Tax-Related Appraiser Liability Claims
In the last several years, we have seen more negligence claims relating to appraisals performed for tax purposes, especially appraisals for conservation easements, charitable deductions, and estate or gift tax. The IRS is particularly focused at this time on scrutinizing appraisals of conservation and preservation easements submitted for the purpose of substantiating a charitable deduction by the property owner/tax payer. Here, the property owner is generally proposing to record an easement over his property to protect a natural aspect or preserve historic features like a building facade. The easement typically will be donated to and held by a charitable organization, such as a land trust or historic preservation trust, or by a government agency. The appraisal will then be used by the property owner to claim a charitable deduction or other tax incentive. The owner obviously will hope for a valuation that maximizes these benefits.
Most appraisers who perform appraisals of conservation and preservation easements are aware of the penalties that the IRS may assess against appraisers under Internal Revenue Code sections 6694 and 6695A for valuation misstatements. These penalties are usually addressed in the relevant appraisal courses. Have we seen the IRS impose penalties against appraisers? Yes. Far worse, however, and a subject that is often not addressed by the appraisal coursework is the prospect of a professional liability claim against the appraiser by the taxpayer for damages. When the IRS has determined that a taxpayer has underpaid taxes based on deficiencies with an appraiser’s valuation, the taxpayer may blame the appraiser for the lost tax benefits and for the substantial penalties and interest being demanded by the IRS. Have we seen such claims? Unfortunately, yes.
Another common tax-related appraisal claim area is the valuation of assets for gift or estate tax. Here, the client will probably be hoping for a low valuation that will minimize gift or estate tax. A case filed recently in the Northwest involves an appraiser who appraised various business assets for gift tax purposes. The client planned to give assets away to relatives with a value below the individual gift tax exemption and the appraiser delivered a report valuing the assets below that threshold. The IRS determined that the appraiser greatly understated the value. As a result, the IRS imposed gift taxes, penalties and interest against the taxpayer totaling several hundred thousand dollars. The taxpayer sued the appraiser for the tax headache.
Any appraiser venturing into tax work obviously should be well-versed in the appropriate methodologies and specific tax agency requirements. I suggest that appraisers performing appraisals for federal tax purposes search review the latest applicable Tax Court decisions involving such appraisals. An appraiser can search for tax cases at http://www.ustaxcourt.gov. Also, I would suggest that any appraisers performing conservation easement work read the IRS’ publication “Conservation Easement Audit Technique Guides.”
Beyond education, however, an appraiser performing tax-related work should give special thought to the engagement agreement and consider ways to address the risk of an adverse tax determination. A well-written engagement agreement, from the appraiser’s point of view, will advise the client that the IRS or other tax agency may disagree with or not accept the valuation, that the appraiser cannot guarantee the outcome or be financially responsible to the client for any taxes, penalties or interest imposed, and that the appraiser’s liability will be limited in an appropriate manner. The following is an example engagement agreement provision addressing these concerns:
Client intends to utilize Appraiser’s appraisal(s) and/or report(s) prepared under this Agreement in connection with a tax matter. Appraiser provides no warranty, representation or prediction as to the outcome of Client’s tax matter. Client understands and acknowledges that the taxing authority (whether it is the Internal Revenue Service or any other federal, state or local taxing authority) may disagree with or reject Appraiser’s appraisal(s) and report(s) or otherwise disagree with Client’s tax position, and further understands and acknowledges that the taxing authority may seek to collect from Client additional taxes, interest, penalties or fees. Client agrees that Appraiser shall have no responsibility or liability to Client or any other party for any such taxes, interest, penalties or fees and that Client will not seek damages or other compensation from Appraiser relating to any taxes, interest, penalties or fees imposed on Client or for any attorneys’ fees, costs or other expenses relating to Client’s tax matter.
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I need to preface this by disclosing I was a former Sr. Appraiser for the IRS Large Business & International Division (LB&I) which is the division that handles conservation easement issues; and most estate & gift tax appraisal reviews for SBSE.
The IRS is directly targeting all land trust conservation easements; many if not most façade easements and a host of other appraisal related issues. Too many appraisers are now seeking estate work with inadequate experience. Suggestion: IF you still refer to any appraisal as a ‘date of death’ appraisal, you are NOT competent to perform it. Period. There is a power point presentation on my website covering this. If the link becomes inoperative, email and I’ll send it direct to you.( mike@mfford.com )
For EACH tax issue, IRS uses a different definition of Fair Market Value (FMV) which is NOT the same as Market Value. I’ve listed these on my website. They are applicable to the West Coast and may or may not be applicable to eastern jurisdictions. http://www.mfford.com definitions of Value tab-near the bottom of the text.
Whether you are an MAI or another experienced appraiser, delving into these waters is ‘risky’ at best. I still chat with my old associates on a near weekly basis. IRS is STILL going after tax avoidance schemes often represented by these types of appraisals. It is not a case of ‘maybe’ I’ll get audited. You WILL be audited (meaning your client will be audited) with a conservation easement deduction. Don’t count on any of the National Land Trusts to come to your aid when it happens.
For my fellow appraisers that will ignore the above caution, familiarize yourself with IRS perceptions of: imminently probable with respect to H&BU (not “reasonably probable or possible, but imminently probable and its related case law). Make sure you understand the specific FMV definitions that will be used in your jurisdiction. In all probability, the sole measure of charitable donation value will be the difference between [PRACTICAL] before and after values-not hypothesized values. Lastly ,if there is ANY kind of quid pro quo involved, the donation deduction will not be recognized (allowed) at all. If there are familial owned contiguous parcels, those will ALSO be used to calculate the before and after impact (diminished value) of the easement. its not a case of “right”-that is what the IRS will do, not necessarily what they should ethically do.
For E&G issues, its not quite as risky for an honest appraiser but be careful. KNOW the rules and procedures! Stay away from fractional interest discounting. Leave that to the CPAs! For TIC interests, nothing but partition cost related discounts are (likely) going to be recognized as being valid anyway. The more aggressive discounts for various facets of lack of marketability (DLOM); controlling-non controlling, etc. typically found in entity valuations will not survive a review appraisal involving tenants in common fractional interest discounting.
By the way-you wont know for three years! That’s about how long it takes to filter through the system. Three years of a Sword of Damocles hanging over your head, and that of the taxpayer. Three years interest and penalties plus any principle tax liability adjustment.
For those that HAVE the requisite experience, you probably don’t need my site but feel free if you do. Or call me (number is on the site) or call (714) 366 9404. This is not meant to discourage potential competition. Its meant to try to help fellow appraisers avoid trouble.
Best!
Have YOU joined the American Guild of Appraisers yet? AGA is looking out for YOU! http://www.appraisersguild.org