Estate Valuation: Understanding Its Role in Tax Planning
As the 2026 lifetime gift and estate tax exemption sunset approaches, it has become even more important to wind up your estate planning. If the estate tax provisions of the Tax Cuts and Jobs Act (TCJA) are not extended, we expect the lifetime federal estate and gift tax exemption to drop to $6.99 million in 2026 from $13.99 million in 2025.
To fully exploit this tax-saving opportunity while it lasts, you must understand the instrumental role of an unbiased assessment of the estate’s worth in tax planning. In estate valuation, you can directly and effectively reduce your tax liabilities by applying appropriate discounts.
In this article, we will explore some discounts commonly used to minimize tax liabilities. We will also explore how the timing of an estate valuation affects tax liabilities. Read on to know more!
Role of estate valuation in tax planning
In a tax planning exercise, the role of a professional valuation analyst is to ensure that the assets to be transferred are not overvalued in any way. This means that the professional valuation analyst must identify all applicable discounts for the assets in the estate.
At the same time, the estate valuation cannot be unreasonably low as that can attract the ire of the Internal Revenue Service (IRS) which could result in hefty penalties.
So, the focus should be on finding true asset values and not low asset values. To do so, the professional valuation analyst must correctly apply the following discounts:
Discount for lack of marketability (DLOM)
When there is no active market for a particular asset, we must discount its value. The reasoning behind applying this discount is that when the asset holder tries to fully realize the asset’s value by selling it, they will face considerable hardships.
The asset holder must either wait a long period to find a buyer themselves, pay a hefty commission to a broker, or offer a significant discount to ensure that the sale goes through. Hence, we apply the discount for lack of marketability (DLOM) on assets lacking an active market.
Some assets on which DLOM is applicable are shares of closely or privately held corporations, minority interests in family limited partnerships, and equity compensation such as phantom stocks, and restricted stock units (RSUs).
Discount for lack of control (DLOC)
A stake in a company is more valuable when it gives you control over the company. Conversely, if your equity stake does not give you control over the company, it has less value. When you do not have control over a company, you cannot influence its operations to suit your financial needs.
For instance, a founder-controlled startup is likely to focus on long-term, product-enhancing projects. However, if investors have a controlling interest in a privately held company without stable revenue, they have an incentive to push the company to improve its key metrics so that it appears more attractive for acquisitions.
Also, if an acquiring company wants complete control, the majority shareholder in favor of this deal can compel minority shareholders to sell at the same terms by exercising drag-along rights.
Because of the disadvantages of a minority or non-controlling stake, we must apply a discount for lack of control (DLOC). The DLOC is applied commonly in estate valuations because having multiple beneficiaries turns controlling stakes into smaller, non-controlling stakes.
Fractional interest discount
The fractional interest discount is similar to DLOC since it also tries to account for the disadvantages of partial ownership over total ownership. The only difference is that fractional interest discount is applied even in cases of majority stake. We apply the fractional interest discount to assets that cannot be fully controlled unless you have total ownership or assets that lose value when split into smaller assets.
Some of the assets on which fractional interest discount is applicable are:
- Real estate – When you have partial ownership of a property, it significantly limits your ability to sell it. You may need the vote of other owners to even earn a rental income from the property.
- Diamonds and other precious gems – The value of diamonds and other precious gems drops significantly when they are cut into smaller pieces. Essentially, the sum of all parts is seldom equal and often lower than the whole. So, when people gain partial ownership of a precious gem, we can apply a fractional interest discount since cutting the gem would reduce its value but selling it as a whole requires the consent of the other party.
- Collectibles and fine art – Fractional interest discount is also applicable on partial ownership stakes in works of art, vintage cars, thoroughbred horses, jewelry, coins, antiques, first editions of well-known books or comics, or even limited-edition vintage trading cards.
Blockage discount
When a large number of shares are sold in a single transaction, i.e. a block sale, it can significantly impact a listed company’s market capitalization. A block sale by a long-standing investor, promoter, or executive to a third party shows a lack of faith in the company’s fortunes.
Although estate distributions are not the same as block sales, the market may still view them as a transfer from an experienced stakeholder who could take an active part in company management to much less experienced beneficiaries who may not be capable of making similar contributions.
We typically apply the blockage discount to stocks and other assets whose value is affected by large sales.
Example
In this example, we will see how the discounts we discussed are actually applied in estate valuations.
Roger Williams left behind an estate comprising cash and a controlling interest in FinWiz, a wealth management firm. This estate is to be divided equally among Betty and Theo Williams. The details of Roger Williams’ estate are as follows:
- Cash and cash equivalents = $500,000
- Roger Williams held a 51% stake in FinWiz, which had assets under management (AUM) worth $1.5 billion.
Here, we will be valuing FinWiz as per the market-based valuation approach. To do so, we must first make a list of similar companies that were recently involved in M&A transactions or funding rounds. Then, we must find their AUMs and valuations.
| Firm | Assets Under Management (AUM) | Valuation |
|---|---|---|
| Summit Wealth Partners | $2,500,000,000 | $300,000,000 |
| Golden Horizon Financial | $1,800,000,000 | $220,000,000 |
| Silverstone Wealth Advisors | $3,000,000,000 | $380,000,000 |
| Pinnacle Trust Management | $1,200,000,000 | $150,000,000 |
| Legacy Capital Advisors | $2,000,000,000 | $250,000,000 |
| Total | $10,500,000,000 | $1,300,000,000 |
Now, we must divide their total valuation by their total AUM to find the market valuation multiple.
Market valuation multiple = Total valuation ÷ Total AUM
= $1,300,000,000 ÷ $10,500,000,000
= 0.1238095238
We can apply this market valuation multiple to find the valuation of FinWiz.
FinWiz valuation = Market valuation multiple × FinWiz AUM
= 0.1238095238 × $1,500,000,000
= $185,714,285.71
Now, we must apply the blockage discount, discount for lack of control (DLOC), and discount for lack of marketability as per market standards.
| Particulars | Amount |
|---|---|
| Initial FinWiz Valuation | $185,714,285.71 |
| Discount for Lack of Marketability (30%) | $55,714,285.71 |
| Adjusted FinWiz Valuation | $130,000,000.00 |
| Blockage Discount (15%) | $19,500,000.00 |
| Post-Blockage Valuation | $110,500,000.00 |
| Discount for Lack of Control (40%) | $44,200,000.00 |
| Final Valuation After All Discounts | $66,300,000.00 |
Since Roger Williams’ 51% stake will be equally divided among Betty and Theo, we can calculate their stakes as follows.
| Particulars | Amount |
|---|---|
| FinWiz valuation | $66,300,000.00 |
| Roger Williams' stake (51%) | $33,813,000.00 |
| Betty's stake (half of Roger's stake) | $16,906,500.00 |
| Theo's stake (half of Roger's stake) | $16,906,500.00 |
Eqvista- Minimize your tax liability with reliable valuations!
As part of estate valuation, you can apply discounts like the discount for lack of marketability (DLOM), discount for lack of control (DLOC), fractional interest discount, and the blockage discount to effectively reduce your tax liability. These discounts are meant to capture the reduction in asset value because:
- The asset is challenging to liquidate
- The ownership percentage is not enough to allow you to control the business to suit your financial needs
- The asset loses its value upon splitting
- The transfer itself affects the market perception of the asset
You can also benefit from placing appreciating assets in a Grantor Retained Annuity Trust (GRAT) and choosing an alternate valuation date since you will be taxed on the part of your estate before it appreciates and the other part after it depreciates.
For estate valuations and more such tips that unlock tax savings, contact Eqvista!
