Valuation and the Internal Revenue Service

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					    Valuation and the
Internal Revenue Service
           August 24, 2007
   13th Annual Summer Conference

1. Valuation Review Process
2. Appraiser Responsibility
2 A     i             ibili
3. Technical Topic / Fractional Interests
• The comments and views presented by
  Harry Fuhrman may not reflect the
  position or policy of the IRS. The
  opinions offered are those of Mr.

• Everything depends on the facts and
  circumstances of the case at hand
        How Your Valuation is Selected
•       Cincinnati service center
    –     Service center sorting
    –                         ( ETA ) five week
          Estate tax attorney (“ETA”) five-week rotation
    –     Inclusion of valuation experts
•             i     l f      l
        ETA internal referral process
•       Shift toward “early resolution”
    How your Valuation is Reviewed
•              y g        property               y
        Underlying real p p y value handled by a real
        property appraiser
•       Discounts (DLOC, DLOM, FID, etc.) typically
        handled by a business appraiser
•       Does the fair market value and/or discounts pass
        the ‘smell’ test?
    –     Was a full analysis done?
    –     Does the conclusion consider both the hypothetical buyer
          and seller
•       Have there been any transactions in the
     If your Valuation is Challenged
•    Emphasis on Early Resolution
             »   Schedules are prepared by Service Valuator
             »   Meet with taxpayer’s representative and/or the taxpayer’s
                 appraiser to discuss differences in approaches and
    – If no resolution is reached
             »   Formal report is prepared by Service Valuator, and
                 F     l      ti         db S i V l t             d
                 taxpayer proceeds to...
•     pp         p
     Appeals Group
             »   Attempt again to resolve issues; may involve presentations
                 by both parties to Appeals officers.
•    Tax Court
                        Sample Cases
• Lack of full analysis
   – Appraiser estimated and applied a percentage diminution of value to a
     property subject to a façade easement without performing an ‘after’
• Excessive discounts
   – 99 percent fractional interest in Southern California single family home
     discounted at 45 percent.
• Non-Qualified Donee / Non-Qualified Donation of a
  Conservation Easement
   – Treas. Reg. § 1.170A, Internal Revenue Code § 170
              g          ,
• Subsequent Sale of Property
   – Subject valued at date of death for $2 million. Subsequent sale 6-
     months later for $3.4 million.
Appraiser P f i l
A    i Professional
       p        y

  The Latest Developments
            Appraiser Professional Responsibility
       p                                    ,          g
   Disputes over valuation fill our dockets, and for good
   reason. Approximately 243 sections of the Code
   require fair market value estimates in order to assess
   ta liability, and 15 million tax returns are filed each
   tax liabilit                  ta ret rns
   year on which taxpayers report an event involving a
   valuation-related issue. It is no mystery, therefore,
                                      y y,              ,
   why valuation cases are ubiquitous.1

1Estate of Auker v. Commissioner, T.C. Memo. 1998-185
         Appraiser Professional Responsibility
                      Looking Forward
•   Three strategic goals for our agency – One of
    which is to
    –                                  law
        Enhance enforcement of the tax law.
    –   We need to:
         •   Ensure practitioners adhere to professional standards
             and follow the law and
         •   Increase our review of professional responsibility
         Appraiser Professional Responsibility
          Walk Away if Necessary
    A donor s
• “A donor’s aggressive acts bring discredit to
  all involved, and the IRS and the Congress to
  the door. Here is where I will ask for your
  help. Please exercise prudence. If you perceive
  that there is something out of whack with a
  transaction, if it does not pass the smell test, if
                   valued       away
  it is not fairly valued, walk away. Do not
  accept it, and let us know about it.”
                         Miller, TEGE
   – Commissioner Steven Miller TEGE, March 2006
         Appraiser Professional Responsibility
                  In the News…
• Tax Notes - MAY 22, 2007
     CONTRIBUTIONS (author Fred Stokeld, Tax Analysts)
• Senate Finance Committee Letter – June 18, 2007
             di    b i            i    i l i      h        ib i
   – …regarding abusive transactions involving the contribution
     of non-cash property to a charity and the claiming of a
     charitable deduction in an amount that substantiallyy
     exceeds the true fair market value of the property.
         Appraiser Professional Responsibility
     Status of Penalty Investigations
• Four penalties asserted against two real property
  appraisers – Currently at OPR

• Types of referrals
   – Conservation easements – facades and open space
   – Abusive schedule A deductions
   – E&G valuations
          Appraiser Professional Responsibility
      Status of Penalty Investigations
• Total Referrals – 75
   – Approved – 25 (across all types of appraisers)
   – Recommended (Not yet approved) – 23
   – Suspended (Insufficient information – still being developed
     factually) – 18
     Discontinued (Developed – no action necessary) – 7
   – Di     ti d (D l d               ti             )
   – Surveyed (Investigations not warranted) - 2
           Appraiser Professional Responsibility
        Pension Protection Act of 2006
•   Congress – Stronger tools with PL 109-280
    (PPA/H.R. 4)

