Charles F. Vuotto, Jr., Esq. and Cheryl E. Connors, Esq.
As matrimonial practitioners we often fall into the trap of concentrating on valuation, tax and other issues only in the context of business valuation and fail to consider that the same issues exist with regard to many other assets that are addressed in divorce including but not limited to real estate. This article will address the appropriate standard of value to be utilized when valuing real estate incident to divorce and whether it is consistent with the standard used in valuing a business.
What “standard of value” should be applied when valuing real estate incident to divorce? Perhaps the more interesting question is whether there should be one “standard of value” for all assets being valued in the context of divorce. Unfortunately, no New Jersey matrimonial case specifically discusses the appropriate standard of value to be applied when valuing real estate incident to divorce. Therefore, we must evaluate standards applied to real estate valuation in other contexts.
The “standard of value” is that standard by which a property or asset is measured. Shannon Pratt, discussing standard of value, states the following:
The standard of value usually reflects an assumption as to who will be the buyer and who will be the seller in the hypothetical or actual sales transaction regarding the subject assets, properties or business interests. It defines or specifies the parties to the hypothetical transaction. In other words, the standard of value addresses the questions: “value to whom?” and “under what circumstances?” The standard of value, either directly by statute or (more often) as interpreted in case law, often addresses what valuation methods are appropriate and what factors should or should not be considered.
Shannon P. Pratt, Robert F. Reilly & Robert P Schweihs, Valuing a Business – The Analysis and Appraisal of Closely Held Companies 28 (4th ed. 2000). The standard of value sets the criteria upon which valuation analysts rely. Jay E. Fishman, Shannon P. Pratt & William J. Morrison,Standard of Value: Theory and Applications xvii (2007) [hereinafter “Fishman I”]. A standard of value is “a definition of the type of value being sought.” Pratt, supra, at 28. “Among many factors, it dictates whether you use a hypothetical buyer and seller, a market-participant buyer and seller, value to a single person, or a willing or unwilling buyer and seller.” Fishman I, supra, at xvii. Before we explore the standard of value applicable to real estate, we will briefly summarize the definitions of the more widely utilized standards. These are most often, but not always, in the context of business valuation.
The essence of our discussion in this section is an analysis of “value.” Black’s Law Dictionary defines value as “the significance, desirability, or utility of something” or “the monetary worth or price of something; the amount of goods, services, or money that something will command in exchange.” Black’s Law Dictionary 1586 (8th ed. 2004). Therefore, notwithstanding the numerous standards of value that exist, the standards are essentially divided into two camps (i.e., “value in use” and “value in exchange”).
There are a number of standards of value. Some, but not all, are defined below:
Value in Exchange: “[T]he value arrived at in a hypothetical sale, with assumptions ranging from the seller departing immediately and competing with his or her former business, to the seller staying on to help transition management.” Underlying value in exchange are two standards: (1) Fair Market Value and (2) Fair Value. Fishman I, supra, at 167.
Fair Market Value: “[T]he price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.” Sometimes this standard further assumes that the hypothetical buyer and seller are “able, as well as willing, to trade and to be well informed about the property and concerning the market for such property.” Jay E. Fishman & Bonnie O’Rourke, Value: More Than a Superficial Understanding is Required, 15 J. Am. Acad. Matrimonial Law. 315, 316-17 (1998) [hereinafter “Fishman II”].
Fair Value: A context- and geographically-sensitive term, this usually represents a standard of value created by statute and/or precedent for specific circumstances. In New Jersey, fair value is essentially fair market value without discounts for lack of control or lack of marketability/liquidity, barring extraordinary circumstances. See Fishman I, supra, at 91. However, over-application of this general rule is dangerous. “Extraordinary circumstances” usually relates to the good or bad faith of the shareholders involved in the particular corporate action. While this concept completely contradicts divorce litigation policy, which makes marital fault irrelevant in deciding the distribution of assets, it is the standard to be used when valuing closely held corporations for purposes of equitable distribution. Brown v. Brown, 348 N.J. Super. 466, 471, 475, 483, 487-88 (App. Div.), certif. denied, 174 N.J. 193 (2002).
