Appraisals Are Important: 3 Steps to Getting It Right
Written by Lauren R. Talkington
Most everyone knows that appraisals are used to document how much assets are worth. Appraisals play a particularly important part in estate planning and administration. Accurate asset values may be needed for estate tax and charitable deduction requirements, as well as for determining accurate values for selling an asset or making accurate distributions to beneficiaries.
If an appraisal is needed, it helps to consider the following steps:
Step One. What asset needs to be valued? Real estate is very common, but appraisals may be needed for personal property such as antiques, artwork, or jewelry; or, business interests. Particularly in the context of the business appraisals, value may not just be derived from the tangible assets (inventory, real estate, accounts receivable) of the company but also intangible assets – goodwill, intellectual property, or even branding.
If valuing a 40% partnership interest that owns a piece of real estate, there will usually be an appraisal for the real estate, and then an additional appraisal determining the value of a 40% partnership interest in an entity owning that underlying real estate. Because of what partial interests would actually sell for, the valuation is not simply 40% of the property.
Step Two. What is purpose of the appraisal? Understanding why the appraisal is being obtained can dictate the methodology used by the appraiser. For example, valuing a business entity for gift- and estate-tax purposes has a specific set of requirements and factors to be addressed by the appraisal report (Internal Revenue Ruling 59-60).
Step Three. Who should do the appraisal? The appraiser should be experienced in the type of asset in need of valuation and understand the purpose of the appraisal. Most of the guiding principles concerning appraisals come from the Internal Revenue Code, regulations, and rulings. Any qualified appraiser should be familiar with the IRS guidance.
In fact, the IRS has provided a definition of a “qualified appraiser” for the purposes of charitable contribution income tax deductions. Because it is already IRS approved, this definition is a good rule-of-thumb for all tax purposes. To summarize the definition, the appraiser must be appropriately accredited by a recognized appraisal organization and must regularly perform appraisals for compensation (the exact definition can be found at 26 U.S. Code § 170(f)(11)(E)(ii)). Within the recognized appraisal organizations, there are different levels of qualifications and/or specializations that can further differentiate appraisers.
To highlight the importance of appraisals, consider the case Gardner v. Commissioner (August 24, 2017). The controversy stemmed from a charitable deduction of $1,425,900 claimed for donating hunting specimens to an ecological foundation. The IRS did not agree with the deduction value and issued deficiency notices for two tax years. The Tax Court took a detailed look at the relied-upon appraisal report methodology (replacement cost vs. comparable sales) and even noted that the appraisal report itself contained poor-quality photographs and generalized information. Ultimately, the court decided the charitable contribution deduction was limited only to $163,045. That’s right – a difference of $1,262,855!
There are even specific rules that require an appraisal to be prepared and provided to the IRS at a certain time. If the appraisal is not provided at the specific time, or if the wrong interest is valued, even if the taxpayer can later clearly prove the value of the asset, the deduction may be lost for good.
Appraisals are an important part of many estate plans and administrations, so it is good to understand how they may fit in to your overall plan.