What is Tenancy in Common?
When a farm or commercial property has two or more owners, the ownership structure is typically called “tenancy in common.” According to the Appraisal Institute’s Dictionary of Real Estate Appraisal, this is defined as “an estate held by two or more persons, each of whom has an undivided interest.”
In these situations, appraisers must determine the estimated value of each owner’s undivided or “fractional” ownership interest and the specific percentage each party holds.
Why Fractional Interests Require Special Valuation Methods
Fractional ownership interests face two significant challenges that impact their market value:
- Lack of marketability: Partial ownership interests are more difficult to sell than complete ownership.
- Lack of control: Individual owners cannot make unilateral decisions about the property.
These factors typically result in fractional interests being valued at a discount of the property’s fair market value when sold as a complete unit.
Two Primary Approaches to Fractional Interest Valuation
- Market Approach This method applies a discount to the appraised value of the entire property. The process involves:
- Determining the property’s fair market value as if owned in fee simple.
- Calculating the fractional share based on ownership percentage.
- Applying an appropriate discount based on empirical market data.
- Income Approach This method determines the discount by calculating costs that would be incurred in a hypothetical partition lawsuit. In other words, it essentially measures the economic impact of forced sale scenarios.
Understanding Discount Rates: What the Data Shows
Research from published studies and tax court decisions provides valuable insight into appropriate discount rates:
Published Studies:
- Discount ranges: 6% to 87%
- Most common range: 23% to 37%
- Properties generating significant income typically receive smaller discounts.
- Larger ownership interests (over 50%) also receive smaller discounts.
Tax Court Decisions:
- Permitted discounts: 13% to 60%
- Strong inverse correlation between ownership percentage and discount rate
- 25% ownership interest: approximately 60% discount
- 50% ownership interest: approximately 20% discount