“In one context, fair value can entail an exchange, but not necessarily from a willing seller. Fair value may also assert that a lack of intention to sell a business prevents its valuation as a value in exchange.” Fishman I, supra, at 180. Other fair value cases adhere more to a value to the holder premise. Ibid. Because fair value of an asset could be its market value, its intrinsic value, or its investment value, this standard is subject to wider interpretation from a judicial perspective than fair market value. Id. at 4-5. In the shareholder context, “‘[f]air value carries with it the statutory purposes that shareholders be fairly compensated, which may or may not equate with the market’s judgment about the stock’s value. This is particularly appropriate in the close corporation setting where there is no ready market for the shares and consequently no Fair Market Value.’” Id. at 91 (quoting Lawson Mardon Wheaton, Inc. v. Smith, 160 N.J. 383 (1999)). No reported case in the State of New Jersey (before Brown) has expressly utilized “Fair Value” as a standard of value incident to divorce, although one may interpret various cases as having implicitly utilized this or some other value standard. In fact, all cases expressly speaking to the issue have specifically used “Fair Market Value.” The real question is: Can or should this standard be applied to real estate?
Investment Value/Value to the Holder: This is the specific value of an investment to a particular investor or class of investors based upon individual investment requirements. Pratt, supra, at 28; see also Fishman II, supra, at 320 (defining investment value as “value perceived by a specific buyer based on a specific set of circumstances”). “Application of this standard contemplates value not to a potential hypothetical buyer but rather to a particular buyer, which in the case of divorce is the current owner, hence, value to the holder.” Fishman I, supra, at 181.
Intrinsic or Fundamental Value: The value to an investor of an investment (usually common stock) based upon the perceived characteristics of an asset. This becomes the basis of the “market value” for the asset. The methods of calculating intrinsic value are usually based upon finance theory. See Fishman II, supra, at 320 (stating that intrinsic value is “often used interchangeably with investment value and is often thought of as the value as a going concern, to a particular owner, without taking into consideration the marketability of the business or practice”). This standard of value is based on the assumption that the business or business interest will not be sold. Fishman I,supra, at 167.
The standard of value varies from state to state. It is important to note that courts may refer to one standard of value while in reality the court is applying a different standard of value. Id. at 172. In other words, a court may declare that it is applying a fair market value standard while attributing elements and theory more closely related to investment value. These “misnomers” are likely a result of the courts’ desires to distribute assets in a fair and equitable manner. Ibid.
In the context of business valuation incident to divorce, thirty-three states and the District of Columbia fall under a value in exchange premise, including Arkansas, Alaska, Connecticut, Delaware, Florida, Hawaii, Idaho, Illinois, Indiana, Iowa, Kansas, Louisiana, Maryland, Massachusetts, Minnesota, Mississippi, Missouri, Nebraska, New Hampshire, North Dakota, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Carolina, Tennessee, Texas, Utah, Vermont, Virginia, West Virginia, Wisconsin, and Wyoming. Id. at 226. Only two states, Louisiana and Arkansas, have statutes that provide guidance as to the standard of value to be used in divorce, both directing that fair market value be applied. Id. at 186-87. Ten states fall under some version of a value to the holder premise including Arizona, California, Colorado, Kentucky, Michigan, Montana, Nevada, New Mexico, North Carolina and Washington. Id. at 242. The remaining seven states do not fall into either category.
