WHAT IS AN ESTATE TAX APPRAISAL…………WHY, HOW, WHEN and WHAT………??
Why are there so many different types of appraisals? Do professional advisors requisition the correct appraisals to address the many unique legal and financial objectives? How can there be extremely different appraised values for the same item?
These are some of the questions on the subject of appraisals that haunt the estate attorneys, financial planners and tax consultants. The successful appraisal requires a critical understanding of the purpose for which the appraisal is needed. To the extent that the purpose is confused the particular method of valuation employed may lead the professional astray producing a document of little or no value to their client.
Here we begin to understand that all appraisals are not necessarily the same.
A Hypothetical ……. The compounding misuse of an appraisal format
The client had an appraisal done for estate tax purposes and, looking for a shortcut, made use of that estate tax valuation (Fair Market Value) appraisal in order to:
- Determine the value of tangible asset as part of an equitable distribution, including cash, to embattled heirs. This should have been addressed in a separate Marketable Cash Value document which would have more importantly made use of net rather than gross fair market value numbers (25% to 30% less). Also, the proper appraisal would not have included an illegal non-saleable asset (i.e., ivory, Native American artifacts, etc.) which, because they were included in the distribution, created a totally unequal distribution.
- Oversee the immediate liquidation of some of the heir’s assets for prompt cash-out. This yield is normally less than half that of FMV as would have been addressed in a separate Liquidation Value document giving their client an accurate expectation of sale results.
- Determine the value for insuring those items retained by the estate, which would have been properly noted in a separate Replacement Value document describing a substantially higher appraisal valuation.
The above example illustrates the many reasons for distinctly separate appraisals, each with their own specific approach to valuation, each with a very different appraised value determination.
The different approaches to valuation ….. (THE WHY) –
For IRS, estate tax and donation,……. Fair Market Value : Fair market value, is defined as the gross price that property would sell for on the open market between a willing buyer and willing seller, with neither being required to act, within reasonable timing and both having reasonable knowledge of the relevant facts. This value includes all fees and sales commissions. It is important to recognize that this is a gross figure, usually 25% to 30% higher than the monies that will ultimately be received by the consignor. This market suggests an “orderly event”, one that allows for proper announcement and time for preparation and organization. When large quantities of the same objects are being offered (same artist, etc.) blockage discounts will be recognized in the appraisal.
For equitable distribution,….. Marketable Cash Value:
This is fair market value but net of all expenses. This value excludes all fees, costs and sales commissions and addresses the marketability of questionable items. As the value so derived represents the actual proceeds that will be paid to the seller after the sale which is in some cases 25% to 30% less than sale or hammer price, this method is most often used in equitable distribution as well as divorce settlements.
For casualty insurance,….. Replacement Value:
This is the amount it would cost to replace an item with one of similar and like quality, age and provenance, purchased in the most similar and appropriate marketplace to the original within a specific and limited amount of time. Replacement value is generally the highest valuation assigned to personal property and is used in cases of loss or theft.
For loss replacement less depreciation,….. Actual Cash Value:
This insurance valuation used where there are items with limited life spans and is defined as the replacement cost less accumulated depreciation. This method may be used when appraising machinery.
For immediate sale after distribution or for bankruptcy,….. Liquidation Value:
Liquidation value is the sales revenue achieved within an immediate and specified period of time and is the lowest valuation assigned.
The Methodology to Valuation….. (THE HOW):
The three generally accepted methods used in valuation are:
Market Comparison Approach: Where value is determined by comparing those prices asked or achieved by dealers or at auction and where like markets in like locations must be used. The markets to be considered include; the wholesale market, broker’s market, the glamour market, the collector’s market (California impressionists may sell at different prices in California then in New York) and even the “discreet” or illegal market.
The “Discreet” or Illegal Market can complicate the appraisal. As a case in point, in the Sonnebend case, the estate appraisers for estate tax purposes valued an iconic Rauschenberg painting at zero because of an “attached” rare stuffed bald eagle (covered by the eagle protection act) that banned the painting from sale. The IRS and the Art Advisory Council took a very different view of the painting and valued the art at 65 million dollars and demanded payment of a 29.2 million dollar estate tax and an 11.7 million dollar penalty and fine. Even though there is 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 part of the settlement the IRS dropped the tax assessment and in exchange the family was required to donate the painting, “Canyon” to The Museum of Modern Art in New York City without being allowed to claim a tax deduction.
