Taxable events can sometime give rise for the need of an appraisal. But what should we consider before accepting the assignment? There is more than Federal law that can dictate how to proceed. Is the value information stated or certified? Who says distribution needs to be equitable?

Jim White, the discoverer of Carlsbad Caverns declared upon seeing the cavern entrance for the first time, "Standing at the entrance of the tunnel I could see ahead of me a darkness so absolutely black it seemed solid." Some appraisal assignments seem solid black.

It is difficult to navigate a cave without some snapshots of the cavern from the entrance to the grotto. But guided by the photos of the cave's interior, the darkness no longer seems as much of a hindrance.

        Transfer of Property - Tax Man Cometh

A change of owners is a taxable event. Thus, we have taxes for gifts, selling and buying goods, estate taxes, inheritance taxes, charitable donation, etc. The question is not whether there is a tax liability but rather how to render the report in accordance with the legal requirements.

        Such a Priviledge

When someone dies, they can no longer administer their estate. Hence, the court appoints someone to administer the decedent's estate. Thus, an estate tax is a privilege tax - a tax for the privilege to have someone administer one's estate after they die.² Estate tax is a privilege tax paid by the estate. But wait, there is another privilege tax called an inheritance tax. Inheritance tax is a tax paid by an inheritor for the privilege of receiving property from an estate. Although there is no federal inheritance tax, what about the states?

Most states have neither an estate nor an inheritance tax. A few states have one but not the other. And not many states have both. The gemologist-appraiser must render the report to follow the federal as well as state regulations.³ Do not assume the state's needs match the federal requirement.

        Probate

Probate is a "court procedure by which a will is proved to be valid or invalid."⁴ State courts conduct the administration of estate settlements. The court is commonly referred to as probate court. If one does not have a will (intestate) the state will have one for you. Understand that one may need a will if they do not like their state's version of a will.

If there is a will and the person named in the will to administer the estate, if approved by the probate court, will be called an executor (male), or an executrix (female). If the person named in the will cannot serve or there was no will,⁵ then the court will appoint someone. That person is called an administrator (male) and administratrix (female). I recommend that you do not try to use the four Latin suffixed terms but instead simply refer to the person administering the estate as a "personal representative."⁶

The federal government has an estate tax.⁷ The federal estate tax has a value threshold under which no tax is paid. We will not address the federal tax value levels⁸ in this article. If a federal tax is to be paid then states get a piece of the action - called a pick-up tax.⁹ It makes sense since the state courts handle the probate.

        Comply Twice

You now know that there is a federal as well as a state tax involvement. Only a few states have an estate tax. And for the few states with an estate tax, it appears that they deferto the federal definition.¹⁰ This used to not be the case, with several states not only having different value terms but value definitions. It is now easier to render appraisals that comply with federal as well as states regulations. But states may still have their own value terms and definitions. For example, Maryland requires "clear value" which turns out to be "fair market value (FMV)" in essence.¹¹

        I Swear

Beware that states may have special rules. For example, in Illinois the appraiser must affirm to an oath.¹² You must comply with both the federal and state mandatory laws!

        Fair Market Value is Retail

The federal definition for FMV as used for estate tax liability requires values extracted from the retail market. Just to be certain, let us review the FMV definition:

"The fair market value is the price at which the property would change hands between a willing buyer and willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts. The fair market value of an item of property includable in the decedent's gross estate is not to be determined by a forced sale price. Nor is the fair market value of an item of property to be determined by the sale price of the item in a market other than that in which such an item is most commonly sold to the public, considering location of the item wherever appropriate. Thus, in the case of an item of property includable in the decedent's gross estate, which is generally obtained by the public in the retail market, the fair market value of such an item of property is the price at which the item or a comparable item would be sold at retail."¹³