Breaking down those categories into specific standards of value, eleven states, Arkansas, Connecticut, Florida, Hawaii, Kansas, Louisiana, Missouri, Nebraska, New York (New York is also categorized as a hybrid state because it has case law that directs the use of investment value), South Carolina, and Wisconsin, specifically direct the use of fair market value by statute or decisional law, and one state, Minnesota, uses the term market value, which could be categorized as fair market value under the circumstances presented in the case law. Id. at 192-93 (citing Ark. Code Ann. § 9-12-315; Tortorich v. Tortorich, 902 S.W.2d 247 (Ark. Ct. App. 1995); Dahill v. Dahill, 1998 Conn. Super. LEXIS 846 (Conn. Super. Ct. Mar. 30 1998); Christians v. Christians, 732 So. 2d 47 (Fla. Dist. Ct. App. 1999); Antolik v. Harvey, 761 P.2d 305 (Haw. Ct. App. 1988); Bohl v. Bohl, 657 P.2d 1106 (Kan. 1983); La. Rev. Stat. Ann. § 9:2801; Bateman v. Bateman, 382 N.W.2d 240 (Minn. Ct. App. 1986); Hanson v. Hanson, 738 S.W.2d 429 (Mo. 1987); Taylor v. Taylor, 386 N.W.2d 851 (Neb. 1986); Beckerman v. Beckerman, 511 N.Y.S.2d 33 (N.Y. App. Div. 1987); Hickum v. Hickum, 463 S.E.2d 321 (S.C. Ct. App. 1995); Sommerfeld v. Sommerfeld, 454 N.W.2d 55 (Wis. Ct. App. 1990)). In addition to the states that expressly identify fair market value as the standard, it is implicit in case law of numerous states that the fair market value standard is being applied. These states include Alaska, Delaware, Idaho, Illinois, Iowa, Maryland, Massachusetts, Mississippi, New Hampshire, North Dakota, Oklahoma, Oregon, Pennsylvania, Rhode Island, Tennessee, Texas, Utah, Vermont, and West Virginia. Id. at 196-98 (citing Richmond v. Richmond, 779 P.2d 1211 (Alaska 1989); E.E.C. v. E.J.C., 457 A.2d 688 (Del. 1983); Chandler v. Chandler, 32 P.3d 140 (Idaho 2001); In re Marriage of Zells, 572 N.E.2d 944 (III. 1991); In re Marriage of Hoak, 364 N.W.2d 185 (Iowa 1985);Prahinski v. Prahinksi, 582 A.2d 784 (Md. Ct. Spec. App. 1990); Goldman v. Goldman, 554 N.E.2d 860 (Mass. App. Ct. 1990); Singley v. Singley, 2003 Miss. LEXIS 283 (Miss.); Hanson v. Hanson, 738 S.W.2d 429 (Mo. 1987); Taylor v. Taylor, 386 N.W.2d 851 (Neb. 1986); In re Watterworth, 821 A.2d 1107 (N.H. 2003); Sommers v. Sommers, 660 N.W.2d 586 (N.D. 2003); Ford v. Ford, 840 P.2d 36 (Okla. Civ. App. 1992); Marriage of Maxwell, 876 P.2d 811 (Or. Ct. App. 1994); Butler v. Butler, 663 A.2d 148 (Pa. 1995); Moretti v. Moretti, 766 A.2d 925 (R.I. 2002); Alsup v. Alsup, 1996 WL 411640 (Tenn. Ct. App. July 24, 1996); Nail v. Nail, 486 S.W.2d 761 (Tex. 1972); Sorenson v. Sorenson, 839P.2d 774, 775-76 (Utah 1992); Goodrich v. Goodrich, 613 A.2d 203 (Vt. 1992); May v. May, 589 S.E.2d 536 (W. Va. 2003)). In contrast, four states, Indiana, Louisiana (although Louisiana has a statute directing the use of fair market value, the language used in one decision suggests fair value), Virginia, and Wyoming apply a fair value standard. Id. at 198 (citing Bobrow v. Bobrow, 711 N.E.2d 1265 (Ind. 1999); Ellington v. Ellington, 842 So. 2d 1160 (La. Ct. App. 2003); Howell v. Howell, 523 S.E.2d 514 (Va. Ct. App. 2000); Neuman v. Neuman, 732 P.2d 208 (Ariz. 1987)). Ten states, Arizona, California, Colorado, Kentucky, Michigan, Montana, Nevada, New Mexico, North Carolina, and Washington, apply an investment value. Id. at 198-200 (citing Mitchell v. Mitchell, 732 P.2d 208 (Ariz. 1987); Golden v. Golden, 75 Cal. Rptr. 735 (Cal. Ct. App. 1969); In re Marriage of Huff, 834 P.2d 244 (Colo. 1992); Clark v. Clark, 782 S.W.2d 56 (Ky. Ct. App. 1990); Kowalesky v. Kowalesky, 384N.W.2d 112 (Mich. Ct. App. 1986); In re Marriage of Hull, 712 P.2d 1317 (Mont. 1986); Ford v. Ford, 782 P.2d 1304 (Nev. 1989); Mitchell v. Mitchell, 719 P.2d 432 (N.M. Ct. App. 1986); Poore v. Poore, 161 S.E. 532 (N.C. 1931); In re Marriage of Fleege, 588 P.2d 1136 (Wash. 1979)). New Jersey, New York and Ohio have been characterized as hybrid states, applying more than one standard of value. Id. at 200 (citing Brown v. Brown, 348 N.J. Super. 466 (App. Div.), certif. denied, 174 N.J. 193 (2002); Dugan v. Dugan, 92 N.J. 423 (1983); Moll v. Moll, 722 N.Y.S.2d 732 (N.Y. Sup. Ct. 2001); Beckerman, supra, 511 N.Y.S.2d 33; Goswami v. Goswami, 787 N.E.2d 26 (Ohio Ct. App. 2003); Kahn v. Kahn, 536 N.E.2d 678 (Ohio Ct. App. 1987)). States that have not identified a definitive standard of value are Alabama, Georgia, Maine and South Dakota. Id. at 199.
