -

From June 17 to June 20, 1994, decedent was hospitalized in

Palm Springs. Medical records prepared at that time contain the

explanation set forth below:

This is one of multiple Desert Hospital admissions

for this 85-year-old Caucasian who is well known to

have metastatic colonic carcinoma and prostatic

carcinoma and admitted at the present time for poor

oral intake, poor fluid intake, dehydration and for

further rehydration, close observation, nutrition

support, etc.

After his release, decedent went to Oregon, where he resided

until his death. He first stayed with Michael for approximately

a month and then moved into a nearby Oregon retirement facility

known as Carmen Oaks. Carmen Oaks served independent individuals

and was not a nursing center.

Thereafter, by a document entitled Assignment of Partnership

Interest and Amendment No. 1 to Agreement of Limited Partnership

for Harper Financial Company, L.P., dated and made effective as

of July 1, 1994, the Trust transferred to Michael and Lynn 60

percent of the Trust’s partnership interest. As a result,

Michael and Lynn became holders of 24- and 36-percent limited

partnership interests, respectively, and were given corresponding

percentages of the Trust’s capital account balance. The limited

partnership interests held by Michael and Lynn were designated as

“Class B Limited Partnership Interest[s]” and were entitled to 60

percent of the income and loss of the entity, with 40 percent

thereof going to Michael and 60 percent to Lynn.

- 13 -

The Amendment also reclassified the Trust’s remaining 39-

percent limited partnership interest as a “Class A Limited

Partnership Interest” which was entitled to 39 percent of the

entity’s income and losses and to a “Guaranteed Payment” of

“4.25% annually of its Capital Account balance on the Effective

Date, payable quarterly no later than twenty (20) days after the

close of any such calendar quarter (or sooner, if cash flow

permits).” Decedent, as trustee of the Trust, Michael, and Lynn

signed the document.

On July 26, 1994, decedent commenced the process of

transferring the Trust’s portfolio to the partnership, which

process continued for approximately the next 4 months. On July

26, 1994, decedent executed as trustee an allonge endorsement

assigning to HFLP the Trust’s interest in the Marsh note. A

collateral assignment of the Trust’s interest in property

securing the note was also signed on that date. Then, on August

28, 1994, a letter agreement confirming and/or finalizing the

transfer was executed by or on behalf of Mr. Marsh, the Trust,

and HFLP.

Next, a letter dated September 29, 1994, was sent by

decedent to M.L. Stern & Co. confirming instructions for (1) the

sale of all securities held in the Trust’s account and (2) the

use of the proceeds for the immediate repurchase of the same

securities for an account established on behalf of the

- 14 -

partnership. Michael, as managing general partner, completed the

requisite form opening a new account with M.L. Stern & Co. for

the partnership. The form designated Michael as the “individual

* * * authorized to enter orders on behalf of customer”. Neil

Hattem served as decedent’s broker and subsequently as the broker

on the HFLP account.

Letters dated September 30, 1994, were then sent by decedent

to Putnam Investor Services and to Franklin Templeton requesting

transfer of the respective Putnam and Franklin Fund accounts to

HFLP. Lastly, by a letter dated November 22, 1994, decedent

requested transfer of the Trust’s stock in Rockefeller Center

Properties to the partnership.

During this period, on September 23, 1994, Michael opened a

checking account at Bank of America in the name of the

partnership with a $200 deposit. Thereafter, the first activity

in the account, other than the debiting of a monthly service

charge, was a deposit on October 13, 1994, of $3,750 representing

interest paid on the Marsh note. The check register maintained

by Michael, in conjunction with his explanatory testimony,

reflects checks written for the benefit of HFLP partners in 1994

and 1995, as follows:

- 15 -

Date Lynn Michael Trust Description and/or Purpose

11/9/94 $120 reimbursement of contribution to

checking account opening deposit

11/9/94 $80 reimbursement of contribution to

checking account opening deposit

11/9/94 4,200 distribution

11/9/94 2,800 distribution

11/9/94 $3,800 distribution

12/19/94 2,250 distribution

12/19/94 1,500 distribution

12/19/94 3,750 distribution

1/10/95 2,250 distribution

1/10/95 1,500 distribution

1/10/95 3,750 distribution

1/17/95 6,520 “additional distribution” to cover

tax voucher

1/30/95 4,000 “additional distribution” to

complete gift

5/30/95 5,000 “return of capital” for an estate

expense

8/30/95 5,000 “return of capital” for an estate

purpose

10/13/95 5,000 “capital return” for an estate

expense

10/30/95 195,000 “return of capital” to cover

estate taxes

11/15/95 7,200 distribution

11/15/95 4,800 distribution

- 16 -

The funds to make the $195,000 payment on October 30, 1995,

were obtained through two deposit transactions. Proceeds in the

amount of $135,000 from the liquidation of a money market account

with M.L. Stern & Co. and in the amount of $60,000 from a

reduction in principal on the Marsh note were placed into the

bank account on October 30, 1995. Michael negotiated the $60,000

payment on the Marsh note in return for agreeing to extend the

maturity date of the remaining principal balance.

Prior to establishment of the partnership account, amounts

received with respect to securities contributed to HFLP were

deposited in the Morton B. Harper Trust checking account.

In January of 1995, decedent entered hospice care in Oregon.

Preceding that time, he had been hospitalized on three occasions,

in late September, early October, and late November. He had also

renewed his vehicle registration on September 23, 1994, and his

driver’s license was current at the time of his death. Decedent

passed away on February 1, 1995.

Thereafter, in March or April of 1995, Michael engaged a

certified public accountant, David S. Blankstein, to prepare

financial books and tax returns for the partnership and also to

prepare the income, gift, and estate tax returns due with respect

to decedent. In furtherance of these objectives, Mr. Blankstein

reviewed the partnership Agreement; the certificate of limited

partnership; the Amendment; checking account records for the

- 17 -

partnership, the Trust, and decedent; M.L. Stern & Co. statements

for the partnership and the Trust; Putnam Investments statements

for the partnership and the Trust; Franklin Funds statements for

the partnership and the Trust; the Rockefeller Center Properties

stock certificate; and the Marsh note.

Mr. Blankstein set up a general ledger for HFLP to

categorize and account for all transactions affecting partnership

assets and income beginning June 14, 1994. Capital accounts were

established for each partner, as well as ledger accounts to show

distributions to partners, income received by the partnership on

the various portfolio assets, proceeds from the sale of

securities, and costs and charges incurred. In addition, an

account labeled “Receivable from Trust” was created primarily to

reflect amounts received by the Trust after June 14, 1994, that

should properly have been received by the partnership. This

account was presumably necessitated in large part by the delay in

transferring title to the portfolio securities and in opening the

partnership bank account. The balance in this account was then

treated as a distribution to the Trust; no funds were actually

transmitted between the two entities. Mr. Blankstein also

conceded that several items which should have been attributed to

the partnership were omitted.

A Form 709, United States Gift (and Generation-Skipping

Transfer) Tax Return, and a Form 706, United States Estate (and

- 18 -

Generation-Skipping Transfer) Tax Return, were filed on behalf of

decedent and were received by the Internal Revenue Service on

October 16, 1995, and November 2, 1995, respectively. The gift

tax return reported the .4-percent general and 24-percent limited

partnership interests given to Michael and the .6-percent general

and 36-percent limited partnership interests given to Lynn. The

estate tax return included as part of decedent’s gross estate the

Trust’s 39-percent limited partnership interest in HFLP.

Notices of deficiency were issued with respect to the above

returns on October 21, 1998. As previously stated, respondent

therein advanced a primary and an alternative position. Under

the primary position, the full value of the assets held by HFLP

was included in decedent’s gross estate, and prior taxable gifts

were reduced to $0, resulting in an estate tax deficiency of

$331,171 and no deficiency in gift tax. Under the alternative

position, respondent determined an estate tax deficiency of

$150,496 and a gift tax deficiency of $180,675.

OPINION

I. Contentions of the Parties

The parties in this case disagree regarding how properly to

treat the partnership interests transferred by decedent to his

children during life and the interest included through the Trust

in his estate at death. Respondent contends that the full fair

market value of the assets contributed to HFLP is includable in

- 19 -

decedent’s gross estate upon either of two alternative theories.

Respondent argues that the partnership lacked economic substance

and should thus be disregarded for transfer tax purposes or,

alternatively, that section 2036(a) applies to include the value

of the contributed property in decedent’s gross estate due to

decedent’s retention of the economic benefit of the assets.

Furthermore, respondent maintains that even if the

partnership is respected and section 2036(a) is found not to

apply, the discounts claimed by the estate with respect to

valuation of the subject partnership interests are excessive,

unsupported, and should not be sustained. Respondent offers and

relies upon the expert reports of John A. Thomson in connection

with this latter argument.

Conversely, the estate emphasizes that HFLP was a duly

organized and operating limited partnership established with the

business purpose of protecting from Lynn’s creditors the assets

that Lynn would receive or inherit from decedent. Hence,

according to the estate, the partnership must be recognized for

tax purposes. Moreover, it is the estate’s position that section

2036(a) has no application here because the Trust unconditionally

transferred the portfolio assets to HFLP, the Trust received

adequate and full consideration for the transfer in the form of a

credit to its capital account, and there existed no express or

implied agreement that decedent would retain a right to control

- 20 -

over or income generated by the contributed property. The estate

thus contends that this controversy devolves to a valuation case

where the property to be valued takes the form of partnership

interests in HFLP and where the analysis provided by the estate’s

expert Clint Cronkite establishes a sound appraisal thereof.

II. Evidentiary Issues

As a preliminary matter, we address several evidentiary

objections reserved by the parties in the stipulation of facts.