The Income Approach: If the item can be used to generate income ( i.e., Getty Images leases film clips by the second) the value determined can then be based on the market value needed in the appropriate business period to generate an equal or comparable income stream often based on then prevailing bond yields.
The Cost Approach: Here value is determined through a comparison of the cost to replace, through manufacture, another similar or like item. While this approach is limited in the valuation of most fine arts, it has been especially valuable in the area of documentary film and photographs. Addressing the normally increasing production and reconditioning costs are crucial when appraising the value of film which will often move the appraiser to apply, in addition to the income approach, a cost analysis.
A Hypothetical …… Finding Four Discreet Valuations for the Same Image
An iconic image is created by an established living artist and has been valued differently based upon a variety of uses.
- Market comparison approach (1): An image that is to be donated by a collector owner for use on a political campaign button – Market Value of $25,000
- Market comparison approach (2): An image that has been struck as a lithograph in a series of 50, each selling at @ $2,500
- Cost approach: An image commissioned by an advertising agency as a company logo – Market Value of $375,000
- Income approach: The image that is leased to a manufacturer for a clothing line (scarves, shoes, accessories, etc.) – Market Value of $600,000
An appraisal is a valuation in a specific moment of time. This must be understood in light of the practical understanding that “all fine art is considered to be appreciable” and as such has the potential for increasing in value over time. Of course, with less established artists…….. timing, the market and reputation may lead to a diminution in value as well.
The Market….. (THE WHERE):
Many marketplaces exist as; auctions, galleries, antique shows, the internet. The appraisal should select the most appropriate market or markets for the items and the clients. i.e., jewelry purchased on Rodeo Drive should be valued as being replaced at that venue while items purchased on the diamond exchange should be valued at their discounted level. A piece of contemporary Chinese art may not do as well in New York as in Beijing but must be valued in situ, in its appropriate market. It follows that for insurance purposes it is inappropriate to use auction prices for items that may or may not become available for a long time, but rather one should use retail or gallery prices for items currently available. Considering this issue of timeliness and availability, retail prices as replacement values are the highest valuations.
The important factors for determining the market from which to choose comparables are: the market where the owner would or did purchase the item; the market in which the item is normally sold; and the market that is geographically most fitting. An appropriate appraisal establishes the market place with a full explanation including the history (provenance) of the items being valued.
Specifically in cases involving taxation, i.e., estate valuation and donation or a sophisticated collector or dealer the market would be, in all probability, the auction market that he or she frequents while the casual owner could successfully argue that they purchase from galleries who offer guarantees of authenticity and uncontested title. This issue may become crucial in determining a valuation for the deduction of donations.
Condition …… ( THE WHEN, ESPECIALLY WITH WINE )
In fine art, film, sculpture, collectibles and most other tangible assets the immediate condition is somewhat easily distinguished. Where necessary scientific investigation is used along with the provenance which, if available, can be researched and catalogued. However, in the case of fine and rare wines condition is a more esoteric consideration. A large cellar with bottles stacked on their sides cannot be disturbed to enable the appraiser to check ullage (amount of loss through evaporation)for fear of roiling the sediment. Then there are the questions of; Where has the bottle been and what were the temperature conditions (wide swings are not good for wine)? Is the storage damp or humid, with a minimum of 70% humidity and a maximum of 95% (mold sets in above 95%)? Is the area free from vibrations, heavy traffic, washer/dryers, refrigerators? How have the bottles been transported and, of course, what is the vintage. These conditions, however difficult to discern, are crucial to determining value. In most cases, for the appraiser, tasting is the last and least important measure.
Provenance….. ( THE WHAT )
Jackie Kennedy’s $500 three strands of faux pearls were sold to the Smithsonian at auction for $211,500. An honest and scholarly provenance is the highest insurance for a fair and correct appraisal; on the other hand, a provenance attached to the ownership by a celebrity may falter when the celebrity’s star dims. The famous Andy Warhol cookie jars that, because they were his, in 1988, sold for $200,000, most assuredly will not retain that value in the future. A painting by a recognized artist that is owned by a famous collector or recognized dealer will, due to its provenance, take on a higher fair market value because a collector assumes that the “expert” has vetted the painting’s lineage. In this case the provenance is an indicator of fine taste and high quality. An important value to provenance is that fakes abound in both the high and not so high market. The high incidence of a fake Dali, Chagall, Miro, Calder Picasso or, among many others a Faberge Egg, can shake the collectors and the appraiser’s confidence leading to a more conservative valuation when this might be harmful, say, in the case of donation. Going back to the Sonnabend case, the fact that the contraband eagle was caught by Teddy Roosevelt coupled with Rauschenberg’s rich history, may have left the Art Advisory Council to reason that provenance trumped the inability to legally sell as an issue.
