“In light of the Kollsman decision, estate administrators should proceed with caution, when considering for estate tax purposes the use of appraisals prepared by merchants simultaneously seeking to sell the appraised property.”
The U.S. Tax Court in Estate of Kollsman v. Commissioner held that an art collector’s estate significantly underreported the value of two artworks for estate tax purposes. How did this happen? The estate relied on the appraisals by an auction house specialist who had an incentive to “lowball” the appraisals, in order to win the right to later auction the works.
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).
Estate administrators should use independent appraisers who aren’t involved in the intended sale of the properties being appraised. An appraisal report prepared in compliance with the Uniform Standards of Professional Appraisal Practice includes a certification that the opinions expressed in those reports are the appraiser’s unbiased professional opinions and that the appraiser has no present or prospective interest in the property being appraised or personal interest with respect to the parties involved. If interests exist, they must be disclosed to clarify the parties’ relationship and create a paper trail that can help estates avoid problems in the future.
Collectors should also assume that post-valuation date events, like an auction sale, will be relevant to the valuation analysis.
Reference: Wealth Management (March 31, 2017) “Appraisal Relied on by Estate Undervalued Paintings By $1.77 Million”