The below chart illustrates these statistics:
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The standards of value referenced above are the most common. However, other standards exist in different areas of the law. For example, in the context of taxes, several standards of value have been applied: full value, full cash value, cash value, fair cash value, full and fair cash value, true value, true and actual valuation, actual value, full and actual cash value, full and true value, true cash value, true value in money, and market value of fair market value. John P. Ludington, Requirement of full-value real property taxation assessments, 42 A.L.R. 4th 676 (1985). For purposes of federal gift and estate taxes, fair market value is the statutory standard of value. Fishman I, supra, at xix. The Estate and Gift Tax Regulations set forth requirements for determining the fair market value as follows: the price at which a property would change hands; a willing buyer; a willing seller; neither being under any compulsion; both having reasonable knowledge of the relevant facts; specific value as of a specific valuation date; and applicability of subsequent events. Id. at 84-85. In contrast, fair value is the mandated standard for financial reporting that is subject to regulation by the Securities and Exchange Commission. Id. at xix. Fair value is also used in almost every state as the standard for dissenting and oppressed shareholder action. Ibid. Although the standard of value may be identified in these contexts, “there is no guarantee that all would agree on the underlying assumptions of that standard.” Id. at 1. These examples illustrate the vast array of standards that can be applied, but the question here is: what standard of value is appropriate in valuing real estate?
New Jersey Constitution
To determine the appropriate standard of value for real estate in New Jersey in the context of a divorce, we first turn to the New Jersey Constitution. The Constitution states:
All real property assessed and taxed locally or by the State for allotment and payment to taxing districts shall be assessed according to the same standard of value, except as otherwise permitted herein, and such real property shall be taxed at the general tax rate of the taxing district in which the property is situated, for the use of such taxing district.
N.J. Const. art. VIII, § 1, ¶ 1. The concept of standard of value for real property is not only addressed in our State Constitution but also in numerous provisions throughout our statutory scheme.
New Jersey Statutes
For instance, in the context of taxation, the Legislature has declared that “Article VIII, Section I, paragraph 1 of the Constitution of the State of New Jersey requires that all real property in this State be assessed for taxation under the same standard of value, which the Legislature has defined as “true” or “market” value.” N.J.S.A. 54:1-35.40; see also N.J.S.A. 54:4-2.25 (“All real property subject to assessment and taxation for local use shall be assessed according to the same standard of value, which shall be the true value of such real property and the assessment shall be expressed in terms of the taxable value of such property . . . to be applied uniformly throughout the county.”). The meaning of “true value” in the Constitution and the statutory scheme has been defined by case law as “fair market value” as of the date of tax assessment and as the price in money at a fair sale between a willing seller and willing buyer. Town of Kearny v. Div. of Tax Appeals, 137N.J.L. 634, 635 (Sup. Ct. 1948), aff’d, 1 N.J. 409 (1948); Murphy v. Town of West New York, 132 N.J.L. 111, 114 (Sup. Ct. 1944).