Authentication……..Appraiser’s job?
Financial professionals and unsophisticated owners are not necessarily expected to spot fakes, so they should, where indicated, check to see that the appraiser has consulted scholars, museum curators, dealers, auction houses, families of artists and catalogues raisonnés (a comprehensive list of works by an artist). It is incumbent upon the appraiser to be sensitive to the possibility of the problem and to recommend the use of scientific analysis if there is a question.
Counterfeit wines are estimated to account for as much as five percent of the secondary market (Wine Spectator). For centuries, most wineries made little effort to make sure their wines could not be faked. Unfortunately, even the most advanced RFID technologies cannot absolutely ensure that the product inside the bottle is genuine.
The appraiser is required to make every reasonable effort to gather all available information relative to the appraised object. But in some cases, even experts have been unable to come to agreement as to whether a work is authentic. In George O. Doherty and Emelia A. Doherty v. Commissioner, 16 F.3d 338 (9th Cir., 1994), two of the foremost authorities on the paintings of Charles M. Russell could not resolve the question of authenticity of a donated painting. In 1969, the Dohertys bought “Attacking Stagecoach,” which may or may not have been painted by Russell, for $10,000. They donated an undivided 40% interest in the painting to the Charles M. Russell Museum in Great Falls, Mont., in tax year 1982 and the remaining 60% in tax year 1983. In those years, they claimed charitable contribution tax deductions in the amounts of $140,000 and $210,000. The IRS, backed by its expert, maintained that the painting was a forgery and worth only $100. The court noted that the credentials of the two sides’ experts were beyond question, yet they had reached different conclusions. The court said that it could not rule on authentication and concluded that the painting had a value of $30,000, recognizing the fact that even if the painting were authentic, the dispute had affected its fair market value.
The Appraisal
The accuracy of the appraisal is as important as choosing the right type of appraisal , especially where taxes are concerned. The following are the results of the Annual Summary Report for Fiscal Year 2020 of The Art Advisory Panel that provides advice and makes recommendations to the Art Appraisal Services unit in the Office of Appeals for the IRS. The Panel helps the IRS review and evaluate the acceptability of tangible personal property appraisals of fair market value claimed on works of art involved in income, estate, and gift tax returns.
The AAS appraisers review appraisals by researching publicly-available information; the Panel provides additional knowledge of private sales based on their personal experience as dealers, scholars, and museum curators, and from information obtained from other members of their relatively small industry. The panelists’ knowledge is particularly beneficial when questions exist about the authenticity of works of art.
The Panel meets once or twice a year in each specialty area. During FY2020, the Panel completed its review of 43 items with a combined taxpayer valuation of $57,672,000 on 14 cases under audit.
The Panel recommended accepting 12 items or 28% of the items presented. It adjusted the value of 31 items or 72 percent. On the 31 items adjusted, the Panel recommended total net adjustments of $12,372,565 to the claimed values, a 24.45% increase.
From the 2020 IRS Art Advisory Panel report
The Appraiser
It must be noted that there are no licensure requirements for the appraisal of personal tangible assets (not so in real estate) and, as it is not regulated, appraising may be considered self regulated. Also, to be considered is the fact that all appraisal documents are, by their very nature and definition, subjective. It is therefore most incumbent upon the legal and financial professional to interview and review the credentials or provenance of the appraiser in depth in order to determine the level of expertise.
In conclusion
We have defined appraisals in different ways and in different contexts. But, at the end of the day an appraisal is an opinion or statement of value. When a report is created by one who holds himself or herself out to the general public as a professional, that report and its conclusions can be considered to be a legal document. Verbal appraisals or judgments of value may also be subject to the same legal oversight.
As stated initially, all appraisals are not the same. All legal and financial professionals do not necessarily address the fundamental nature of the appraiser or the appraisal report equally. It behooves all legal and financial professionals to work closely with their clients to determine the real purpose for which the appraisal will be written and review that purpose with the appraiser. Ultimately it is an informed appraiser and the process that will bring the “right” value to the table.