Valuation Discounts, Qualified Appraisals and Adequate Disclosure for Family Entity Gifts

By Eric Ridley, attorney, Ridley Law. Updated October 2026.

Estate size this page matters for: $15 million to $100 million, and $100 million and up, where a discount on a gift of an LLC or partnership interest saves gift and estate tax at 40%. Below $15 million for one person or $30 million for a married couple, there’s usually no federal estate tax to save, and a discount can cost you, because it can also lower the new basis your heirs receive. See high-net-worth estate planning in California for that side of the line.

What a discount on a family LLC gift is worth

Say a parent owns an LLC holding $20,000,000 of real estate and investments and gives a 40% nonvoting interest to a trust for the children. Without a discount the gift is $8,000,000. With discounts at the levels courts allowed in the opinions below, it’s less, and the difference is exemption the parent keeps. The numbers are hypothetical.

At the 31.6% level the court allowed in Nelson, the gift uses $2,528,000 less exemption, worth $1,011,200 of estate tax at 40% if the parent’s exemption would otherwise be used up. It’s also a starting point for growth, because appreciation after the gift builds up in the trust.

That saving lasts only as long as the IRS can’t take it back, and it has several ways to try. It can dispute the discount itself. If the parent kept control of the LLC or kept using its assets, it can ignore the entity at death and tax the assets directly under IRC § 2036. And if the gift tax return didn’t disclose the gift adequately, the value stays open to challenge with no time limit.

How the IRS values an interest in a family entity

A gift is valued on the date it’s made (IRC § 2512(a)), at “the price at which such 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” (Treas. Reg. § 25.2512-1). For an interest in a business or partnership, the regulations look to the value of the assets, the earning capacity of the business and the other factors used for closely held stock, and they ask for complete financial data with the return (Treas. Reg. § 25.2512-3).

A buyer of a minority interest pays less than that interest’s share of the assets, and that gap is the discount the appraiser has to explain. A lack-of-control discount reflects that a minority or nonvoting owner can’t set distributions, sell assets or dissolve the entity. A lack-of-marketability discount reflects that there’s no ready buyer for the interest. California law supplies part of the reason: under Corp. Code § 17705.02, a person who receives a transferable interest in an LLC gets the distributions the transferor would have received, but can’t vote or take part in management unless admitted as a member. Operating agreements usually add transfer restrictions, and appraisers count those too, subject to IRC §§ 2703 and 2704 below.

The buyer and seller are hypothetical. In Grieve v. Commissioner, T.C. Memo. 2020-28, the IRS’s expert valued a 99.8% nonvoting interest by assuming a buyer would also buy the 0.2% voting interest held by the donor’s daughter. The court rejected that. The daughter had testified she didn’t intend to sell, and a value can’t rest on events that aren’t reasonably probable. The court valued the interest the donor gave.

Marketability discounts are usually built from studies of restricted stock sales and pre-IPO sales, adjusted for the entity in front of the appraiser. Estate of Jones, T.C. Memo. 2019-101, lists the ten factors the Tax Court distilled in Mandelbaum (1995), including distribution history, transfer restrictions, the holding period needed to make a profit, and the company’s redemption policy.

What courts have allowed, and what made them cut it

Every figure below comes from an opinion read for this page. Discounts depend on what the entity owns and what its agreement says, so another family’s number can be higher or lower.

Courts accept discounts in the 25% to 40% range when the appraisal is built from data and explains the entity’s actual terms, as with the timber and sawmill interests in Jones. They cut discounts sharply when the entity holds only cash or public stock that a buyer could easily value, or when the agreement can be undone by the family.

In two cases the court rejected the IRS’s method and adopted the taxpayer’s side. In Estate of Jones the IRS determined a $44,986,416 gift tax deficiency on gifts of interests in a timber partnership and a sawmill company, valuing a partnership unit at $2,530. The court rejected that asset-based method because there was no likelihood the timberlands would be sold, adopted the estate’s expert, allowed a 35% marketability discount and valued the units at $380 each. The IRS had already conceded the § 6662(h) penalty. In Grieve the IRS determined a $4,399,032 deficiency and a $628,199 penalty on gifts of 99.8% nonvoting interests in two LLCs, one holding Ecolab stock and cash and the other cash, partnership interests and notes. The IRS conceded the penalty before trial, and the court rejected its expert’s method and adopted the donor’s appraisal: 13.4% and 12.7% for lack of control and 25% for lack of marketability.