Numerous statutes address the concept of standard of value or specify the standard of value to be applied to real estate or other property rights in a particular context. See, e.g., N.J.S.A. 54:4-2.44. Some employ the fair market value standard. See, e.g., N.J.S.A. 2A:18-77 (abandoned tenant property); N.J.S.A. 2A:38A-2 (value of computer systems); N.J.S.A. 2A:42-138 (multifamily housing); N.J.S.A. 2A:43A-1 (library materials); N.J.S.A. 2A:50-3 (bonds and notes); N.J.S.A. 2A:50-22 (bonds, notes and mortgages); N.J.S.A. 2A:50-63 (foreclosure on residential mortgages); N.J.S.A. 2C:1-14 (theft offenses); N.J.S.A. 3B:19B-4 (estates and trusts); N.J.S.A. 4:1B-8 (agricultural preserves);N.J.S.A. 4:1C-31 (farmland preservation); N.J.S.A. 12:3-12.1 (tidelands management); N.J.S.A. 13:8C-32 (garden state preservation trust);N.J.S.A. 13:18A-39 (pinelands protection); N.J.S.A. 17:46A-2 (mortgage guarantee insurance); N.J.S.A. 18A:20-4.1 (education); N.J.S.A.20:3-6 (eminent domain); N.J.S.A. 27:12-1.1 (sale of state highways); N.J.S.A. 46:3B-4 (New Home Warranty and Builders’ Registration Act);N.J.S.A. 52:31-1.5 (state property); N.J.S.A. 54:4-9.1 (tax assessment of personal property). Others refer to fair value. See, e.g., N.J.S.A.54:23.20 (state farmland assessment); N.J.S.A. 54:5-104.100 (conveyance of outstanding interest against certain residential realty); N.J.S.A.4:1C-31 (farmland preservation); N.J.S.A. 12:6-19 (inland waterways); N.J.S.A. 14A:5-6 (liabilities of shareholders in corporations); N.J.S.A.14A:10-5.1 (mergers and acquisitions of corporations); N.J.S.A. 14A:11-6 (rights of dissenting shareholders); N.J.S.A. 18A:18A-45 (sale of personal property in education context). Several statutes use intrinsic value. See N.J.S.A. 2A:17-22 (oath of appraisers); N.J.S.A. 2A:33-9 (time for owner of distrained property to take action); N.J.S.A. 3A:8-3 (appointment of appraisers). Finally, one statute refers to value to the holder. See N.J.S.A. 17B:26-45 (sale of health insurance).
It must be noted that our legislature had the opportunity to expressly mandate a specific standard of value when N.J.S.A. 2A:34-23.1 was added to the statutory framework of divorce law in 1988 (and amended in 1997). It did not do so. This must imply that the legislature has accepted the standard adopted by case law at least to that point in time.
New Jersey Cases
Notwithstanding the foregoing, no case in New Jersey directly addresses the appropriate standard of value to be applied to real estate in the context of matrimonial litigation. However, multiple cases discuss or apply a fair market value standard in assessing the marital home. Genovese v. Genovese, 392 N.J. Super. 215, 222 (App. Div. 2007) (affirming the trial court’s findings as to the fair market value of the marital home for purposes of equitable distribution); Overbay v. Overbay, 376 N.J. Super. 99, 102 (App. Div. 2005) (discussing trial court’s findings on fair market value of marital residence); Elkin v. Sabo, 310 N.J. Super. 462, 474 (App. Div. 1998) (accepting trial court’s valuation of marital home based on fair market value standard); Chambon v. Chambon, 238 N.J. Super. 225, 229 (App. Div. 1990) (stating that court-appointed expert’s report acknowledged that valuation of business did not include the fair market value of real estate owned by the business and that such real estate should have been considered in the valuation); Arnold v. Anvil Realty Investment, Inc., 233 N.J. Super. 481, 484, 487 (App. Div. 1989) (awarding husband difference between sale price of marital home as sold by wife and fair market value); Pascarella v. Pascarella, 165 N.J. Super. 558, 564 (App. Div. 1979) (acknowledging that trial court properly considered the present fair market value of the marital residence, less the outstanding mortgage, as an asset of the marriage); Orgler v. Orgler, 237 N.J. Super. 342 (App. Div. 1989) (accepting fair market value as the standard applicable to value the marital home); Gemignani v. Gemignani, 146 N.J. Super. 278, 282 (App. Div. 1977) (referring to fair market value as the proper standard for assessing the value of the marital home); Colucci v. Colucci, 252 N.J. Super. 73, 79 (Ch. Div. 1991) (rejecting husband’s contention that his interest in marital home was sold below fair market value). For example, in several cases the Appellate Division affirmed the trial court’s findings as to the fair market value of the marital home for purposes of equitable distribution. Genovese, supra, 392 N.J. Super. at 222; Overbay, supra, 376 N.J. Super. at 102; Elkin, supra, 310 N.J. Super. at 474;Pascarella, supra, 165 N.J. Super. at 564. Other Appellate Division cases simply refer to fair market value as the standard applicable in valuing the marital home. Orgler, supra, 237 N.J. Super. 342; Gemignani, supra, 146 N.J. Super. at 282. One Appellate Division case awarded the husband the difference between the fair market value of the marital home and the sale price in light of the fact that the wife sold the home for less than fair market value. Arnold, supra, 233 N.J. Super. at 484, 487. In one trial court decision, the court rejected the husband’s contention that his house was sold below fair market value. Colucci, supra, 252 N.J. Super. at 79. Even in the case of Brown v. Brown, in which the court set the standard of value for business valuation as fair value, the Appellate Division declined to interfere with the trial court’s equitable distribution of the marital home, which was valued using the fair market value standard by stipulation of the parties. 348 N.J. Super.466, 471, 475, 483, 487-88 (App. Div.), certif. denied, 174 N.J. 193 (2002). Moreover, in that case the court distinguished between fair value and fair market value, stating:
“Fair value” carries with it the statutory purpose that shareholders be fairly compensated, which may or may not equate with the market’s judgment about the stock’s value. This is particularly appropriate in the close corporation setting where there is no ready market for the shares and consequently no fair market value.