The estate objected to the admission of Exhibit 27-J on grounds

of authenticity, relevance, and prejudice. Exhibit 27-J is a

facsimile of medical records for decedent requested by and sent

to the Internal Revenue Service. The estate pointed out at trial

that the lines within the document for the doctor’s signature are

blank. During the proceeding, respondent offered as Exhibit 53-R

signed copies of key portions of the records. The estate agreed

that no objection would be pressed as to the authenticity of

Exhibit 53-R, at which time the document was admitted into

evidence with the estate renewing objections as to relevance and

prejudice. Given this posture, Exhibit 27-J is largely

cumulative, and we sustain the estate’s objection thereto. We

also overrule any remaining objections to Exhibit 53-R.

The estate similarly objected to Exhibit 28-J on grounds of

authenticity, relevance, and prejudice. This document is a

letter to the Internal Revenue Service from one of decedent’s

- 21 -

physicians, and the estate again cites concerns with the

signature thereon. In light of these concerns and the fact that

the letter does not appreciably add to the information reported

in the admitted medical records, we sustain the estate’s

objection.

The estate’s final objection in the stipulation was to the

admission of Exhibit 29-J, a letter to Michael from decedent’s

doctor, on grounds of relevance and prejudice. These objections,

however, were overruled at trial, and the document was taken into

evidence.

Respondent in the stipulation objected to the admission of

Exhibits 33-J through 37-J, which pertain to the Hawaii

arbitration, on the ground of relevance. On reply brief,

respondent expressly waived objection to these documents.

Exhibits 33-J through 37-J are admitted into evidence.

Respondent also in the stipulation raised relevancy

objections to Exhibits 41-J, 44-J, and 45-J. Since these

documents (a photo of decedent taken in the 1950s and copies of

various checks written for gifts and charitable contributions)

all relate to periods prior to those at issue and do not bear in

any meaningful way on matters considered herein, we sustain

respondent’s objections.

- 22 -

III. Inclusion in the Gross Estate--Section 2036

A. General Rules

As a general rule, section 2501 imposes a tax for each

calendar year “on the transfer of property by gift” by any

taxpayer, and section 2511(a) further clarifies that such tax

“shall apply whether the transfer is in trust or otherwise,

whether the gift is direct or indirect, and whether the property

is real or personal, tangible or intangible”. For purposes of

determining whether a gift has been made, section 2512(b)

provides: “Where property is transferred for less than an

adequate and full consideration in money or money’s worth, then

the amount by which the value of the property exceeded the value

of the consideration shall be deemed a gift”. The tax is then

computed based upon the statutorily defined “taxable gifts”,

which term is explicated in section 2503. Section 2503(a) states

generally that taxable gifts means the total amount of gifts made

during the calendar year, less specified deductions.

Similarly, the Internal Revenue Code imposes a Federal tax

“on the transfer of the taxable estate of every decedent who is a

citizen or resident of the United States.” Sec. 2001(a). Such

taxable estate, in turn, is defined as “the value of the gross

estate”, less applicable deductions. Sec. 2051. Section 2031(a)

- 23 -

specifies that the gross estate comprises “all property, real or

personal, tangible or intangible, wherever situated”, to the

extent provided in sections 2033 through 2045.

Section 2033 broadly states that “The value of the gross

estate shall include the value of all property to the extent of

the interest therein of the decedent at the time of his death.”

Sections 2034 through 2045 then explicitly mandate inclusion of

several more narrowly defined classes of assets. Among these

specific sections is section 2036, which reads in pertinent part

as follows:

SEC. 2036. TRANSFERS WITH RETAINED LIFE ESTATE.

(a) General Rule.--The value of the gross estate

shall include the value of all property to the extent

of any interest therein of which the decedent has at

any time made a transfer (except in case of a bona fide

sale for an adequate and full consideration in money or

money’s worth), by trust or otherwise, under which he

has retained for his life or for any period not

ascertainable without reference to his death or for any

period which does not in fact end before his death--

(1) the possession or enjoyment of, or the

right to the income from, the property, or

(2) the right, either alone or in conjunction

with any person, to designate the persons who

shall possess or enjoy the property or the income

therefrom.

Regulations likewise explain that the gross estate under section

2036 includes the value of transferred property if the decedent

- 24 -

retained the “use, possession, right to the income, or other

enjoyment of the transferred property”. Sec. 20.2036-1(a)(i),

Estate Tax Regs.

Given the language used in the above-quoted provisions, it

has long been recognized that “The general purpose of this

section is ‘to include in a decedent’s gross estate transfers

that are essentially testamentary’ in nature.” Ray v. United

States, 762 F.2d 1361, 1362 (9th Cir. 1985) (quoting United

States v. Estate of Grace, 395 U.S. 316, 320 (1969)).

Accordingly, courts have emphasized that the statute “describes a

broad scheme of inclusion in the gross estate, not limited by the

form of the transaction, but concerned with all inter vivos

transfers where outright disposition of the property is delayed

until the transferor’s death.” Guynn v. United States, 437 F.2d

1148, 1150 (4th Cir. 1971).

As used in section 2036(a)(1), the term “enjoyment” has been

described as “synonymous with substantial present economic

benefit.” Estate of McNichol v. Commissioner, 265 F.2d 667, 671

(3d Cir. 1959), affg. 29 T.C. 1179 (1958); see also Estate of

Reichardt v. Commissioner, 114 T.C. 144, 151 (2000). Moreover,

possession or enjoyment of transferred property is retained for

purposes of section 2036(a)(1) where there is an express or

implied understanding to that effect among the parties at the

time of the transfer, even if the retained interest is not

- 25 -

legally enforceable. Estate of Maxwell v. Commissioner, 3 F.3d

591, 593 (2d Cir. 1993), affg. 98 T.C. 594 (1992); Guynn v.

United States, supra at 1150; Estate of Reichardt v.

Commissioner, supra at 151; Estate of Rapelje v. Commissioner, 73

T.C. 82, 86 (1979). Regulations likewise provide that “An

interest or right is treated as having been retained or reserved

if at the time of the transfer there was an understanding,

express or implied, that the interest or right would later be

conferred.” Sec. 20.2036-1(a), Estate Tax Regs.

The existence or nonexistence of such an understanding is

determined from all of the facts and circumstances surrounding

both the transfer itself and the subsequent use of the property.

Estate of Reichardt v. Commissioner, supra at 151; Estate of

Rapelje v. Commissioner, supra at 86. However, an exception to

the treatment mandated by section 2036(a) exists where the facts

establish “a bona fide sale for an adequate and full

consideration in money or money’s worth”.

B. Burden of Proof

Typically, the burden of disproving the existence of an

agreement regarding retained enjoyment has rested on the estate,

and this burden has often been characterized as particularly

onerous in intrafamily situations. Estate of Maxwell v.

Commissioner, supra at 594; Estate of Reichardt v. Commissioner,

supra at 151-152; Estate of Rapelje v. Commissioner, supra at 86.

- 26 -

With respect to the case at bar, however, respondent conceded on

reply brief that the opposite burden applies here. The estate

had asserted on opening brief that the burden of proof regarding

nonvaluation issues shifted to respondent, to which contention

respondent replied as follows:

The respondent agrees that the lack of economic

substance and I.R.C. § 2036 issues are new matters

within the meaning of Tax Court Rule 142(a). As such,

the petitioner correctly states that the respondent

bears the burden of proof on these issues under Shea v.

Commissioner, 112 T.C. 183 (1999). * * * [Fn. ref.

omitted.]

For purposes of this litigation, we have accepted

respondent’s concession and have considered its role in our

analysis. Nonetheless, after reviewing all of the evidence

presented, we have found that our resolution does not depend on

which party bears the burden of proof. Both parties adduced

testimony and offered exhibits in support of their respective

positions, and the evidence so introduced was not evenly balanced

in favor of the competing alternatives. Accordingly, we have

based our conclusions upon the preponderance of the evidence

rather than upon an allocation of the burden of proof.

C. Existence of a Retained Interest

As previously indicated, section 2036 mandates inclusion in

the gross estate of transferred property with respect to which

the decedent retained, by express or implied agreement,

possession, control, enjoyment, or the right to income. The

- 27 -

focus here is on whether there existed an implicit agreement that

decedent would retain control or enjoyment, i.e., economic

benefit, of the assets he transferred to HFLP.

Respondent avers that section 2036’s applicability is

established on these facts, emphasizing in particular actual

conduct with respect to partnership funds. Respondent further

maintains that this case is indistinguishable from the situations

presented in Estate of Reichardt v. Commissioner, supra, and

Estate of Schauerhamer v. Commissioner, T.C. Memo. 1997-242. The

estate, on the other hand, discounts the evidence and cases

relied on by respondent, emphasizing instead the formal terms of

the partnership arrangement and the accounting treatment of

entity assets.

In Estate of Reichardt v. Commissioner, supra at 147-148,

the decedent formed a family limited partnership, the general

partner of which was a revocable trust created on the same date.

The decedent and his two children were named as cotrustees, but

only the decedent performed any meaningful functions as trustee.

Id. at 147, 152. He was the only trustee to sign the articles of

limited partnership, to open brokerage accounts, or to sign

partnership checks. Id. at 152. He transferred his residence

and all of his other property (except for his car, personal

effects, and a small amount of cash in his checking account) to

the partnership and subsequently gave his two children limited

- 28 -

partnership interests. Id. at 148-149, 152-153. The decedent

deposited partnership income in his personal account, used the

partnership checking account as his personal account, and lived

at his residence without paying rent to the partnership. Id. at

152. Based on these facts, we concluded that nothing but legal

title changed in the decedent’s relationship to his assets after

he transferred them to the partnership. Id. at 152-153.