The families lost ground where the discount went past what the assets supported. In Knight v. Commissioner, 115 T.C. 506, the Knights claimed 44% on a family partnership. The court respected the partnership, rejected the IRS’s argument to disregard it and held § 2704(b) didn’t apply, but it allowed discounts totaling 15% and valued each gift at $394,515. The Holmans claimed overall discounts slightly over 49% on gifts of interests in a partnership that held only Dell stock. The Tax Court accepted the IRS expert’s 12.5% marketability discount and minority discounts of 4.63% to 14.34%, in part because the partners could unanimously dissolve the partnership, which put a natural ceiling on any marketability discount. The Eighth Circuit affirmed (Holman v. Commissioner, 601 F.3d 763 (8th Cir. 2010)). In Nelson the court allowed discounts but cut them, to 5% and 28% for the partnership interest instead of the 15% and 30% the donors’ appraiser used. That raised the value of a 1% interest from $341,000 to $411,235, and a formula clause that pointed to the appraiser didn’t help (T.C. Memo. 2020-81, aff’d, 17 F.4th 556 (5th Cir. 2021)). See defined value clauses.

Restrictions in the agreement that the IRS ignores

The transfer restrictions that support a discount have to survive § 2703 and § 2704 before an appraiser can count them. Under § 2703, an option, buy-sell right or “restriction on the right to sell or use” property is ignored in valuing it unless it is a bona fide business arrangement, isn’t a device to transfer property to family for less than full value, and has terms comparable to arm’s-length arrangements (IRC § 2703(a), (b)). In Holman the partnership’s right to buy back interests transferred outside the family failed that test, because the Tax Court found the restrictions were designed mainly to keep the children from spending the gifts, not to serve a bona fide business purpose, so the appraisal had to ignore them.

The family can’t write a limit on liquidating the entity into the agreement and then rely on it in the appraisal either. When family members control the entity under § 2704(b), an “applicable restriction” is disregarded in valuing a transferred interest. The regulations define that as a limit on liquidation that is more restrictive than the state law that would otherwise apply, and that lapses or that the family can remove (IRC § 2704(b) and Treas. Reg. § 25.2704-2(b)). Restrictions imposed by state law itself don’t count, and in Knight the Tax Court held § 2704(b) didn’t apply to the Knights’ partnership.

The 2016 proposed regulations are gone. In August 2016 Treasury proposed regulations under § 2704 that would have limited discounts for interests in family-controlled entities (REG-163113-02, 81 FR 51413), and it withdrew them on October 20, 2017 (82 FR 48779). The current § 25.2704-2 rules apply.

For the operating agreement, that means restrictions that only repeat California’s default LLC rules, or that the family can’t remove alone, hold up better than a buy-back right written for the family with no business reason behind it. See California LLC operating agreements.

When the assets come back into the estate, the discount goes with them

If the donor keeps control of an entity or keeps living off its assets, IRC § 2036(a) puts the assets back into the estate and the discount stops mattering. When the section applies to the transfer into the partnership, the estate is taxed on the assets themselves. It reaches any property the person transferred while keeping “the possession or enjoyment of, or the right to the income from, the property,” or the right, “either alone or in conjunction with any person,” to designate who enjoys it.

The way out is a “bona fide sale for an adequate and full consideration,” which for a family entity means a legitimate and significant nontax reason for the transfer. Wayne Bongard had a nontax reason for the holding LLC he put his company stock into, and that transfer passed § 2036. His later transfer of LLC units to a family partnership had none, and those units came back into his estate. The IRS had determined a $52,878,785 estate tax deficiency (Estate of Bongard v. Commissioner, 124 T.C. 95 (2005)).

Retained enjoyment can be implied, as Albert Strangi’s estate learned. The court found an implied agreement that he would keep the enjoyment of the property and included the $10,947,343 of underlying assets under § 2036(a)(1), against the $6,560,730 his estate reported for the interest. As his health failed, he had moved about $10 million of assets into a family partnership, kept living in a house he had put in it, and had the partnership pay out over $100,000 for his funeral, estate expenses, bequests and personal debts (Strangi v. Commissioner, 417 F.3d 468 (5th Cir. 2005)).