•   Engineering program role in
    –   public guidance
    –   enforcement effort
           Appraiser Professional Responsibility
                PL 109-280 (H.R. 4)
•                        g    ,      (      p
    Enactment Date – August 17, 2006 (Exception for
•   New Civil Penalty - §6695A - Appraisers
•   Removes “Threshold Restriction – Direct referrals to
    OPR are now possible without a 6701 penalty
•   Relaxes the Knowledge Standard – Lower standard of
    p         p     y
    proof for penalty assertions under 6701
•   Limited application to non-cash charitable
         Appraiser Professional Responsibility
                 Notice 2006-96
•Improved Definitions
  –   Q lifi d Appraisal
      Qualified A    i l
  –   Qualified Appraiser
•Comment     period has ended
        Appraiser Professional Responsibility
                  Next Steps
• Two parallel workgroups to address H.R. 4
  – OPR – Public guidance to appraisers
  – Office of Chief Counsel – Regulations
• Level of scrutiny has increased for all
• The assistance of the governing appraisal
  institutes is vital.
Fractional Interests
 in Real Property
                     Fractional Interest Discounts
                                  Case Law

•         Courts have concluded on discounts that
          have ranged from 5%1 to 60%2

•         Amount of discount for a fractional interest
          holder is governed by “the record in the
          instant case, and not on what a court found
          reasonable in another case”
1Estate of Scull v. Commissioner, supra note 2, TC Memo 1994-211 at 1172, 67 TCM 2957-6
2Estate of Sels v. Commissioner, supra note 8, TC Memo 1986-501 at 2277, 52 TCM 743
3LeFrak v. Commissioner, supra note 8, TCM 1993-526 at 2821, 66 TCM 1308
                      Fractional Interest Discounts
                           Case Law (Cont’d)
•         “[t]he            f hi di               ld d
          “[ ]h amount of this discount would depend on     d
          various factors such as the type of property, the size
          of the divided interest owned, and the number of
•         In Caldwell v. United States2, the Court outlined
          factors to consider including the (i) size of
          fractional interest, (ii) number of co-tenants, (iii)
          size of tract, (iv) utility of parcel if partitioned, and
          (iv) ability to use undivided interest as collateral for
1Estate         v          States      F Supp 836      n1
      of Smith v. United States, 589 F. Supp. 836, 838 n.1
2Caldwell v. United States, supra note 36, 50 AFTR2d at 6149;
          Fractional Interest Discounts
       Quantifying the Discount

• Transactional Data
• Partition Analysis
• Other Methods
    Limited P t     hi T d
  – Li it d Partnership Trades
  – Restricted Stock Studies
       i      i i      d l
  – Option Pricing Models
             Fractional Interest Discounts
               Transactional Data

•   Need to see underlying data for
    confirmation/comparability between Subject
                       p       y              j
    Interest and transactional data, including:
        –   Time frame
        –   Property type
            P      t t
        –   Size of interest transacted
        –   Number of co-tenants
        –   Size of tract / ability to partition (if applicable)
•   Need to see the “link” between transactions used
      d th        t i       ti
    and the property in question
              Fractional Interest Discounts
                Partition Analysis
•    Ab l t Right of Holder
     Absolute Ri ht f H ld
    – In the absence of a waiver to the contrary, a
       California owner of an undivided interest in
       realty has an absolute right of partition pursuant
       to Code of Civil Procedure § 872.710(b), the
          l b i        li idi i h             f     ii
       only barrier to liquidity is the cost of partition
       and the time value of money until the property
       can be sold.
    – California is a ‘fast-track’ state, with a one-year
       expected time horizon for a partition/forced sale
              Fractional Interest Discounts
           Partition Analysis (Cont’d)
•    State C      t S ifi
     St t / County Specific
    – California is a ‘fast-track’ state, with a one-year
       expected time horizon for a partition/forced sale
    – The length of time it will take to complete a
       partition action or court-ordered-sale is based on
       the backlog of cases in the county where the suit
       is brought.
            Fractional Interest Discounts
          Partition Analysis (Cont’d)
•    Assumptions underlying partition analysis
     A       ti      d l i       titi      l i
    – Must look to current economic climate
    – Must look to the specific facts of the
       subject interest at hand
    – Should make sense from a ‘global’
             Fractional Interest Discounts
          Partition Analysis (Cont’d)
•    Major         ti      d l i     titi
     M j assumptions underlying a partition
     analysis include:
    – Time to sell
    – Cost to “carry”
    – Costs related to action
    – FMV of property
      •   At time partition action is brought
      •            t     l d t         d d b th C t
          At property sale date, as ordered by the Court
                       Fractional Interest Discounts
                              Other Methods
•                     p
   Limited Partnership trades
  – Main differentiating factors include tenant in
     common interest holder’s right to force a
     sale/partition action. Appraiser must bridge this
  – Estate of Harrison v. Commissioner1 - Parties
      ti l t d th t 77 8         t li it d    t    hi
     stipulated that 77.8 percent limited partnership
     interest had much higher fair market value while
     it possessed right to liquidate partnership than
     when unaccompanied by such power
•  Restricted Stock Studies
•  Option pricing models
1TC   Memo. No. 1987-8 at 41, 52 TCM 1308
Kym Taborn
Supervisory Tax Attorney, Van Nuys Office
Kym M Taborn@irs gov
(818) 756-4522

Harry Fuhrman
Fi     i lA l t L         Ni l Offi
Financial Analyst, Laguna Niguel Office
      389 4041
(949) 389-4041

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