In Estate of Schauerhamer v. Commissioner, supra, the

decedent formed three limited partnerships. The decedent and one

of her three children were named as the general partners of each

partnership, with the decedent’s being designated as the managing

partner. Id. The decedent transferred business assets,

including real estate, partnership interests, and notes

receivable, to the partnerships in undivided one-third shares.

Id. Limited partnership interests in these entities were given

to family members. Id. Partnership bank accounts were opened,

but the decedent deposited the income earned by the partnerships

into the account she used as her personal checking account, where

it was commingled with funds from other sources. Id. Checks

were then written from this account to pay both personal and

partnership expenses. Id. The decedent’s children later

acknowledged at trial that formation of the partnerships was

merely a way to enable the decedent to assign interests in the

partnership assets to family members, with the assets to be

- 29 -

managed by the decedent exactly as in the past. Id. We

therefore found the assets includable under section 2036(a). Id.

We agree with respondent that the circumstances before us

bear many similarities to those in Estate of Reichardt v.

Commissioner, 114 T.C. 144 (2000), and Estate of Schauerhamer v.

Commissioner, supra, and are convinced that a like result should

obtain. We focus particularly on the commingling of funds, the

history of disproportionate distributions, and the testamentary

characteristics of the arrangement in support of our conclusion

that there existed an implied agreement that decedent would

retain the economic benefit of the assets transferred to HFLP.

As regards commingling of funds, we note that this fact was

one of the most heavily relied upon in both Estate of Reichardt

v. Commissioner, supra at 152, and Estate of Schauerhamer v.

Commissioner, supra. We find the disregard here for partnership

form to be equally egregious. The Agreement specified: “All

funds of the Partnership shall be deposited in a separate bank

account or accounts”. Yet no such account was even opened for

HFLP until September 23, 1994, more than 3 months after the

entity began its legal existence. Prior to that time,

partnership income was deposited in the Trust’s account,

resulting in an unavoidable commingling of funds.

Michael testified concerning this delay as follows:

Inadvertently, either my account or I failed to apply

timely for any--an employee [sic] identification

- 30 -

number. That is required before a checking account is

open. So I just made the determination that without a

checking account and I wanted the flow of cash, what we

would do is use the Morton B. Harper Trust account as a

holding account, and then I instructed the accountant

to properly credit and account for those funds. * * *

This explanation, however, seems to beg the question. Had

Michael sought promptly upon HFLP’s creation to establish a bank

account, he would have been immediately alerted to the need for

an EIN. Hence, he either neglected to attempt opening and/or

using an account or allowed the lack of an EIN to continue for

several months after having been reminded of its necessity. Both

reflect at best a less than orderly approach to the formal

partnership structure so pressed by the estate.

Moreover, we find Michael’s reliance on post mortem

accounting manipulations to be especially unavailing. Michael

and Mr. Blankstein, HFLP’s accountant, each testified that no

moneys actually changed hands in connection with the adjustments.

In response to similar contentions in Estate of Reichardt v.

Commissioner, supra at 154-155, we stated:

The 1993 yearend and 1994 post mortem adjusting entries

made by Hannah’s firm were a belated attempt to undo

decedent’s commingling of partnership and personal

accounts. There is no evidence that the partnership or

decedent transferred any funds to the other as a result

of the adjusting entries. After-the-fact paperwork by

decedent’s C.P.A. does not refute that decedent and his

children had agreed that decedent could continue to use

and control the property during his life. [Fn. ref.

omitted.]

- 31 -

Here Michael did not even hire Mr. Blankstein until after

decedent’s death, strengthening the inference that the partners

had little concern for establishing any precise demarcation

between partnership and other funds during decedent’s life.

Closely related to the delay in opening the partnership bank

account and consequent commingling of income is the delay in

formally transferring the underlying portfolio assets to HFLP.

No attempt was made to begin the process of title transfer until

July 26, 1994, when decedent executed an allonge endorsement

assigning the Marsh note to HFLP. No action was taken with

respect to any of the other securities until September 29 and 30,

1994, when letters addressing transfer of the M.L. Stern & Co.,

Putnam, and Franklin accounts were drafted and an account with

M.L. Stern & Co. was opened on behalf of HFLP. A letter

requesting transfer of the Rockefeller Center Properties stock

was not prepared until November 22, 1994.

When Michael was asked on cross-examination to explain this

delay between the effective date of the partnership and the

formal transfer of assets into the entity, he replied: “Probably

for different reasons, some mechanical delays and who we’re

dealing with, but generally, there was no rush to do it. We were

just doing it in an orderly fashion.” Next, in response to a

further question asking why there was no rush, he continued:

“There was no rush. I mean, we were just handling the business

- 32 -

in an orderly fashion. There wasn’t any deadline or urgency to

do it and get it done.” The following colloquy then ensued:

Q Now let’s talk for a moment about the income from

the portfolio assets. Before the title to the assets

was transferred to the partnership, your father or his

trust continued to receive the income from those

assets. Isn’t that right?

A Would you restate that? I’m lost.

Q Okay. At a certain point in time the assets were

contributed to the partnership, correct?

A Yes.

Q Okay. Before that happened, your father’s trust

continued to receive the income from those assets,

correct?

A Probably.

Q Well, why isn’t it Yes?

A Well, before he contributed it, he was in control

of that. Who else would get it? I say probably.

Hence, we are again met with an example of indifference by

those involved toward the formal structure of the partnership

arrangement and, as a corollary, toward the degree of separation

that the Agreement facially purports to establish. Moreover,

until title to the assets was transferred to HFLP, decedent would

not have forfeited the control over the underlying securities

that he through the Trust possessed as legal holder. Thus, at

the time of the June 14, 1994, creation of HFLP and for some

months following, decedent’s Trust retained title to the

underlying assets and was issued the dividends and interest

- 33 -

generated thereby. In addition, according to Michael’s own

testimony, the partners were in no hurry to alter this state of

affairs. This speaks volumes concerning how little the partners

understood to have changed in decedent’s relationship to his

assets as a result of the entity’s formation.

Turning to facts regarding distribution of partnership

funds, we find equally compelling indicia of an implied

understanding or agreement that the partnership arrangement would

not curtail decedent’s ability to enjoy the economic benefit of

assets contributed to HFLP. In addition to the deemed

distributions engendered by the commingling discussed above, even

the distributions made by Michael from the partnership checking

account are heavily weighted in favor of decedent. The check

register indicates that during the period extending from

September of 1994 through early November 1995, partnership funds

were distributed for the benefit of Michael and Lynn in the

amounts of $5,800 and $8,700, respectively. These distributions

occurred on November 9, 1994, December 19, 1994, and January 10,

1995. During that same time frame, partnership checks totaling

$231,820, were remitted to the Trust, with the last being written

on October 30, 1995. Only then did distributions to Michael and

Lynn resume with checks drawn on November 15, 1995, in the

amounts of $4,800 and $7,200, respectively. Given this pattern,

we would be hard pressed to conclude other than that the

- 34 -

partnership arrangement did little to curtail the access of

decedent or his estate to the economic benefit of the contributed

property.

Similarly significant is the evidence that certain of the

distributions to the Trust were linked to a contemporaneous

expense of decedent personally or of his estate. These amounts,

variously labeled by Michael “additional distribution”, “return

of capital”, or “capital return”, totaled $220,520 and even

included $4,000 to enable decedent to complete a gift 2 days

before he died. This evidence buttresses the inference that

decedent and his estate had ready access to partnership cash when

needed.

On the issue of distributions, the estate repeatedly

intones, in mantralike fashion: “The managing general partner’s

right to make distributions was unlimited and could be made ‘at

such times and in such amounts as are determined in the sole and

absolute discretion of the Managing General Partner.’” Once

again, however, this point begs the question. The more salient

feature is not that Michael did or did not have authority to make

the distributions but that he frequently used his position to

place partnership funds at the Trust’s disposal in response to

personal or estate needs. No other partner was afforded the same

luxury of “additional” distributions or capital returns.

- 35 -

Furthermore, the fact that the contemporaneous check

register labels various disbursements to the Trust a “return of

capital”, regardless of whether such are proper under the

Agreement and/or should be otherwise classified, also supports

the clear implication that Michael understood decedent’s capital

could and would be made available to him if necessary.

Additionally, Michael even liquidated an M.L. Stern & Co. money

market account and renegotiated the Marsh note in order to obtain

the requisite cash to enable the Trust to pay decedent’s estate

taxes. These facets, in turn, provide strong evidence of an

implied agreement under which decedent did not divest himself

economically of the contributed assets.

The estate also argues that the distributions to the Trust

were consistent with the guaranteed payment obligation.

Nonetheless, without regard once again to the veracity of this

allegation, we find it of little import in our analysis. The

record supports a conclusion that in making the payments Michael

was motivated by concern not with meeting HFLP’s guaranteed

payment obligation but rather with facilitating underlying

partner expenditures. Michael testified as follows on this

subject:

Q Did you regularly pay the guaranteed payments to

your father during 1994?

A Payments were made, yes.

Q Were they made regularly?

- 36 -

A I don’t know what you mean by “regularly.”

Q Were they made as provided for in the partnership

agreement?

A To the best of my ability, yes.

Q Were you aware that the partnership agreement

called for them to be paid quarterly?

A Not specifically, no.

Q You recall how often you made guaranteed payments

to him?

A I took the approach that I would look at

receivables, and distributions were entirely within my

control, and if the dollars were sitting there, I would

possibly make distributions. It could have been as

often as monthly; I don’t recall, as I sit here.