Retained control can come from the partnership agreement itself. Nancy Powell’s ability to join the other partners in dissolving the partnership was a retained right under § 2036(a)(2). Cash and securities worth $10,000,752 went into the partnership on August 8, 2008, two days after it was formed, and she died on August 15. Section 2043 limited the inclusion to the discount, the gap between the assets and the value of the partnership interest. The court also held that her son’s transfer of the partnership interest to a charitable lead trust under her power of attorney was void or revocable, because the power didn’t authorize gifts that large, so the partnership interest itself stayed in her estate (Estate of Powell v. Commissioner, 148 T.C. 392).

A partnership formed in the last weeks or months of life with nearly everything the person owns fails. The Tax Court included about $17 million of assets under § 2036(a) in Estate of Fields, sustained a $1,828,594 deficiency and a $270,417 negligence penalty, and the Fifth Circuit affirmed in 2026 (T.C. Memo. 2024-90). The assets went in weeks before Anne Milner Fields died, with $17 million of her assets in by ten days before she died. The entity was created and funded while she was incapacitated, and it left too little cash to pay her bequests. Her attorney emailed the appraiser about “obtaining a deeper discount,” the only contemporaneous written evidence of motive, and the estate reported the interest at $10,877,000.

For gifts made years before death, the planning lesson is the same. Form the entity for a real nontax reason, keep enough outside it to live on, run it as a business with separate accounts, pay fair rent for anything you use, and make distributions by the agreement’s terms. Don’t put most of an elderly parent’s assets into a partnership in the last months of life and report the interest at a discount. See family limited partnerships in California, and for the deathbed versions that lost, estate planning strategies that backfire.

What the gift tax return has to show to limit the IRS to three years

What goes on the Form 709 controls how long the IRS can question the discount. A gift is adequately disclosed when the Form 709 or an attached statement describes it well enough “to apprise the Internal Revenue Service of the nature of the gift and the basis for the value so reported,” under Treas. Reg. § 301.6501(c)-1(f)(2), which lists the required items.

• A description of the property and any consideration the donor received.
• The identity of each donee and their relationship to the donor.
• For a gift in trust, the trust’s tax identification number and a brief description of its terms, or a copy of the trust.
• A detailed description of the valuation method, the financial data used, any restrictions considered, and each discount claimed.
• For an entity interest valued from its assets, the value of 100% of the entity without discounts, the share transferred, and the value reported.
• A statement of any position contrary to a Treasury regulation or revenue ruling.

With adequate disclosure, the IRS generally has three years from filing to assess (IRC § 6501(a)). Without it, any gift tax “may be assessed… at any time” (IRC § 6501(c)(9)). Once the period runs on an adequately disclosed gift, that value is treated as finally determined when the estate tax is later computed (IRC § 2001(f)). A gift left off the return entirely, or reported in one line with no valuation support, stays open with no time limit.

Attaching an appraisal that meets Treas. Reg. § 301.6501(c)-1(f)(3) takes the place of the detailed valuation description the disclosure rule otherwise requires, which makes it the standard way to comply. The defined term “qualified appraisal” (IRC § 170(f)(11)(E)) belongs to charitable deductions and doesn’t govern gifts to family. The appraiser has to hold himself or herself out as an appraiser or appraise regularly, be qualified for the type of property, and not be the donor, a donee, a family member of either, or anyone they employ. The appraisal has to state the dates and purpose, describe the property and the process, list the assumptions and restrictions, include financial data “sufficiently detailed so that another person can replicate the process,” and explain the method and the specific basis for the value.

Penalties when the reported value is too low

A 20% accuracy-related penalty applies when the value reported on a gift or estate tax return is 65% or less of the correct value (IRC § 6662(g)), and it rises to 40% when the reported value is 40% or less (IRC § 6662(h)). The penalty doesn’t apply unless the underpayment from the understatement exceeds $5,000. Appraisers face their own penalty under IRC § 6695A: the greater of $1,000 or 10% of the underpayment, capped at 125% of the appraiser’s fee, unless the appraised value was more likely than not correct.

