shareholders requesting approval for the proposed merger. Approximately 88 percent of FOH stockholders, including the trusts, voted in favor of the merger. After negotiating the price, Knightsbridge and FOH entered into an agreement dated September 25, 1997. Pursuant to this agreement, Knightsbridge purchased from the Harriett trust and the QTIP trust all of the FOH shares that were held by the trusts for $6.90 per share. Immediately thereafter, pursuant to the merger agreement, Knightsbridge acquired the remaining outstanding shares of FOH from the remaining shareholders for $7.75 per share.

On examination, respondent determined that the FOH shares that were held by the Harriett trust and the QTIP trust would be merged for valuation purposes, and, in the January 15, 1997, notice of deficiency, respondent indicated that the FOH shares in each trust should be valued at $20,820,159.39 or $8.46 per share.

Overview of FOH

Founded in 1946 by Mr. Mellinger and incorporated in Delaware in 1962, FOH began as a small mail-order operation selling an assortment of women's intimate apparel. In 1947, the business was moved to Hollywood, California, opening its first retail store there in 1952. In its beginning, FOH's name was synonymous with risque lingerie. The company's original market was American GI's who, after spending time abroad, were eager to get for their wives or girlfriends the lingerie that was fashionable in Europe. FOH pioneered many trends in the industry including the extensive use of black, the pointy snow-cone bras of the 1950's, and the revival of garter belts in the 1980's. The company's products had the reputation of being "slightly naughty" but not offensive, and this style proved to be highly successful in the 1960's and 1970's.

By the early 1980's, however, the risque look of FOH's products began losing appeal. These trends caught FOH off guard, and the company's operations began to falter. At the same time, Mr. Mellinger developed Alzheimer's disease. He retired in 1984 with FOH's profits dwindling. Under new management, FOH enacted a plan to turn the company around. The company's catalogs were purged of nudity, and the black and white pictures were replaced with color photo

graphs of models. On the retail store side, a major overhaul was also enacted. The company spent heavily to upgrade store ambience and to improve the merchandise mix.

All of these steps successfully repositioned FOH as a specialty retailer of intimate apparel. The company operates 206 specialty boutiques in 39 States with the highest concentration of stores in California. FOH developed a mail-order subsidiary to engage in extensive operations in all 50 States, with catalogs published 11 times a year.

For convenience, the following chart shows the net sales, net earnings, earnings per share, total assets, and equity of FOH for the fiscal years ended September 1, 1990; August 31, 1991; August 29, 1992; and August 28, 1993.

At the valuation date, FOH had one class of stock outstanding that traded on the NYSE, and those shares were unregistered with the SEC. Additionally, on the valuation date, the average price of FOH stock on the NYSE was $6.9375 per share.

Economic Conditions at the Valuation Date

At the valuation date, the American economy was experiencing a transition from recession to a recovery. The U.S. gross domestic product (GDP) grew 2.1 percent in 1992 following the 1991 recession. Economic improvements had generally been fueled by low interest rates, increasing corporate profits, and strong productivity growth. Despite these positive factors, structural problems, including excessive debt, corporate restructuring and related uncertainties regarding job growth, overvalued real estate, weak banks, defense spending reductions, and consumer confidence continued to hamper the strength and speed of the recovery.

A survey of economists by the Wall Street Journal in early 1993 revealed a a consensus estimate of a 3-percent GDP growth rate for 1993, with a 2.8-percent growth rate expected

in the first half. This rate represents continued moderate growth but is below below that that normally experienced in postrecessionary years. Nondurable goods expenditures advanced 5.9 percent in 1992 after falling 5.6 percent in 1991.

The California marketplace did not experience the rebound seen in the majority of the nation in 1992. Its economy continued to be impacted negatively by defense industry layoffs and a declining housing market. The Wall Street Journal reported that the California economy was expected to continue to trail far behind that of the rest of the United States in 1993.

ULTIMATE FINDINGS OF FACT

The fair market value of FOH shares includable in decedent's gross estate should reflect a 25-percent discount for lack of marketability. On the valuation date, the fair market value of each of the two 27.8671-percent interests in FOH that were held by the trusts was $12,802,705, or $5.2031 per share.

OPINION

Issue 1

Section 2031 generally provides that the value of a decedent's gross estate includes the value of property described in sections 2033 through 2044. See sec. 20.20311(a), Estate Tax Regs. Under section 2033, the value of a decedent's gross estate includes the value of all property beneficially owned by the decedent at the time of death. See sec. 20.2033-1(a), Estate Tax Regs. Section 2044(a) includes in the gross estate the value of property in which the decedent had a qualified income interest for life and for which a marital deduction was allowed to the estate of a predeceased spouse under section 2056(b)(7) (QTIP property). Accordingly, at the death of the second spouse, QTIP property is taxed as part of the surviving spouse's estate. Sec. 2044(c).