Q How did you compute the amount of the guaranteed

payments?

A I don’t understand. What do you mean, how did I

compute it?

Q How did--how did you compute the amounts that you

paid? Did you compute them? I mean, they were 4.25

percent of the portfolio, right?

A Oh, I don’t know if I did it--

Q Of the capital--I’m sorry; I stand corrected. The

capital account. They were supposed to be 4.25 percent

of the capital account.

A That’s my--that’s my understanding, yes.

Q Did you make computations when you made those

guaranteed payments?

A It seems to me I did, yes.

Q Did you do them in writing?

A Well, I did them, and then I asked the accountant

to double-check me on all of them--

- 37 -

Q When?

A --because I’m not an accountant.

Q When did you ask him to double-check you on that?

A Regularly.

The foregoing exchange solidifies our belief that moneys

were not remitted to the Trust in a calculated effort to comply

with the 4.25-percent entitlement. The vague nature of the

testimony makes clear that the guaranteed payment averments are

nothing more than an attempted after-the-fact justification for

Michael’s actions.

In addition, given that Mr. Blankstein was not engaged until

March or April of 1995, after decedent’s death, his help was

unavailable to Michael for purposes of any of the 1994 or early

1995 distributions, a circumstance which apparently did not deter

Michael from proceeding despite his admitted lack of accounting

expertise. There are also questions with regard to whether

profit and loss allocations called for by the Agreement should

have been made prior to any distribution of funds. In any event,

we are satisfied that respect for the Agreement was not the

catalyst for the disproportionate distributions made to the

Trust.

We are equally unimpressed by the estate’s references to the

fiduciary capacity in which Michael purportedly acted as managing

general partner. The estate claims: “Michael, as the managing

- 38 -

general partner, is a fiduciary and must act on behalf of the

Partnership and all of its partners and cannot favor any one of

them over any other of them. He cannot make distributions to one

partner without making distributions to all partners and did not

do so.” The record, on the other hand, shows a consistent

pattern of acting in response to particular needs of decedent or

his estate. We simply are unable to agree that Michael was

acting in these instances first and foremost for the good of HFLP

and not primarily as the son of his father.

Lastly, we focus on testamentary characteristics of the

partnership arrangement. According to the estate:

It is clear from the record that the organization

of the Partnership and the contribution by the Trust of

the Portfolio to the Partnership’s capital was not

“testamentary.” No part of such transaction was

intended to be effective at the time of Morton’s death.

The terms and conditions of the Partnership Agreement

and the funding of the Portfolio were complete and

unconditional and changed the relationship of the

parties to the Portfolio assets. * * *

While we acknowledge that HFLP did come into existence prior to

decedent’s death and that some change ensued in the formal

relationship of those involved to the assets, we are satisfied

that any practical effect during decedent’s life was minimal.

Rather, the partnership served primarily as an alternate vehicle

through which decedent would provide for his children at his

death.

- 39 -

As previously discussed, decedent continued to be the

principal economic beneficiary of the contributed property after

HFLP’s creation. The few minor distributions made to Michael and

Lynn, which tellingly ceased throughout the entire period that

funds were being disbursed for final gifts and estate expenses,

hardly evidence a meaningful economic stake in the assets during

decedent’s life. Michael’s technical control over management and

distributions is likewise of little import. Although there was

testimony that Michael reinvested proceeds of maturing bonds, and

he presumably collected interest and dividends paid on securities

held in HFLP’s name, these activities are more akin to passively

administrating than to actively managing the contributed

portfolio. From the documents in the record, it appears that the

composition of the portfolio changed little prior to decedent’s

death. We also note that a significant percentage of the

portfolio consisted of professionally managed bond funds.

Given the above, we place little weight on averments

concerning change, during decedent’s life, in the partners’

relationships to the contributed property. In addition, we

believe that our conclusions in this regard are corroborated by

the alleged reason advanced at trial and on brief for

establishment of the partnership. The estate contends:

- 40 -

Morton’s primary reason for transferring the

Portfolio to the Partnership was to create an

arrangement that would protect from Lynn’s creditors,

the assets that Lynn would receive or inherit from

Morton. * * *

* * * * * * *

Once Morton learned of the [arbitration] award and

its seriousness, he knew that he needed to address his

concerns about Lynn’s handling of her finances in a

different manner than that provided in the Trust.

Pursuant to Article V of the Trust agreement, on

Morton’s death, Lynn’ [sic] share would be distributed

to her outright. Following such distribution, Lynn

would have the responsibility to manage her assets and

Lynn’s creditors could reach them without restriction

or limitation. This was unacceptable to Morton.

* * * * * * *

Therefore, by placing Michael in charge of the

Partnership and providing by gift and on Morton’s death

that all but a fraction of Lynn’s interest would be

held as a limited partner, Morton addressed his

concerns about Lynn. Lynn’s creditors would be

inhibited due to the legal limitations of collecting a

judgment from a limited partner’s interest. [Citations

omitted.]

The emphasis of this discussion is patently post mortem as

opposed to inter vivos. Hence, not only the objective evidence

concerning HFLP’s history but also the subjective motivation

underlying the entity’s creation support an inference that the

arrangement was primarily testamentary in nature. The objective

record belies any significant predeath change, particularly from

the standpoint of economic benefit, in the partners’ relationship

to the assets. Likewise, the subjective impetus prompting

- 41 -

decedent to form HFLP centered on what would happen to his

property after death. He wanted to protect what Lynn would

receive from him, not what she currently possessed.

Other facets of the entity’s establishment are similarly

consistent with a testamentary arrangement. In particular, the

largely unilateral nature of the formation, the extent and type

of the assets contributed thereto, and decedent’s personal

situation are indicative. Michael testified that decedent made

all decisions regarding the creation and structure of the

partnership. During cross-examination he stated: “We really

didn’t discuss anything. He told me what he wanted to do and he

explained why, and I accepted the assignment.” Later, when asked

why the guaranteed payment clause was added to the HFLP

Agreement, Michael replied: “The same reason every provision was

put in the agreement. * * * Specifically, because that’s what he

wanted.” Such statements are far more consistent with a

description of one man’s estate plan than with any sort of arm’s-

length transaction or joint enterprise between partners.

The fact that the contributed property constituted the

majority of decedent’s assets, including nearly all of his

investments, is also not at odds with what one would expect to be

the prime concern of an estate plan. We additionally take note

of decedent’s advanced age, serious health conditions, and

experience as an attorney.

- 42 -

In summary, we are satisfied that HFLP was created

principally as an alternate testamentary vehicle to the Trust.

Taking this feature in light of all that is discussed above, we

conclude that decedent retained enjoyment of the contributed

property within the meaning of section 2036(a).

D. Existence of Consideration

Having decided that decedent retained enjoyment of the

transferred assets for purposes of section 2036(a), we turn to

the question whether the statute’s application may nonetheless be

avoided on the basis of the parenthetical exception for “a bona

fide sale for an adequate and full consideration in money or

money’s worth”. The estate contends:

The primary reason why I.R.C. §2036 does not apply

to Petitioner is that the Trust’s transfer of the

Portfolio to the Partnership in exchange for a credit

to its capital account for 99% of the fair market value

of the Portfolio assets and a 99% interest in profits

and losses is a “bona fide sale for an adequate and

full consideration in money or money’s worth.” * * *

We, however, disagree on the ground that the estate’s

position fails to take into account significant aspects of the

jurisprudence addressing this exclusionary language. The phrase,

as used in a predecessor statute, was explained in early caselaw

of this Court, as follows:

Accordingly, the exemption from tax is limited to those

transfers of property where the transferor or donor has

received benefit in full consideration in a genuine

arm’s length transaction; and the exemption is not to

be allowed in a case where there is only contractual

- 43 -

consideration but not “adequate and full consideration

in money or money’s worth.” * * * [Estate of Goetchius

v. Commissioner, 17 T.C. 495, 503 (1951).]

It has similarly been stated in construing the “bona fide

sale” terminology: “The word ‘sale’ means an exchange resulting

from a bargain”. Mollenberg’s Estate v. Commissioner, 173 F.2d

698, 701 (2d Cir. 1949). The foregoing interpretations have

subsequently been cited with approval in related contexts by both

this and other Federal courts. See, e.g., Bank of N.Y. v. United

States, 526 F.2d 1012, 1016-1017 & n.6 (3d Cir. 1975) (noting

that “the statutory basis for requiring an arm’s length bargain

would seem to be the requirement of a ‘bona fide’ contract”);

Estate of Morse v. Commissioner, 69 T.C. 408, 418 (1977)

(observing that judicial decisions refer to a bona fide contract

“as an arm’s-length transaction or a bargained-for exchange”),

affd. 625 F.2d 133 (6th Cir. 1980); Estate of Musgrove v. United

States, 33 Fed. Cl. 657, 663-664 (1995). From the above language

it can be inferred that applicability of the exception rests on

two requirements: (1) A bona fide sale, meaning an arm’s-length

transaction, and (2) adequate and full consideration.

On the facts before us, HFLP’s formation at a minimum falls

short of meeting the bona fide sale requirement. Decedent,

independently of any other anticipated interest-holder,

determined how HFLP was to be structured and operated, decided

- 44 -

what property would be contributed to capitalize the entity, and

declared what interest the Trust would receive therein. He

essentially stood on both sides of the transaction and conducted

the partnership’s formation in absence of any bargaining or

negotiating whatsoever. It would be an oxymoron to say that one

can engage in an arm’s-length transaction with oneself, and we

simply are unable to find any other independent party involved in

the creation of HFLP.

