The Personal Property Appraisal and Appraiser, By Alan Breus
Different objectives demand different approaches to value
The success of an appraisal requires a critical understanding of the purpose for which that particular qualified appraisal is needed. Whether for donation and estate tax issues, equitable distribution, insurance or liquidation, the wrong path chosen may result in some very unwelcomed outcomes.
Different purposes dictate different appraisal methods.
- Insurance liability, which uses “replacement” or “retail value”, normally generates the highest value in appraising, typically twice that of “fair market value” (FMV).
- For estate tax and donation purposes, “fair market value” is a principle favored by the IRS and is a gross value that includes all sales costs and commissions.
- With divorce and equitable distribution, we use “marketable cash value” (MCV) which is defined as how much the seller would actually receive if the item was offered for immediate sale “net of expenses” or some 25% to 30%+ less than FMV.
- “Liquidation value” is defined as the “the price realized in a sale situation under forced or limiting conditions and under time constraints” and is traditionally the lowest valuation.
Using any of the methods incorrectly will result in clearly unintended valuation errors and the possible consequence of egregious fines from Govt. agencies.
Donation and Estate Tax
For donation and estate tax issues, appraisers must use fair market value (FMV). Treasury Regulations Section 25.2512-1 defines FMV as, “the price that property would sell for on the open market between a willing buyer and a willing seller, neither being required to act, and both having reasonable knowledge of the relevant facts.” This is the only definition accepted by the Internal Revenue Service for taxation purposes. This is the gross value inclusive of all fees and sales commissions.
Equitable Distribution and Divorce
For equitable distribution, appraisers should use marketable cash value (MCV) (which includes no commissions or fees). In an actual case culminating in a 700 page-plus appraisal report, the advisor had the initial appraisal done for estate tax purposes and then, looking for a shortcut, used the estate tax valuation (FMV) appraisal to determine the value of tangible assets as part of an equitable distribution to embattled heirs. By doing so the trustees created a totally imbalanced and inequitable allocation of funds to cash distributions when they did not explaine to the heirs that the results of any immediate sale would be the MCV which is 25% to 30% less than the inappropriate FMV appraisal valuation. Also, the heirs were burdened with unequal monetary allocations when the trustees failed to note that the illegal commodities had no market value even though presented as part of the FMV of the estate and distributed accordingly.
MCV makes use of the net (no commissions or fees) rather than gross FMV numbers (25 percent to 30 percent higher). Also, the proper document leading to determining distribution doesn’t include illegal or non-saleable assets (for example, ivory, prohibited firearms), which, although they’re included in the estate at FMV their distribution, create a totally imbalanced real value allocation.
The IRS maintains that an illegal commodity (for example, ivory, Indian feathers or eagles due to the eagle protection act) may have a very real personal property estate FMV, and the FMV of this property must be included in the decedent’s gross estate. Concerning the illicit market (in which ivory objects are regularly sold), in Publicker v. Commissioner, the U.S. Court of Appeals for the Third Circuit considered the FMV for gift tax purposes (applicable to donations and estate tax issues) of rather unique jewels. The question arose as to whether, because of the uniqueness of the jewels, there was a viable retail market. The court stated that there were dealers willing to purchase the items, which established an available market, noting that uniqueness doesn’t condemn a property to no market. Therefore, the court concluded that, even though property may be unique, a “market” nevertheless exists in which the value of the property may be measured.
In a case involving the estate of Ileana Sonnabend (which eventually settled), the estate appraisers valued an iconic Rauchenberg, with a rare stuffed bald eagle “attached” to the canvas, at zero. The IRS and the Art Advisory Panel took a very different view of the “painting” and valued the piece at $65 million. It demanded payment of a $29.2 million estate tax and an $11.7 million penalty and fine. Even though there’s no legal market for this painting, there may be an extralegal avenue, and the true intrinsic value of the art must be considered due to its stunning and stellar quality.
As an interesting point, had the painting been donated prior to the owner’s death (the owner was aware of the problems), the proposed FMV might have been a deduction (with its inherent advantages), and the estate wouldn’t have been burdened with the problem.
Insurance
Going in the other direction, any items retained in the estate or kept by the by the beneficiaries that will be insured should be properly illustrated in a separate replacement value document describing a substantially higher appraisal valuation.