Property includable in the gross estate is generally included at its fair market value on the date of a decedent's death. Sec. 2031(a); sec. 20.2031-1(b), Estate Tax Regs. Fair market value is defined as the price that a willing buyer would pay a willing seller, both persons having reasonable

knowledge of all of the relevant facts and neither person being under a compulsion to buy or sell. United States v. Cartwright, 411 U.S. 546, 551 (1973); sec. 20.2031-1(b), Estate Tax Regs. The willing buyer and the willing seller are hypothetical persons, rather than specific individuals or entities, and the individual characteristics of these hypothetical persons are not necessarily the same as the individual characteristics of the actual seller or the actual buyer. Propstra v. United States, 680 F.2d 1248, 1252 (9th Cir. 1982). The issue in this case is whether FOH shares in the Harriett trust should be aggregated with FOH shares in the QTIP trust for purposes of ascertaining the fair market value of property passing from decedent.

Historically, undivided fractional interests in property included in an estate have been valued at a discount to reflect lack of marketability and minority interest holdings. See Estate of Andrews v. Commissioner, 79 T.C. 938, 952-953 (1982) (minority interests); Estate of Piper v. Commissioner, 72 T.C. 1062, 1084-1086 (1979) (marketability discount). Respondent, however, has long opposed such discounts and has argued for unity of ownership principles in estate tax cases. See, e.g., Estate of Bonner v. United States, 84 F.3d 196, 198 (5th Cir. 1996); Propstra v. United States, supra at 1251; Estate of Bright v. United States, 658 F.2d 999, 1001 (5th Cir. 1981); Estate of Andrews v. Commissioner, supra at 952-956. Specifically, respondent has argued that a decedent's fractional interest in property should be aggregated with fractional interests owned by family members in the same property for purposes of valuing the property in the estate. Propstra v. United States, supra at 1251; Estate of Bright v. United States, supra at 1001; Estate of Andrews v. Commissioner, supra at 952. Respondent's basis for this position was that such undivided fractional interests should be valued by taking into consideration family cooperation and the likelihood that fractional interests will be sold together rather than separately. See Propstra v. United States, supra at 1251; Estate of Andrews v. Commissioner, supra at 952. Respondent relied on this argument despite section 20.2031– 1(b), Estate Tax Regs., which ignores subjective factors of ownership in valuing estate assets. Estate of Bonner v. United States, supra at 198. Ultimately, respondent reviewed this position and conceded that, for estate tax purposes,

respondent would follow Estate of Bright v. United States, supra, and Propstra v. United States, supra, where family attribution had been rejected. See Rev. Rul. 93-12, 1993–1 C.B. 202.

The Court of Appeals for the Ninth Circuit addressed the Commissioner's aggregation theory in Propstra v. United States, supra. In Propstra, the decedent died with an undivided one-half interest in several parcels of real estate owned by him and his wife as community property. These parcels of community property had an undisputed fair market value of $4,002,000, but, in valuing the property for estate tax purposes, the executrix discounted the fair market value of the decedent's one-half interest by 15 percent to account for the relative unmarketability of the decedent's undivided fractional interest. The Commissioner disallowed the 15-percent discount, arguing that the decedent's interest in the property should be valued together with the interest owned by the surviving spouse. “[O]ne can reasonably assume that the interest held by the estate will ultimately be sold with the other undivided interest and that interest's proportionate share of the market value of the whole will thereby be realized." Id. at 1251.

*

The Court of Appeals for the Ninth Circuit considered the language of sections 2031 and 2033, along with the accompanying regulations, and decided that Congress did not intend to have "unity of ownership" principles apply to property valuation for estate tax purposes. Id. The court stated: By no means is * * [the language of section 20.2031-1(b), Estate Tax Regs.] an explicit directive from Congress to apply unity of ownership principles to estate valuations. In comparison, Congress has made explicit its desire to have unity of ownership or family attribution principles apply in other areas of the federal tax law. See, e.g., I.R.C. §§ 267, 318, and 544. In the absence of similarly explicit directives in the estate tax area, we shall not apply these principles when computing the value of assets in the decedent's estate. [Id. at 1251.]

The court concluded that the decedent's fractional interest in the subject property should be valued separately from the accompanying fractional interest held by the surviving spouse, upholding the 15-percent discount. Id. at 1253.

Respondent argues that decedent's situation is distinguishable from Propstra because all of the property to be aggregated in this case is included in decedent's estate. The FOH