In the case of the Estate of John A. Pulling, Sr v. Commissioner, TC Memo 2015-134, the Tax Court was asked to decide the highest and best use of three parcels of land held by an estate. While disagreeing with the estate’s initial argument that Florida case law controlled the proper valuation of the parcels, the Court eventually accepted the estate’s values on different grounds.

The estate held three parcels of land that were part of a set of five contiguous parcels of land that, if combined, could be developed. However unless that combination took place then development of the three parcels held by the estate was not economically feasible. At the moment the land was zoned for agricultural use.

The other two parcels were held by an entity in which the decedent held a 28% interest and over which he had influence, but he could not unilaterally cause the related entity to dispose of its parcels.

The IRS argued that the value of the land held by the estate should be that if it was used as part of a development, arguing that the economics of the situation (which made all of the parcels far more valuable if used for development) argued for assuming that such a combination of the properties was reasonably probable so that a willing buyer would value the land at that use.

The estate initially argued that such an assumed combination was not allowed based on Florida case law that looked for physical contiguity, unity of ownership, and unity of use to determine whether parcels are separate and independent or a single tract. The estate, arguing those tests were not met, claimed that the Tax Court had to treat the parcels as separate and could not assume a combination.

The Tax Court disagreed with that view. First, as the Court pointed out, while Florida law may determine what was transferred, federal law alone is determinative of the value. Thus, even if Florida law did provide for such a three-factor test to be used for all state law purposes, the federal law value would still be determined under federal provisions.

Second, the Court noted that, in any event, Florida’s case law was limited to the use of the factors when considering eminent domain proceedings and for determining if a taking had taken place in an inverse condemnation action. The Tax Court noted that it had not been shown that Florida courts had used this three-factor test in the context of assemblage.

But the Court also did not accept the IRS view that it must assume a future combination was a given when valuing the property. The Court, citing the case of United States ex rel. TVA v. Powelson, 319 U.S. 266, 275 (1943) found that the IRS must show that there existed a reasonable probability of the lands being combined in the reasonably near future. The court noted that there is a presumption that the use the land was being put to when the decedent passed is its highest and best use, and thus the burden is on the IRS to show that assemblage is reasonable likely.

The Court found:

Respondent does not cite, nor have we found, any evidence in the record suggesting that assemblage was reasonably likely. Instead, respondent asks us to assume that assemblage was likely because of (1) the economic benefits of assemblage and (2) the ties between decedent and the various stakeholders in TCLT. The estate argues that respondent’s position is unsupported by the caselaw and that the evidence shows that assemblage was unlikely. We agree with the estate.

The Court notes that arguing that the fact the land would be of far greater value if combined than if it wasn’t isn’t a relevant fact in determining if assemblage would take place, referring to this as placing the cart before the horse. Only after it is shown that an assemblage is reasonably likely would the economic benefits of such a combination become relevant.

The Court noted that the actual record suggest such an assemblage wasn’t likely. The other owner had turned down a prior offer to sell its property as part of a residential development. And even the IRS’s expert testified at trial that he would not recommend to a hypothetic buyer of the estate’s property it be purchased as an investment due to uncertainty regarding the cooperation of the other party needed to sell the property for development.

The Court also would not allow the IRS to argue that the estate’s significant minority stake in the other owner and relationships with other owners meant a combination was required, finding the IRS had failed to show evidence beyond the existence of relationships, not that that the estate was in effective control of the other entity.