Replacement value is defined as: “The amount it would cost to replace an item with one of similar and like quality purchase in the most appropriate market place in a limited amount of time. Replacement value is generally the highest valuation ascribed to an item of personal property.”
Liquidation
The FMV or MCV appraisal would be inappropriately re-used to value the immediate liquidation of any of the heir’s assets for prompt cash-out. Immediate liquidation yield is typically less than half that of FMV. A separate report by the appraiser is suggested in the normal course of events giving an accurate expectation of sale results and not the angry heir’s reactions that the error might generate.
Qualified Appraiser
There are no licensure requirements for the qualified appraiser of personal tangible assets (not so in real estate) so appraising may be considered self-regulated. Also, consider the fact that all appraisal documents are, by their nature and definition, subjective. It’s therefore most incumbent on the legal and financial professional to interview and review the credentials or provenance of the appraiser in depth to determine their level of expertise.
When a tax return selected for audit includes an appraisal for a single work of art or cultural property valued at $50,000 or more, the IRS examining agent or appeals officer must refer the case to Art Appraisal Services (AAS) for possible referral to the Panel, unless a specific exception exists. The appropriate results from the appraisal may depend on choosing the right appraiser with the right qualifications, especially when taxes are concerned. In the world of checks and balances, the Art Advisory Panel (the Panel)6 provides advice and makes recommendations to the AAS unit in the Office of Appeals. This Panel, with its own appraisers, helps the IRS review and evaluate the acceptability of tangible personal property appraisals of works of art involved in income, estate and gift tax returns.
Qualfied appraisal. According to IRS Pub 561 the qualified appraisal (value) of each claim must be performed by a “qualified appraiser.”
Per Notice 2006-96, the IRS defines “qualified appraisal” as a document that:
- is made, signed and dated by a qualified appraiser (defined below) in accordance with generally accepted appraisal standards
- meets the relevant requirements of Regulations section 1.170A-13(c)(3) and Notice 2006-96, 2006-46 I.R.B. 902 (available at www.irs.gov/irb/2006-46_IRB/ar13.html)
- relates to an appraisal made not earlier than 60 days before the date of contribution of the appraised property
- doesn’t involve a prohibited appraisal fee
- includes certain information, such as a property description, terms of the sale agreement, appraiser identification information, date of valuation and valuation methods employed, among other requirements.
Taxpayer penalties.
- Twenty percent penalty: Where adjusted basis is determined to be 150 percent or more, and tax underpayment is determined to be more than $5,000
- Forty percent penalty: Where adjusted basis is determined to be 200 percent or more, of the correct amount, and tax underpayment is more than $5,000
The IRS defined “qualified appraiser” as an individual who:
Has earned an appraisal designation from a recognized professional appraisal organization (such as the Appraisal Institute, ASFMRA, NAIFA, ASA, AAA etc.)
OR, has met certain minimum education and experience requirements:
Education requirements. These include:
Class room hours (120) in appraisal theory, practice, ethics and methodology and area(s) of appraisal specialization, and
Fifteen hour USPAP Foundation Course, and
Thirty semester credit hours from an accredited college, junior college, community college, or university, or
An associate’s degree or higher
Experience requirements. These include:
Seven hundred hours appraisal research, development and writing experience, and
Eighteen hundred hours of market-related experience (at least 900 of which are
in the appraiser’s area of specialization), and
Four thousand, five hundred hours of market-related personal property non-appraisal experience in area(s) of specialization, or
An equivalent combination of market-related personal property appraisal experience and market-related non-appraisal experience in area(s) of the appraiser’s specialization based on a minimum ratio of one year to two and a half years of continuing education.
Continuing education. Seventy hours every five years, which must include at least 20 hours valuation theory-related
coursework, and
seven hours of USPAP Update Course every two years or 15 hours USPAP Update Course every five years
- Regularly prepares appraisals for which the individual is paid
- Demonstrates verifiable education and experience in valuing the type of property being appraised
- Hasn’t been prohibited from practicing before the IRS under IRC Section 330(c) at any time during the 3-year period ending on the date of the appraisal
- Isn’t an excluded individual (someone who’s the donor or recipient of the property).