Reasonable cause and good faith are a defense to the penalty. Michael Jackson’s estate is the example: the court imposed no accuracy-related penalties because the estate reasonably relied in good faith on reputable appraisers (Estate of Jackson, T.C. Memo. 2021-48). The estate had reported his image and likeness at $2,105 and his interest in the trust holding the Mijac music catalog at $2,207,351, and the court found $4,153,912 and $107,313,561. The estate won on its Sony/ATV interest, valued at zero, and the court called the IRS expert’s image valuation “fantasy.” A bare appraisal isn’t enough, though. The court looks at the appraiser’s assumptions and the circumstances.

Where California changes the picture

The discount also lowers basis. Property received from a decedent takes a basis equal to its fair market value at death (IRC § 1014(a)), so a discounted value for estate tax is also a discounted basis for income tax. For a California family under the exemption ($15 million per person in 2026 under Rev. Proc. 2025-32, $30 million for a married couple), where no estate tax is due either way, a large discount at death can mean more capital gain later with nothing saved, and California taxes capital gains as ordinary income, with no lower rate (FTB). For a married couple, community property held at the first death can get a new basis on both halves (IRC § 1014(b)(6)), so the effect of a discount reaches the surviving spouse’s half too. See community property vs. separate property step-up.

A discount does nothing for Prop 13, which counts percentages of the entity rather than values. If the LLC owns California real estate, a gift of interests can be a change in ownership. Gaining control of more than 50% triggers reassessment (Rev. & Tax. Code § 64(c)), and so do transfers by the original co-owners of “cumulatively more than 50 percent” when the property went into the entity without reassessment under § 62(a)(2) (§ 64(d)). A change in ownership statement is due to the Board of Equalization within 90 days, from the entity under § 480.2 or from whoever acquires control under § 480.1, and a late filing costs 10% of the tax (§ 482(b)). See rental property in an LLC and holding company LLCs.

A California taxpayer appeals from the Tax Court to the Ninth Circuit, and Powell involved a California decedent, so the Ninth Circuit would have heard any appeal. Discounts are fact findings, and the Tax Court decisions above apply the same federal valuation rules in every circuit.

How this fits with the rest of the plan

This matters to families above the federal exemption who hold real estate, a business or a large investment portfolio in an LLC or partnership and are making gifts or sales of interests to trusts. It also matters to families below the line who were told a discount always helps, because for them a discount can cost money through a lower basis. See how discount-based gifts fit with other techniques on estate planning strategies compared and ultra-high-net-worth estate planning.

I work alongside your CPA and, where the matter calls for it, co-counsel. Work at this level is built for each family and quoted in writing before any drafting starts.

Working with Ridley Law

If you’re about to give interests in a family entity, or a gift tax return you filed reported one without an appraisal, the first call is free and runs 30 minutes, by phone or Zoom.

Book my 30-minute call or call 805-244-5291.

Frequently asked questions

What valuation discounts are allowed for a family LLC?

Discounts for lack of control and lack of marketability, set by appraisal. In the opinions on this page, courts allowed combined discounts from 15% (Knight) to about 40% (holding company stock in Nelson), depending on the assets and the agreement.

How long can the IRS challenge the value of a gift?

Generally three years after the return is filed if the gift is adequately disclosed (IRC § 6501(a)). If it isn’t, there’s no time limit (IRC § 6501(c)(9)).

Does a gift tax return need an appraisal?

The law doesn’t require one, but the return has to describe the valuation in detail, and attaching an appraisal that meets Treas. Reg. § 301.6501(c)-1(f)(3) is the standard way to meet that rule.

What is the penalty for undervaluing a gift?

20% of the resulting underpayment if the reported value is 65% or less of the correct value, and 40% if it’s 40% or less (IRC § 6662(g), (h)). Reasonable, good-faith reliance on a reputable appraiser can be a defense.

Were the 2016 section 2704 regulations finalized?

No. Treasury proposed them in August 2016 and withdrew them on October 20, 2017 (82 FR 48779).

Does a family partnership holding only marketable securities get a discount?

It can, but a smaller one. In Holman, a partnership holding only Dell stock got a 12.5% marketability discount. In Grieve, LLCs holding public stock and cash got about 35% combined because the donor’s appraisal was well supported and the IRS’s theory failed.

Does a valuation discount help a California estate under the exemption?

Usually not. With no estate tax due, a discount at death mainly lowers the heirs’ new basis under IRC § 1014, which means more taxable gain when they sell.