Furthermore, lack of a bona fide sale aside, we believe that

to call what occurred here a transfer for consideration within

the meaning of section 2036(a), much less a transfer for an

adequate and full consideration, would stretch the exception far

beyond its intended scope. In actuality, all decedent did was to

change the form in which he held his beneficial interest in the

contributed property. We see little practical difference in

whether the Trust held the property directly or as a 99-percent

partner (and entitled to a commensurate 99-percent share of

profits) in a partnership holding the property. Essentially, the

value of the partnership interest the Trust received derived

solely from the assets the Trust had just contributed. Without

any change whatsoever in the underlying pool of assets or

prospect for profit, as, for example, where others make

contributions of property or services in the interest of true

joint ownership or enterprise, there exists nothing but a

- 45 -

circuitous “recycling” of value. We are satisfied that such

instances of pure recycling do not rise to the level of a payment

of consideration. To hold otherwise would open section 2036 to a

myriad of abuses engendered by unilateral paper transformations.

We note that the foregoing interpretation is supported by

our holdings in both Estate of Reichardt v. Commissioner, 114

T.C. 144 (2000), and, by implication, Estate of Schauerhamer v.

Commissioner, T.C. Memo. 1997-242. In Estate of Reichardt v.

Commissioner, supra at 155-156, the taxpayer contended that the

parenthetical exception should apply. We, however, rejected this

argument, observing that neither did the decedent’s children give

anything to him or to the partnership at the time he contributed

his assets nor did he sell the transferred property to the

entity. Id. In Estate of Schauerhamer v. Commissioner, supra,

the contributed assets were included in the decedent’s gross

estate under section 2036(a) without discussion of the exception,

leading to the inference that it would not apply in such

circumstances.

We further are convinced that the cases cited by the estate

do not require a contrary conclusion. The estate points in

particular to Estate of Jones v. Commissioner, 116 T.C. 121

(2001); Estate of Strangi v. Commissioner, 115 T.C. 478 (2000);

Shepherd v. Commissioner, 115 T.C. 376 (2000), affd. 283 F.3d

1258 (11th Cir. 2002); Estate of Harrison v. Commissioner, T.C.

- 46 -

Memo. 1987-8; and Church v. United States, 85 AFTR 2d 2000-804,

2000-1 USTC par. 60,369 (W.D. Tex. 2000), affd. without published

opinion 268 F.3d 1063 (5th Cir. 2001). The estate apparently

argues that the just-cited cases establish that a proportionate

partnership interest constitutes per se adequate and full

consideration for contributed assets. We believe, however, that

any such global formulation would overreach what can be drawn

from the decisions.

First, with respect to Estate of Jones v. Commissioner,

supra, Estate of Strangi v. Commissioner, supra, and Shepherd v.

Commissioner, supra, none of these opinions involved section

2036. Rather, they considered whether gifts were made at the

inception of family limited partnership arrangements. Estate of

Jones v. Commissioner, supra at 127-128; Estate of Strangi v.

Commissioner, supra at 489-490; Shepherd v. Commissioner, supra

at 384-389. The cases therefore do not control interpretation of

the requirements of section 2036. Furthermore, while section

2512(b) describes a gift as a transfer of property “for less than

an adequate and full consideration in money or money’s worth”,

there exists an equally fundamental principle that a gift

requires a donee--some other individual must be enriched. In

this connection, we note that Estate of Jones v. Commissioner,

supra at 127-128, and Estate of Strangi v. Commissioner, supra at

489-490, which find no gift at inception, say nothing explicit

- 47 -

about adequate and full consideration but do refer to

enhancement, or lack thereof, of other partners’ interests.

Hence, even if relevant here, we would be unable to conclude that

these rulings resolve the question of whether a proportionate

entity interest, in and of itself, constitutes adequate and full

consideration for contributed assets.

Second, although Estate of Harrison v. Commissioner, supra,

and Church v. United States, supra, do address section 2036,

there exist significant differences between these cases, on the

one hand, and Estate of Reichardt v. Commissioner, supra, and

Estate of Schauerhamer v. Commissioner, supra, on the other,

which distinguish the two groups. In both Estate of Harrison v.

Commissioner, supra, and Church v. United States, supra, the

other partners made contributions at the formation of the entity

which were not de minimis in nature. The partnership entity thus

served as the vehicle for a genuine pooling of interests. The

court in each case then went on to conclude that the partnerships

had been created for a business purpose. Estate of Harrison v.

Commissioner, supra; Church v. United States, supra.

Accordingly, it is not unreasonable to assume that a genuine

pooling for business purposes injects something different into

the adequate and full consideration calculus than does mere,

unilateral value “recycling” as seen in Estate of Reichardt v.

Commissioner, supra, Estate of Schauerhamer v. Commissioner,

- 48 -

supra, and the present matter. In the former situation, there is

at least the potential that intangibles stemming from a pooling

for joint enterprise might support a ruling of adequate and full

consideration. We also note that section 25.2512-8, Gift Tax

Regs., specifies that transfers “made in the ordinary course of

business (a transaction which is bona fide, at arm’s length, and

free from any donative intent), will be considered as made for an

adequate and full consideration in money or money’s worth.”

We therefore hold that where a transaction involves only the

genre of value “recycling” described above and does not appear to

be motivated primarily by legitimate business concerns, no

transfer for consideration within the meaning of section 2036(a)

has taken place. Hence, the exception provided in that statute

is inapplicable. Furthermore, although section 2043 can entitle

taxpayers to an offset for partial consideration in cases where a

transfer is otherwise subject to section 2036, this section, too,

is inapplicable where, as here, there has been only a recycling

of value and not a transfer for consideration.

E. Conclusion

We conclude that the property contributed by decedent to

HFLP is included in his gross estate pursuant to section 2036(a).

We further note that, given the foregoing conclusion, we need not

reach respondent’s additional argument for includability, which

argument is premised on disregard of the partnership for lack of

- 49 -

economic substance, a judicial doctrine. Likewise, we need not

address respondent’s contentions with respect to gift tax

liability, as those determinations were made in the alternative

to full inclusion based on either section 2036(a) or the economic

substance doctrine. Accordingly, we now turn to valuation of the

assets to be included in the gross estate.

IV. Valuation

A. Introduction and General Rules

Given our resolution above, the valuation inquiry with which

we are concerned is the value on February 1, 1995, decedent’s

date of death, of the property previously transferred by decedent

to the partnership. In other words, we must ascertain the value

of HFLP’s underlying portfolio assets, without regard to any

claimed discounts attributable to the partnership form.

As used in transfer tax statutes, value denotes fair market

value, meaning “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.” Sec. 20.2031-1(b), Estate Tax

Regs. Both parties submitted expert reports in support of their

contentions regarding the fair market value of all property held

by the partnership, referred to as HFLP’s net asset value. Clint

- 50 -

Cronkite, CA, ASA, prepared reports on behalf of the estate,1 and

John A. Thomson, ASA, MAI, prepared reports on behalf of

respondent. We evaluate expert testimony in light of all

evidence contained in the record and may accept or reject the

proffered opinions, in whole or in part, according to our own

judgement. Helvering v. Natl. Grocery Co., 304 U.S. 282, 295

(1938); Shepherd v. Commissioner, 115 T.C. at 390. In

particular, “‘The persuasiveness of an expert’s opinion depends

largely upon the disclosed facts on which it is based.’”

Shepherd v. Commissioner, supra at 390 (quoting Estate of Davis

v. Commissioner, 110 T.C. 530, 538 (1998)).

The respective appraisals by Mr. Cronkite and Mr. Thomson of

HFLP’s net asset value are summarized below:

ASSET Mr. Cronkite Mr. Thomson

Cash $2,517 $2,517

Marketable Securities 832,299 832,299

(M.L. Stern & Co. Account)

California Tax-Free Income Fund 63,817 63,817

(M.L. Stern & Co. Account)

Franklin AGE High Income Fund 69,130 69,130

Franklin California Tax-Free Fund 249,979 249,979

Putnam American Government Income Fund 71,017 71,017

1

The report submitted on behalf of the estate valuing HFLP

as of February 1, 1995, contains a certification signed by both

Mr. Cronkite and Helena Nam Reich, ASA. However, because it is

Mr. Cronkite who testified at trial, whom both parties refer to

as petitioner’s expert, and whose qualifications have been

stipulated by the parties, we adopt a similar convention of

referring solely to Mr. Cronkite.

- 51 -

Rockefeller Center Properties, Inc. - 14,375 14,375

Common

Note Receivable (Marsh note) 300,000 405,000

NET ASSET VALUE $1,603,134 $1,708,134

As can be seen from the foregoing table, the only difference

reflected in the net asset value analyses of the parties’ experts

lies in their valuation of the Marsh note.2 This level of

agreement is logical in light of the fact that the remaining

assets, in addition to cash, consisted of marketable securities

and mutual funds. Before proceeding to address the Marsh note

specifically, however, we deal with a question that has arisen

concerning burden of proof.

B. Burden of Proof

The estate’s opening brief contains the statement that “the

only matter as to which Petitioner bore the burden of proof was

the determination of fair market value.” Respondent’s opening

brief refers to the estate’s failing to satisfy its burden but

also includes the following remark: “Even if respondent had the

burden with respect to the valuation of the property, the

evidence produced by respondent clearly satisfies any such

burden. See Estate of Mitchell v. Commissioner, 250 F.3d 696

2

Although one of the summary tables contained in Mr.

Thomson’s report states a value of $69,310 for the Franklin AGE

High Income Fund, the $69,130 figure is used elsewhere in the

report and is necessary to derive the oft-repeated total of

$1,708,134. We conclude that the $69,310 amount should be

disregarded as a transcription error.

