How Much is that Doggie in the Window? When to Seek an Appraisal
The concept of valuation comes up frequently in the realm of tax compliance. The value placed on an asset is critical for accurate tax reporting and may have significant impact on tax liability. There are instances when the IRS requires a qualified appraisal. There are also instances when the IRS does not explicitly require an appraisal but securing one is prudent and strongly encouraged by experienced tax advisors.
This article addresses valuations in the context of estate tax, gift tax, and individual income tax deductions for charitable giving. Valuation of marketable securities is easily determined as the values are based on the public market in which they are traded. Thus, this discussion relates to the valuation of assets such as real estate, closely held business, non-marketable securities, art, and other collectibles.
Estate tax and non-charitable gifting
For transfer tax purposes, the IRS defines the value of gifted property as the price at which the property would change hands between a willing buyer and a willing seller when both parties have knowledge of the relevant facts and neither party is under any compulsion to transact. The role of a professional appraiser is to opine on the value of the property transferred.
For estate tax reporting purposes, assets must be valued as of the date of death (or alternate valuation date, if so elected). With few exceptions, the burden of proof in accurately valuing assets rests on the taxpayer. Thus, for a taxpayer to have the most defensible position, a professional appraisal is the taxpayer’s best approach. The higher the value of the asset, the more important it is that an appraisal be performed.
In the gift tax arena, the IRS has established the concept of “adequate disclosure”. If the taxpayer reports a taxable gift on a gift tax return and provides adequate disclosure of the gift and the value, then the statute of limitations begins to run. If the gift is not adequately disclosed, then the IRS has an unlimited period of time in which to assess a gift tax liability. Pursuant to Treasury Regulations, the surefire way to adequately disclose a gift is to include an appraisal of the property with the gift tax return. A “fresh” appraisal prepared contemporaneously with the transfer by a professional appraiser qualified to assess property of the type gifted and for the relevant tax purposes is essential to documenting the value in a defensible manner. An appraisal prepared by an unqualified person, or for purposes other than tax reporting, or at a time far removed from the transfer date would likely be ineffective if challenged by the IRS.
Charitable giving by individuals
Unlike with estate and gift transfers, there are instances in the income tax realm when an appraisal is specifically required under the law. Generally, a “qualified appraisal” is required for donated property for which you claim a charitable income tax deduction of more than $5,000. The $5,000 threshold is applied to any item or group of “similar items” of donated property. “Similar items” means property of the same category or type such as a coin collection, household appliances, furniture, or jewelry.
There are several exceptions to the general rule. An appraisal is not required even if the claimed deduction is over $5,000 if the property is:
- nonpublicly traded stock of $10,000 or less;
- a vehicle (including a car, boat, or airplane) for which your deduction is limited to the gross proceeds from its sale;
- qualified intellectual property, such as a patent;
- certain publicly traded securities; or
- stock in trade, inventory, or property held primarily for sale to customers in the ordinary course of the taxpayer’s trade or business.
You must also obtain a qualified appraisal for any single item of clothing or any household item that is not in good used condition or better for which you deduct more than $500.
Conservation easements for which a tax benefit is claimed also require a qualified appraisal. A conservation easement identifies important historic, scenic, natural, or agricultural characteristics of property benefitting the general public. Although the owner continues to own the property, use restrictions are applied to the property through the legal easement, which ensures that those conservation values are protected, typically, in perpetuity. Further discussion of conservation easements is beyond the scope of this article, however, it will be addressed in a future article.
For donations that require a qualified appraisal, you must receive the appraisal before the due date, including extensions, of the return on which a charitable contribution deduction is first claimed for the donated property.
A qualified appraisal for charitable donation purposes must meet all of the following criteria:
- is made, signed, and dated by a qualified appraiser (as defined by the IRS) in accordance with generally accepted appraisal standards;
- includes sufficient detail to identify the property, the condition of the property, and the date of contribution;
- is made no earlier than 60 days before the date of contribution of the appraised property;
- does not involve a prohibited appraisal fee (a fee arrangement based on a percentage of the appraised value of the property, with some exceptions); and
- includes certain information, depending on the type of asset.
Appraisals can be costly and time consuming; however, it is important to understand the benefits of an appraisal. Although it may seem burdensome, an appraisal will be a taxpayer’s surest defense should the IRS call a valuation into question. When it comes to a contest over value, the fight will come down to the quality of the appraisal provided. Is it prepared by an appraiser suited to the specific property and purpose? Is it contemporaneous? Does it meet the criteria of a qualified appraisal, if required? These are questions that will help determine whether your appraisal will stand up to an IRS challenge.
If you would like to discuss if and when it makes sense to secure an appraisal, please contact Jean McDevitt, tax principal and private client services lead, at 1.800.244.7444.
Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, investment, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.