Id. at 487 (emphasis added).
As an aside, does the emphasized language regarding a “ready market” suggest that a different standard of value (fair market value) should be utilized if there is a ready market for the subject business? Putting that question aside, the Brown court further reasoned that “[c]lose corporations by their nature have less value to outsiders, but at the same time their value may be even greater to other shareholders who want to keep the business in the form of a close corporation.” Ibid.
In the context of real estate, those same concerns may not apply. Generally, there is a market to sell real estate, or at the very least, market comparisons are readily available to value real estate. Thus, the court’s reasons for applying a fair value standard in business valuation may not have any relevance in assessing the value of real estate. However, is it possible to argue that the value of a custodial parent retaining the former marital home for continuity in the children’s lives and other related issues is greater than the value that would result from a sale on the open market? If so, shouldn’t that value be used in order to be consistent with the precepts of Brown?
In light of the case law using fair market value when valuing real estate, the most logical conclusion is that fair market value is the appropriate standard for valuing real estate. In fact, “[o]ne of the most common applications of fair market value is in the valuation of real property.” Fishman I, supra, at 31. In the context of valuing real property, it can be referred to as market value rather than fair market value. Market value is defined as:
A type of value, stated as an opinion, that presumes the transfer of a property (i.e., a right of ownership or a bundle of such rights), as of a certain date, under specific conditions as set forth in the definition of the term identified by the appraiser as applicable in an appraisal.
Ibid.
In assessing the fair market value of real estate, experts generally employ a concept of “highest and best use for the property.” Ibid.; see also St. Joseph Stock Yards Co. v. United States, 298 U.S. 38, 60 (1936) (recognizing the phrase “highest and best use” as a requirement for fair market value of real estate). The phrase “highest and best use” is the “reasonably probable and legal use of vacant land or an improved property that is physically possible, appropriately supported, and financially feasible and that results in the highest value.” Appraisal Institute,The Appraisal of Real Estate 305 (12th ed. 2001). In addition to the requirement that the highest and best use of a property be reasonably probable, it must also meet four implicit criteria: (1) physical possibility; (2) legal permissibility; (3) financial feasibility; and (4) maximal productivity. Id. at 307. These four implicit criteria can be examined through the interaction of four forces, which include social trends, economic circumstances, governmental controls and regulations, and environmental conditions. Id. at 43-44; see also Stephen C. Gara & Craig J. Langstraat, Property Valuation for Transfer Taxes: Art, Science, or Arbitrary Decision?, 12 Akron Tax J. 125, 143-44 (1996).
One caveat is that the highest or maximally productive use of the property may not always be the highest and best use of the property particularly in the context of valuing a residential home. In other words, the valuation expert must distinguish between the “highest and best use of the land as though vacant and highest and best use of the property as improved.” For example, if a single family home used as a residential property is located in a commercial zone, it could potentially be used as a commercial property, which would likely yield the maximum productivity for the property. However, if the market value for residential use is greater than the market value for the commercial use less demolition and improvement costs, then the highest and best use of the property is continued residential use. Id. at 306.