- 52 -

(9th Cir. 2001) [affg. in part and vacating and remanding in part

T.C. Memo. 1997-461].” The estate’s reply brief then focuses on

the foregoing citation to Estate of Mitchell v. Commissioner,

supra, in arguing that respondent does in fact bear the burden of

proof in this situation.

The Court of Appeals for the Ninth Circuit, to which appeal

in this case would normally lie, has addressed the issue of

burden of proof in valuation cases in a series of three recent

decisions. Estate of Mitchell v. Commissioner, supra; Estate of

Simplot v. Commissioner, 249 F.3d 1191 (9th Cir. 2001), revg. and

remanding 112 T.C. 130 (1999); Morrissey v. Commissioner, 243

F.3d 1145 (9th Cir. 2001), revg. and remanding Estate of Kaufman

v. Commissioner, T.C. Memo. 1999-119. In each of these cases,

the Commissioner determined an estate tax deficiency based upon

an increase in the fair market value, over that claimed on the

tax return, of shares in a closely held corporation. Estate of

Mitchell v. Commissioner, supra at 698-699; Estate of Simplot v.

Commissioner, supra at 1193; Morrissey v. Commissioner, supra at

1147. Subsequently, the Commissioner submitted for trial expert

reports opining, and/or the Commissioner conceded, that the value

of the subject stock was less than that asserted in the statutory

notice. Estate of Mitchell v. Commissioner, supra at 702; Estate

of Simplot v. Commissioner, supra at 1193-1194; Morrissey v.

Commissioner, supra at 1147. Confronting this scenario, the

- 53 -

Court of Appeals in each instance indicated that the deviation in

the Commissioner’s litigation posture from the valuation stated

in the notice resulted in a forfeiture of any presumption of

correctness and/or a placing of the burden of proof on the

Commissioner. Estate of Mitchell v. Commissioner, supra at 702;

Estate of Simplot v. Commissioner, supra at 1193; Morrissey v.

Commissioner, supra at 1148-1149.

Under the rule of Golsen v. Commissioner, 54 T.C. 742, 757

(1970), affd. 445 F.2d 985 (10th Cir. 1971), this Court will

“follow a Court of Appeals decision which is squarely in point

where appeal from our decision lies to that Court of Appeals”.

We also acknowledge that the notice of deficiency issued with

respect to decedent’s estate tax placed a value of $1,750,000 on

decedent’s interest in the assets held by HFLP, while the expert

report and posttrial briefs submitted by respondent advocate a

value of $1,708,134. Nonetheless, the record in this case is

such that our conclusion would be the same regardless of any

presumption of correctness or the falling of the burden of proof.

We therefore need not further probe the implications here of the

above-described decisions by the Court of Appeals for the Ninth

Circuit and shall base our ruling on the preponderance of the

evidence.

- 54 -

C. Value of Marsh Note

The subject note, with principal amount of $450,000, was

issued on April 15, 1991. Jack P. Marsh was the maker, and the

Trust was the payee. The original due date was April 14, 1992,

and the original interest rate borne by the note was 10.75

percent. As of decedent’s date of death, the note had been

renewed annually for 1-year extensions, the interest rate had

been reduced to 10 percent, and payments of interest were

current.

The Marsh note was secured by collateral in the form of a

45-percent interest in a $1 million note, which note in turn was

secured by a deed of trust on Carson Harbor Village, a mobile

home park. Jack P. Marsh was the payee of the $1 million note

and beneficiary of the deed of trust, and Carson Harbor Village,

Ltd., was the payor and trustor. Carson Harbor Village, Ltd.,

was a limited partnership of which Goldstein Properties, Inc.,

was the general partner. James F. Goldstein, as president of

Goldstein Properties, signed the $1 million note and related deed

of trust on behalf of Carson Harbor Village, Ltd.

i. Mr. Cronkite’s Report

Mr. Cronkite, at the outset of his report, states the terms

of the Marsh note and indicates that it is secured by a

collateral interest in the aforementioned note secured by deed of

trust. He continues: “In addition to this note, there is a

- 55 -

first trust deed in the amount of approximately $10-$11 million.”

In estimating the fair market value of the Marsh note, Mr.

Cronkite utilized two approaches: (1) An income approach,

discounting future interest income to present value at its

required yield; and (2) a market approach, discussing the loan

with Mr. Marsh, an alleged secondary loans expert.

With respect to the income approach, Mr. Cronkite explained

that the higher the inherent risk in an income stream, the higher

the required yield to be used in computing present value. The

portion of his report concerning selection of the required yield

to be employed here reads:

The appropriate yield for an investment in this

note was estimated based on a review of the May 1, 1991

Note Secured By Deed Of Trust, which stipulates that in

the event of default, the unpaid amounts will bear

interest at the Contract Rate plus 5% per annum. We

concluded that 15% was an appropriate yield on this

basis.

This 15-percent rate is then used in conjunction with a present

value formula to produce a $300,000 fair market value for the

subject note.

The section of Mr. Cronkite’s report addressing the market

approach references discussions with Mr. Marsh and then sets

forth the following:

According to Mr. Marsh, the $1,000,000 loan was

intended to be interim financing only. Harbor Village

intended to refinance its property, but encountered

environmental issues.

- 56 -

Although the loan is current, Mr. Marsh estimates

that he could only get $0.70 to $0.80 on the dollar for

a 100% interest, and perhaps $0.60 to $0.70 for a 45%

interest (due to liquidity factors).

Based on the above, we conclude that the fair

market value of the Marsh note is $300,000

(approximately 65% of $450,000).

ii. Mr. Thomson’s Report

Mr. Thomson in his report preceded valuation of the Marsh

note with a discussion of certain factual assumptions underlying

his analysis. The report refers to the $1 million note as

equating to “more than 2 to 1 coverage” for the Marsh note and

mentions personal guaranties by Mr. Marsh and Mr. Goldstein. Mr.

Thomson also addresses several items relating to the security for

the $1 million note; namely, the value of the mobile home park,

the existence of any prior liens against the park, and possible

environmental issues pertaining to the park.

Mr. Thomson appraised the 410-unit mobile home park and

concluded that it “could command a price of $40,000 to $50,000

per unit or $16.0 to $20.0 million based on other mobile home

park sales we are familiar with in Southern California.” As

regards potential prior liens, the report states:

We requested any other Trust Deeds (notes), if any,

against the Carson Harbor Village Mobile Home Park

which may have a senior position to the $1,000,000 Deed

of Trust. However, we were not provided any data on

this request from the taxpayor [sic]. We did obtain a

property profile from Chicago Title which showed no

recorded liens as of the appraisal date.

- 57 -

Concerning environmental issues, Mr. Thomson reviewed Park

Environmental Corporation’s environmental analysis dated June 10,

1994, and requested, but was not provided, sections of a remedial

action plan dated January 26, 1995, outlining procedures for

removal and disposal of waste material. Cleanup was ultimately

assumed to require minimal cost in comparison to the overall

property value, such that it would not significantly influence

refinancing or sale.

In then determining whether the Marsh note should be valued

at a discount to its face value, Mr. Thomson weighed five

factors. These were: (1) The collateral securing the note; (2)

the existence of guaranties relating to the note and its

collateral; (3) the interest rate on the note; (4) previously

granted extensions of the note’s maturity date and the currency

of payments; and (5) environmental concerns related to the

collateral. Mr. Thomson concluded that, of the foregoing

factors, the first three enumerated would tend to support no

discount or a slight premium while the latter two would tend to

support a discount.

More specifically, Mr. Thomson opined that the following

facts would tend to decrease any applicable discount: (1) The

Marsh note possessed good collateral coverage in that it was

secured by a $1 million note, which in turn was secured by a deed

of trust on a well-located mobile home park; and (2) the $450,000

- 58 -

note was personally guaranteed by Mr. Marsh and the $1 million

note was personally guaranteed by Mr. Goldstein. Neither

increasing nor decreasing any applicable discount was the fact

that the interest rate, at 10 percent, was a reasonable 87 basis

points over the conventional mortgage rate of 9.13 percent for

the week ended January 27, 1995. Identified as tending to

increase any applicable discount were facts indicating: (1) The

note had been extended several times, such that there could be no

assurance it would be paid in full at the upcoming maturity date

without legal action, although all interest payments were

current; and (2) there could be environmental concerns relative

to a small section of the mobile home property, which could delay

the refinancing and/or sale of the property.

After setting forth the above factors, Mr. Thomson’s report

concludes:

In our opinion, based on our experience with real

property and promissory notes, we believe a range of 5

to 15 percent discount would be applicable to the

subject $450,000 note. Therefore, based on the factors

considered and the note itself, it is our opinion that

a discount of 10.0 percent is reasonable to apply to

the $450,000 note in HFCL.P., as of February 1, 1995.

Accordingly, we have estimated the fair market value of

the $450,000 note in HFCL.P. at $405,000, or ($450,000

x (1.0-.10)).

- 59 -

iii. Analysis

In our comparison of the foregoing views, we generally found

those of Mr. Thomson to be better explained, better supported,

and more convincing. While we conclude that certain factual

assumptions described in Mr. Thomson’s report were not

established by a preponderance of the evidence, the level of

detail in the report’s treatment of individual factors considered

enabled us to make adjustments within what was a reasonable

framework. In contrast, Mr. Cronkite’s report was highly

conclusory and revealed little about the underlying analysis. As

a result, we could neither perform any meaningful evaluation nor

ascertain that the conclusions were supported by an appropriate

foundation. We therefore found Mr. Cronkite’s report

unpersuasive and of minimal assistance in the valuation endeavor.

Accordingly, we sustain respondent’s position to the extent of

the reduced valuation amount discussed below for the Marsh note.