Be careful not to approach your research only in the secondary estate market. And to expand on that caution, do not research just auctions. Federal tax court published precedent-setting cases reveal what is meant by a retail market. One example was a case about the value of an unmounted gemstone. The court reasoned that the unmounted gemstone would most likely sell to a jeweler at wholesale. The jeweler, by setting the gemstone, would alter the item. Thus, the prevailing wholesale prices are the ones to use for determining value.¹⁴ It is simple, follow the steps through markets (dealers) until you discover the ultimate consumer that acquires the item as is (not altered). Be careful with auctions¹⁵ as dealers also purchase merchandise from auctions for resale. Would the sales to their customers be the ultimate consumer? A tax court published "We are not persuaded by petitioners' arguments and agree with respondent that auction sale prices are relevant to the determination of fair market value in this case. The controlling question is whether art auction sales represent sales to the ultimate consumer . . . "¹⁶

A tax court decided that FMV will be the same for all types of federal appraisals. Thus, precedent setting cases for gift tax, casualty loss, charitable donation, and estate tax liability all are to define FMV the same way.¹⁷

        Flanking Valuations

Many appraisers and courses advocate an appraisal caled "Equitable Distribution." It is an appraisal not intended for determining tax liability but merely to assist the personal representative in distributing the estate. The personal representative does not have to divide the estate equitably,¹⁸ but needs values. Be careful to state in the appraisal that it cannot be used for tax liability.

        IRS Knocking

For years appraisers did estate appraisals and merely reported liquidation value for the date of death. Although not proper, this is not uncommon today. Be warned that the IRS has a penalty for not rendering a proper, in compliance, estate appraisal. Learn the rules of the estate valuation road to avoid getting a ticket.

If an appraiser underestimates the value in an estate tax liability appraisal, the IRS can impose a penalty on the appraiser. The code is clear in stating "Imposition of penalty if a person prepares an appraisal of the value of property and such person knows, or reasonably should have known, that the appraisal would be used in connection with a return or a claim for a refund, and the claimed value of the property on a return or claim for refund which is based on such appraisal results in a substantial valuation misstatement . . . a substantial estate or gift tax valuation understatement . . . or a gross valuation misstatement, with respect to such property, then such person shall pay a penalty . . . "¹⁹

The penalty will be the greater of 10% of the value, a thousand dollar fine, or 125% gross income received. Of course, no penalty will occur if the appraiser can establish that the value established in the appraisal was more likely than not the proper value.

        Double Dating

Equally important is the selection of a proper effective date.²⁰ Again, there is more than one choice. The federal regulations allow date of death, alternative valuation date²¹, and date of distribution.²² Always ask the personal representative if the date of death is the date to be used. If it was decided to use the alternate valuation date, then all appraisals must use the same date.

But wait, you must comply with the state handling the estate. States usually use the date of death. Some states have an alternate valuation date, and some do not. If the state, i.e., Florida, does not offer an alternative date,²³ you will need to determine values for two dates if the federal option of an alternate valuation date was selected, and the state of jurisdiction does not provide for one.²⁴ Relax as it is rare to encounter an effective date other than the date of death.

        Check Please

Most appraisers have been taught the various ways to ethically charge for an appraisal. One is never to charge a percentage of the value conclusion. Can one legally charge a percentage of the value conclusion as the fee in an estate appraisal? This is a trick question.

Although it is clear in the federal regulations that one cannot charge a percentage of the value conclusion in a charitable donation appraisal,²⁵ the same restriction does not exist for estates. Remember that we are dealing with both federal and state requirements. California has what is called a probate referee system. The probate courts appoint an appraiser called a probate referee to value estates. The probate referees are registered with the state Controllers' Office. California state law states that the probate referee is to be paid a percentage of the value conclusion!²⁶ If the federal regulations did not allow percentage fees for estate appraisals, they could not accept appraisals from the California probate courts. The answer to the trick question is "yes." But for those who are not probate referees, it is considered unethical among general appraisers.

        Wrapping it Up

You now have some shallow guidelines for rendering estate tax liability valuations. You will need to know the federal as well as state requirements, the proper effective date, your liability,²⁷ and how FMV is defined and fine-tuned.

Written by Bill Hoefer