While not often given much consideration in the matrimonial setting, market value may not always be the most appropriate standard to value real estate. Assume that the wife owns a minority interest in a real estate holding company; the real estate owned by the company is leased by an international bank for use as a retail branch. The international bank has a thirty-year lease. The base rent in the lease was set during a downturn in the local real estate market five years prior to the matrimonial proceeding and rents are only set to escalate with inflation. As such, the rents are significantly below market rates. The husband obtains a “market value” appraisal of the real estate, which he uses to calculate equitable distribution. Upon your review of the appraisal, you find that the husband’s appraiser used current market rents based on comparable properties, as opposed to the actual rents paid that are significantly below market. From an economic perspective, the market value appraisal significantly overestimated the wife’s interest in the real estate holding company because it was based on future income that the company would not receive under the terms of the lease. There is a separate standard of value “leased fee value” which more appropriately values the property as encumbered by the lease, which would also provide a better basis to determine the value of the wife’s interest in the real estate holding company. Given this particular fact pattern, the leased fee standard of value is more consistent with the “fair value” standard than “market value.”
In one Appellate Division case, although the court specified the use of “Fair Market Value,” as applied to the value of the marital home, its approach and discussion suggests that some other standard was used. Gemignani, supra, 146 N.J. Super. at 283. In that case, the marital home was a two-family house and the parties rented out one unit in the house to the wife’s mother. Ibid. The Appellate Division determined that the income production aspect of the home must be considered in the asset’s valuation. Ibid. To determine the value, the court capitalized the income production factor, based on the improbable assumption of a constant monthly rent at the current amount for the next eleven years and a 3.5% rate of interest of an annuity. Ibid. Such calculations suggest that the court employed an investment value rather than a fair market value standard when valuing a home with an income producing aspect. See ibid.
Conclusion
There are certain conclusions we can reach from the foregoing analysis: (1) the Legislature has declared that “Article VIII, Section I, paragraph 1 of the Constitution of the State of New Jersey requires that all real property in this State be assessed for taxation under the same standard of value, which the Legislature has defined as “true” or “market” value.” The meaning of “true value” in the Constitution and the statutory scheme has been defined by case law as “Fair Market Value”; (2) “Fair Market Value” appears to be the most common “standard of value” referenced in reported matrimonial cases, which address the valuation of real estate including but not limited to Brown v. Brown; (3) “Fair Market Value” may not have any functional difference with “Fair Value” since there is a “ready market” for most real estate addressed in a divorce context and there are usually no minority owners – therefore there should be no need for a Marketability Discount or Minority Interest Discount; and (4) at least one court (i.e., Gemignani) used a different approach when dealing with income producing property that more accurately reflected the benefit to the holder when the facts required such an application and under certain circumstances leased fee value may the appropriate standard of value.
However, if the general conclusion is that “Fair Market Value” or “Market Value” is the “standard of value” to be applied when valuing real estate incident to divorce, the question is how does this jive with Brown’s mandate for “Fair Value” in valuing a business? This writer respectfully submits that it does not. Assuming Brown is correct, then shouldn’t all assets in a divorce be valued by the same “standard of value”? I respectfully answer this question in the affirmative. It is clear that the “standard of value” follows the area of the law (e.g., (1) estate and gift tax is “Fair Market Value”; (2) real estate valuations for taxation is “Fair Market Value”; (3) shareholder disputes is “Fair Value”, etc.). Our research has not disclosed varying standards of value within an area of law. This is logical since the “standard of value” is linked to the policy underlying the particular area of law. Remember the definition of “standard of value”: the standard of value addresses the questions: “value to whom?” and “under what circumstances?” The answers in the context of divorce are: husband and wives going through a divorce. The question does not ask, “what kind of property?” If the policy in divorce is to treat divorcing parties fairly and compensate them for the present value of the lost future benefit of the asset they will not retain (as Brown suggests), then this salutary policy should apply to all assets, not just businesses. If the value of a closely-held business interest may have more value in the hands of the owner than to a third party purchaser, the same may apply to the value to a custodial parent’s retention of the marital home versus selling it on the market. How such value may be quantified is problematic. Perhaps one calculates the present value of the future rental value of the home for the retaining party’s lifetime or fixed period before a contemplated sale. This writer understands that there are many potential problems with such an approach. However, that does not mean that one “standard of value” should not be used for all assets, but highlights why the use of “Fair Value” for a business interest is incorrect. As this writer has stated elsewhere, the correct “standard of value” is “Fair Market Value” and should be applied to all assets in a divorce.