Mr. Cronkite’s Approaches: We begin by addressing the

difficulties encountered with Mr. Cronkite’s approaches. As

previously mentioned, Mr. Cronkite included in his report an

income approach discounting interest income at 15 percent.

Although the report explains that the required yield should

reflect inherent risk in the income stream, it fails to offer any

satisfactory link between this premise and the chosen 15-percent

rate. Mr. Cronkite apparently added the 5-percent default

- 60 -

increase specified in the $1 million note to the 10-percent

contract rate of the $450,000 note.3 Why the default provisions

negotiated with a different debtor nearly 4 years earlier

accurately reflect the inherent risk in the Marsh note as of

decedent’s date of death is not elucidated. We are afforded no

information on relative conditions and circumstances that would

facilitate a useful comparison. It is for these reasons that we

were unable to give Mr. Cronkite’s income approach any

significant weight in our analysis. In addition, we observe that

Mr. Cronkite testified at trial to having relied primarily on the

market approach in his valuation.

As regards Mr. Cronkite’s market approach, our concerns in

many respects parallel those highlighted above in connection with

the income approach. Again, the report is cursory, conclusory,

and reveals little underlying reasoning that would enable us to

evaluate the result reached. The report sets forth value

estimates made by Mr. Marsh and characterizes Mr. Marsh as “a

secondary loans expert”. Mr. Cronkite explained at trial only

that Mr. Marsh “represented to me that he was an expert in the

secondary loan market.” When questioned regarding Mr. Marsh’s

3

Although the estate on brief refers to 15 percent as “the

default rate under the Marsh Note” and respondent similarly

characterizes 15 percent as “the default rate on the note”, the

copy of the Marsh note itself in the record does not contain any

provisions regarding a default rate. Rather, the $1 million

note, which bears a contract rate of 11.25 percent, specifies a

default rate of the contract rate plus 5 percent.

- 61 -

role in the valuation, Mr. Cronkite testified: “I relied

primarily on an expert in the field to establish what the fair

market value of the note was. I did some checking on that for

reasonableness, determined that his analysis was reasonable.”

Mr. Cronkite also answered in the affirmative to an inquiry

asking: “So, then, you essentially took your value of the note

from Mr. Marsh, or based a good part of your conclusions on Mr.

Marsh’s own opinion?”

We, however, know almost nothing about the qualifications of

Mr. Marsh beyond the fact that he was involved in lending the $1

million to Carson Harbor Village, Ltd., and was payee of the note

for that amount and beneficiary of the related deed of trust. We

are equally uninformed about the nature of the discussions that

led to his appraisal. To wit, we are unaware of whether the

figures were merely an offhand estimate or followed a period for

study or evaluation. Mr. Marsh did not appear or testify at

trial. Accordingly, we are asked to accept his opinions, as

reported by Mr. Cronkite, without any opportunity to probe their

foundation or any assurances that he was qualified to render

them. We also note that his independence for purposes of

offering a neutral opinion is not free from doubt. Furthermore,

although Mr. Cronkite stated that he checked Mr. Marsh’s analysis

for reasonableness, he gave no indication whatsoever of the

- 62 -

materials or information that figured in such corroboration. His

assertions therefore can do little to increase our confidence.

Another difficulty we have with the valuation produced by

Mr. Cronkite’s market approach is the lack of explanation

concerning the factors taken into account in arriving at the

discount. Environmental issues are mentioned, and Mr. Cronkite

testified that this factor was very important to Mr. Marsh. When

asked what studies he reviewed in making a conclusion as to the

environmental problem, Mr. Cronkite responded:

You know, I don’t--I don’t recall actual studies.

I believe I had a lot of correspondence regarding the

environmental issues. My discussion with Mr. Marsh--he

was certainly well aware of them. The fact that they

couldn’t get, you know, refinancing due to the

environmental concerns was an issue, but my

understanding was, there was no dollar amount, you

know, put on this, this liability.

These remarks, and the reference to environmental issues in

the report, fall short not only of assuring us that Mr. Cronkite

had a reliable foundation for his understanding of the

seriousness of the environmental problem but also of permitting

us to assess the role it played relative to any other factors.

We therefore are unable to accept portions of the analysis while

making adjustments in other aspects that we might find

unsupported by the evidence. Nor can we usefully compare

components as between the two experts. We are placed in a

position of having largely to embrace or reject Mr. Cronkite’s

- 63 -

conclusions in wholesale fashion. As a consequence, Mr.

Cronkite’s market approach, too, offers only a modicum of

guidance in valuing the subject note.

Mr. Thomson’s Approach: We now address Mr. Thomson’s

approach, which weighed five factors in arriving at a 10-percent

discount for the Marsh note. We deal with each of these

components seriatim, beginning with the factor addressing

collateral coverage. Mr. Thomson opined that collateral coverage

on the Marsh note was good and cited both the $1 million note

secured by deed of trust and the underlying mobile home park in

support of this assertion. The estate raises several points in

response to Mr. Thomson’s position on coverage, one of which

involves the existence of a senior lien on the mobile home park.

As previously mentioned, Mr. Cronkite’s report references a

first trust deed in the amount of $10 to $11 million; Mr.

Cronkite testified at trial that this statement was based on his

discussion with Mr. Marsh and that he had seen no documents

related to the encumbrance.

We pause here to note that the estate attempted at trial to

introduce public records from the Los Angeles County Recorder’s

Office relating to the alleged first lien. Respondent’s

objection to these documents was sustained on the grounds that

the information was requested from the estate during discovery,

was not provided, and should have been stipulated and/or

- 64 -

exchanged prior to trial in accordance with Rule 91 and this

Court’s Standing Pre-Trial Order. Presumably Mr. Thomson was

unaware of these documents when formulating his expert opinion,

since he makes no mention of them. The Court deemed the

consequent surprise significant in these circumstances. The

estate then sought by requests and motions filed after trial to

have judicial notice taken of the documents. Such submissions

were denied as an improper attempt to augment the closed record

without the concurrence of the opposing party.

Mr. Thomson relied on a property profile from Chicago Title

showing no prior liens, but this document has not been made a

part of the record. The record also leaves unclear the extent to

which the property profile would have contained historical data

reflecting encumbrances as of February 1, 1995. As a result, we

are not satisfied that either expert relied on adequate

information in developing his opinion.

However, even if we were to hypothesize the existence of a

first lien, we do not believe that Mr. Thomson’s more general

reliance in valuing the Marsh note on good collateral coverage

would be appreciably weakened. Because Mr. Thomson appraised the

mobile home park at $16 to $20 million, generous coverage would

not cease to exist merely on account of a first trust deed in the

$10- to $11-million range.

- 65 -

Furthermore, the record contains no materials that undermine

the value placed by Mr. Thomson on the park, prior to

consideration of environmental issues, or offer an alternative

figure. Mr. Cronkite did not inspect the mobile home park or

perform a real estate appraisal, and his professional

qualifications do not reveal any expertise in the real estate

area. Mr. Thomson, on the other hand, is a licensed real estate

appraiser and broker in the State of California. He testified to

having appraised mobile home parks. We thus are confident that

he would have been in a position to make an informed judgment

about a general value range in comparison to other Southern

California mobile home park sales. In addition, the fact that

the park was refinanced in 1997, after the year in issue, for

nearly $16 million also lends a degree of credence to Mr.

Thomson’s numbers.

Another point raised by the estate concerns references in

Mr. Thomson’s report to the coverage provided by the primary

collateral, the $1 million note, as “more than 2 to 1”. Although

the actual coverage is only “1 to 1”, inasmuch as the Marsh note

was secured by a 45-percent interest in the $1 million note, we

again do not believe that this fact, in and of itself,

eviscerates the basic premise of good coverage. We are equally

unconvinced that any of the various other contentions made by the

estate on brief render unreasonable the conclusion that the Marsh

- 66 -

note was well covered by collateral. Hence, while we acknowledge

that the level of coverage was not as great as Mr. Thomson may

have assumed, we remain satisfied that good coverage could

appropriately be considered as a positive factor enhancing the

value of the subject note.

We next address the factor involving personal guaranties,

about which the parties express significant differences. Mr.

Cronkite indicated at trial that he was not aware of any personal

guaranties at the time he prepared his report, while Mr. Thomson

took guaranties into account in his valuation. The record

contains no guaranty agreement or document relating to either the

Marsh note or the $1 million note, and the notes themselves bear

no evidence of a guarantor. Instead, guaranties are referred to

in several items of correspondence which passed between Mr. Marsh

and either decedent or Michael. The first is an April 15, 1991,

letter from Mr. Marsh to decedent. This letter adverts to the

new $450,000 promissory note and concludes with the following

paragraph:

I am proceeding with the closing of the

$1,000,000.00 loan to James Goldstein that will be

adequately secured by a Note secured by Deed of Trust

on real property. I, of course, will have all the

necessary personal guarantees, etc. on same. If, for

any reason whatsoever, this loan does not close within

the next fifteen days, your funds will be returned to

you upon demand plus 10 3/4% interest from April 15,

1991. If the loan closes, Morton B. Harper, Trustee of

the Morton B. Harper Revocable Trust Dated December 18,

1990, will be assigned, as collateral, a 45% interest

- 67 -

in the $1,000,000.00 Note. Your investment will also be

personally guaranteed by myself along with the personal

guarantee of James Goldstein.

Then, in a second letter from Mr. Marsh to decedent, dated

June 6, 1991, Mr. Marsh enumerates five enclosed documents. The

first four pertain to the $1 million note and deed of trust. The

fifth item is “Personal Guarantee dated May 1, 1991, executed by

Jack P. Marsh.”

