Common sense would tell you that companies or individuals that might be interested in selling a piece of property, particularly with regard to art, antiques or jewelry, should not be the ones setting the value on that same property.
A recent decision from the U.S. Tax Court scored one for common sense, with its decision in Estate of Kollsman v. Commissioner. The art collector’s estate had significantly underreported the value of two pieces of art for estate tax purposes, as a result of the estate relying on appraisals by an internationally known auction house specialist who undervalued the artwork with an eye to winning the right to auction the works at a later date.
In addition to this conflict of interest, the Tax Court held that the values reported by the estate were unpersuasive. The auction house specialist misrepresented the extent of dirt on the paintings and failed to adjust his appraisals after one of the works sold at auction for approximately five times more than the reported value.
Wealth Management’s recent article, “Appraisal Relied on by Estate Undervalued Paintings By $1.77 Million,” tells the story of art collector Eva Kollsman, who died in 2005. Her estate included two 17th century Old Master paintings known as Maypole and Orpheus, the former created by Pieter Brueghel the Younger, and the latter by Jan Brueghel the Elder, Jan Brueghel the Younger, or a Brueghel studio.
Sotheby’s Auction House sent a document to the executor of Eva’s estate (who was also a residual beneficiary of the estate) stating that the fair market values of the two works—“based on firsthand inspection of the property” (but without further elaboration)—were $500,000 and $100,000, respectively. The estate later attached this document to its U.S. Estate (and Generation Skipping Transfer) Tax Return. Sotheby’s also sent an agreement to the executor proposing that the executor grant Sotheby’s the exclusive right to auction the works for five years. The agreement set the values of the works at $600,000 to $800,000 for Maypole and $100,000 to $150,000 for Orpheus. The executor signed the agreement.
The IRS issued a notice of deficiency, asserting that the values of Maypole and Orpheus were $1.75 million and $300,000, respectively. The estate petitioned the U.S. Tax Court for redetermination. After the estate filed its petition, the IRS asserted that the values of Maypole and Orpheus were $2.1 million and $500,000, respectively.
The U.S. Tax Court sustained the IRS determination and afforded very little weight to the opinions of Sotheby’s specialist. The court found that the specialist “had a significant conflict of interest”, because he provided his fair market value estimates at the same time he was soliciting the executor for the exclusive right to sell the works. In light of the fact that Sotheby's stood to earn significant commissions from the anticipated sales, the specialist “had a direct financial incentive to curry favor with [the executor]” by providing ‘lowball’ estimates that would lessen the Federal estate tax burden borne by the estate.” The court noted that, even though Sotheby’s sold Maypole in 2009 for roughly $2.5M, the specialist's valuation opinion didn’t change in the valuation report he prepared for trial.
The Tax Court found that the Sotheby’s specialist exaggerated the dirtiness of the paintings on the valuation date, along with the risks of cleaning them. The IRS expert’s valuations of $2.1 million and $500,000 for Maypole and Orpheus, respectively, were largely acceptable to the court. The court applied a 5% discount for the risks associated with cleaning both paintings, a 10% discount to the value of Orpheus because it was bowed, and an additional 10% discount to the value of Orpheus because of issues surrounding its attribution. The court, therefore, found the values for the paintings were $1.995 million and $375,000, respectively (about four times what was reported by the estate).
To retain their objectivity, an appraisal professional should not be involved in the sale of the item. An independent appraisal should prepare a report in compliance with the Uniform Standards of Professional Appraisal Practice, which includes a certification that the opinions in the report are unbiased professional opinions and a statement that the appraiser has no present or future interest in the property being appraised or any personal interest with the parties involved. If there is any interest, it must be disclosed to clarify the relationship with the parties and document this interest to avoid problems for the estate in the future.
And one final note: post-valuation date events, particularly if the item is sold at auction, must also be documented, as they will be relevant to the valuation analysis.
Reference: Wealth Management (March 31, 2017) “Appraisal Relied on by Estate Undervalued Paintings By $1.77 Million”