Later, an August 15, 1994, letter from Michael to Mr. Marsh

advised that the Trust’s interest in the Marsh note had been

assigned to the partnership and asks Mr. Marsh to acknowledge his

agreement that “all preexisting assignments of the collateral

Note and Deed of Trust security and also your Guarantee dated May

1, 1991 remain in full force and effect for the benefit of” HFLP.

The August 28, 1994, letter agreement between Mr. Marsh and the

Trust then similarly declares that security for the $450,000

investment funds is assigned to the partnership and that “Jack P.

Marsh’s personal guarantee for the $450,000.00 investment funds

is still in effect and is transferred to” HFLP.

Lastly, a February 10, 1995, letter from Mr. Marsh to

Michael states that the “$450,000.00 Note is personally

guaranteed by Jack P. Marsh” and that the “$1,000,000.00 Carson

Harbor Village, Ltd. Note is personally guaranteed by James

Goldstein.”

- 68 -

In assessing the import of this documentary evidence, we

must also be conscious of relevant provisions of State law. Cal.

Civ. Code sec. 2787 (West 1993) defines “guarantor” for purpose

of the statutes relating to rights and obligations which arise

out of a guaranty relationship:

The distinction between sureties and guarantors is

hereby abolished. The terms and their derivatives,

wherever used in this code or in any other statute or

law of this State now in force or hereafter enacted,

shall have the same meaning, hereinafter in this

section defined. A surety or guarantor is one who

promises to answer for the debt, default, or

miscarriage of another, or hypothecates property as

security therefor. * * *

Against the foregoing backdrop, we first consider the

existence of any guaranty by Mr. Marsh. Clearly, Mr. Marsh and

the Harpers were under the impression that Mr. Marsh had executed

a personal guaranty on May 1, 1991. However, to the extent that

the purported guaranty existed and was of the $450,000 note, we

conclude that it should be disregarded in the valuation process.

The $450,000 note on its face is an unrestricted personal

obligation of “Jack P. Marsh”. Accordingly, any personal

guaranty thereof would fail to conform to the definition of a

guaranty under California law, would be no more than a redundant

second promise to pay personally, and would not appreciably

enhance the value of the note. Furthermore, to the extent that

the context provided by certain of the above letters could

support an inference that Mr. Marsh’s alleged May 1, 1991,

- 69 -

guaranty was actually of the $1 million note, the evidence is

ambiguous and fails to establish such a guaranty by a

preponderance.

Concerning a possible guaranty of the $1 million note by Mr.

Goldstein, we again find the record insufficient to meet

respondent’s burden. While the April 15, 1991, letter indicates

prospectively that Mr. Marsh intended to seek a guaranty from Mr.

Goldstein, the absence of any reference to a Goldstein guaranty

in the June 6, 1991, letter is conspicuous. The June 6, 1991,

letter specifically enumerates documents pertaining to the $1

million note, as well as a personal guaranty by Mr. Marsh. The

omission of any mention of a guaranty by Mr. Goldstein could

certainly imply that the anticipated assurance was not obtained.

The only other item which alludes to a Goldstein guaranty is the

February 10, 1995, letter written nearly 4 years later. Given

this record, we are not convinced that the latter document

sufficiently overcomes the inference which can be drawn from the

more contemporaneous letters. In summary then, we conclude that,

on the evidence before us, personal guaranties should not be

considered as a factor enhancing the value of the Marsh note.

As regards the factor directed toward the interest rate on

the note, Mr. Thomson found this element to be neutral. Mr.

Thomson compared the 9.13-percent conventional mortgage rate for

the week ended January 27, 1995, as reported in the Federal

- 70 -

Reserve Statistical Release, to the 10-percent rate born by the

Marsh note. He concluded that the spread of 87 basis points was

reasonable. Mr. Cronkite indicated that he did not research

interest rates, the estate has offered no alternative evidence or

position, and we have no grounds for doubt of Mr. Thomson’s

assumptions on this matter.

Turning to the two factors that Mr. Thomson felt would

increase any applicable discount, we begin with that pertaining

to maturity date and extensions. Mr. Thomson indicated that,

given the repeated annual extensions of maturity, there existed a

lack of assurance that the note would be paid in full at its

upcoming due date. He viewed this circumstance as one which

would favor an increase in discount. Again, the estate has not

challenged the foregoing premise, and we note Mr. Cronkite

testified with similar import. Mr. Cronkite stated: “whether

there’s a pending maturity date, I think is kind of moot. I

believe everyone thought it wouldn’t--it wouldn’t be paid at the

maturity date.” We find Mr. Thomson’s analysis of maturity

issues to be logical.

The remaining factor identified by Mr. Thomson as tending to

support an increased discount focuses on environmental concerns.

Both parties and their experts are in agreement insofar as the

notion that environmental issues relating to the mobile home park

detract from the value of the Marsh note. The estate, however,

- 71 -

places a far greater emphasis on this factor and alleges that Mr.

Thomson trivialized the seriousness of the Carson Harbor Village

property’s environmental condition. Mr. Cronkite, as we have

previously discussed, offered generalized testimony portraying

the environmental issues as very important to Mr. Marsh but

conceded that he had not reviewed any environmental studies in

preparing his report. He also cited the fact that refinancing

for the property was not obtained until 1997 as an indication of

the seriousness of the problem.

Mr. Thomson reviewed an analysis by Park Environmental

Corporation and requested, but was not provided, portions of a

study by McLaren/Hart addressing remedial action. Mr. Thomson

testified that in reading the materials obtained he did not

perceive any groundwater contamination but did see mentioned a

surface tarlike substance which seemed to be confined to a

relatively small, 20- to 30-foot area of the property. Mr.

Thomson described his assessment of this information: “Well, as

an investor wanting to buy that note, I would be concerned about

the environmental, and that did--that’s what really generated our

discount. I would be concerned. I didn’t think it was a big

impact, but it was an impact that was--could delay the

- 72 -

refinancing.” In a similar vein, his report assumes a

comparatively minimal cleanup cost but does recognize the factor

as a contingency detracting from the value of the note.

On this record, we believe that Mr. Thomson has taken the

better supported and more convincing position on environmental

issues. He reviewed objective materials and was able to offer

specifics relating to the physical condition of the property.

Mr. Cronkite relied almost exclusively on the generalized opinion

of Mr. Marsh. While we understand that Mr. Marsh was the

beneficiary of the $1 million note secured by the park, we are

uninformed as to the nature, extent, or basis of his knowledge

regarding the park’s environmental profile. Additionally,

although both sides acknowledge a delay in refinancing that could

have been attributable to environmental problems, we saw before

us no evidence confirming the degree to which environmental

concerns figured in financing negotiations. We therefore

conclude that Mr. Thomson appropriately took environmental issues

into account as one of several factors affecting value and was

not compelled to give greater emphasis to this feature.

The foregoing evaluation thus results in a scenario

comprising one factor tending to decrease and two tending to

increase any applicable discount, with the other two factors

being either neutral or irrelevant. Mr. Thomson used these five

factors to place the discount for the Marsh note within a 5- to

- 73 -

15-percent range. With two positive and two negative elements,

Mr. Thompson appears to have selected the midpoint of the range,

or 10 percent.

As to the range itself, Mr. Thomson’s report states that the

numbers are “based on our experience with real property and

promissory notes”. When asked at trial whether he was aware of

any note transactions or published compilations of note

transactions to use as comparables, Mr. Thomson responded:

“Specific transactions? As a California real estate broker, I

get information all the time. I’m not specifically aware of any

source that necessarily tracks--are you saying trust deeds? * * *

[Counsel replies affirmatively.] I get brokers sending me stuff

all the time, but I don’t have anything specific to track them.”

Mr. Thomson also indicated that he could conceive of situations

where discounts would be 33 percent or greater, as where a note

was unsecured or bore a below-market interest rate.

Mr. Cronkite’s report states: “Mr. Marsh estimates that he

could only get $0.70 to $0.80 on the dollar for a 100% interest,

and perhaps $0.60 to $0.70 for a 45% interest (due to liquidity

factors).” These remarks would seem to refer to discount ranges

for interests in the $1 million note. Mr. Cronkite thus

apparently selected a discount for the Marsh note based on what

Mr. Marsh “estimate[d]” he could “perhaps” get for sales of the

$1 million note. Yet Mr. Cronkite at trial neither expounded

- 74 -

upon the basis for Mr. Marsh’s ranges nor provided any exegesis

for his derivation therefrom of a 33.33-percent discount for the

Marsh note.

Faced with this limited record, we observe that both sides’

treatments of discount ranges leave something to be desired in

terms of support and explanation. Nonetheless, we again are

satisfied that Mr. Thomson has submitted the more convincing

position. We know that he is a licensed real estate broker and

appraiser, and his testimony tied the selected range to data

regularly received from professionals in the real estate

brokerage field. In contrast, we reiterate that Mr. Marsh’s

alleged expertise in this area is not established by the record.

We additionally repeat our concern about the complete absence of

information as to the underpinnings for his views. We therefore

accept Mr. Thomson’s 5- to 15-percent range.

Within the above-stated range, however, we seek a discount

reflective of one factor tending to decrease and two tending to

increase the applicable figure, rather than an even split of

factors. Accordingly, we conclude that 12 percent, or two-thirds

of the spread from 5 to 15 percent (rounded), is an appropriate

discount. The fair market value of the Marsh note is thus held

- 75 -

to be $396,000 ($450,000 x (1-.12)). This results in a total

value for the HFLP assets to be included in decedent’s gross

estate under section 2036 of $1,699,134.

To reflect the foregoing,

Decision will be entered

under Rule 155.