Valuation, Factual and Subjective to a Great Extent

By Kathleen Ford Bay, Esq.  

Richards Rodriguez & Skeith LLP, Austin, TX

In the recent case of Estate of Mitchell (Whittier Trust Company, Executor and Trustee) v. Comr., T.C. Memo 2011-94 (4/28/11), the Tax Court had to value the decedent's real estate holdings and paintings. The court considered numerous assessments by experts who did not agree with each other. At least, the taxpayer and the IRS had agreed on the discounts to be applied to the fair market value, when determined.

The Decedent (Mitchell) owned (through a trust, presumably) 95% of the two real properties whose values were contested.  Shortly before his death, he transferred 5% of the two properties to another trust for his minor sons. The parties stipulated that the following discounts should be applied to the fair market: 19% discount for the estate tax for the decedent's 95% interest in beachfront property subject to a lease, and 32% for the 5% interest gifted to the sons' trust; 35% for the estate tax for the decedent's 95% interest in a ranch, and 40% for the 5% gifted interest.

The opinion (by Judge Kroupa) is a good read, plus there are nuggets of interest to estate practitioners. First, and not necessarily in the order in which items are addressed in the opinion, is that the Tax Court has jurisdiction only to determine IF there is a deficiency based on the IRS's valuations and what was reported on the estate tax return. Here, after the IRS challenged valuations, the taxpayer engaged an expert whose valuation of the beachfront and ranch properties was lower than the value reported on the estate tax return. The Tax Court could not use the lower values when calculating whether there was a deficiency or not. (Query: Can an estate tax return be amended?)

Second, taxpayers and the IRS often wrangle over who has the burden of proof. Rule 142(a) of the Tax Court Rules of Practice and Procedure states that the Commissioner's valuation is presumed correct. Case law supports this. Welch v. Helvering, 290 U.S. 111, 115 (1933). The burden can shift if the taxpayer introduces credible evidence, substantiates items, maintains required records, and cooperates with the Commissioner's reasonable requests. Section 7491(a)(1) and (2)(A) and (B) of the Internal Revenue Code. Guess what? The Tax Court determined that in this case the burden of proof simply did not matter. Each of the taxpayer and the IRS had a case, so to speak, and as a result the Tax Court decided to base its decision on "preponderance of evidence," instead of dealing with burden of proof issues.

Third, expert opinions are treated by evaluating the qualifications of each expert "and all other evidence" (which means, apparently, whatever is of interest in the case to the court), carefully considering the facts, weighing that evidence, and then making a decision, the Tax Court's own decision. An expert's reports and testimony receive a higher grade if the expert includes facts supported by evidence; however, the Tax Court is the final decision maker.

Fourth, the Tax Court relied on the "income capitalization method" for valuing leased property, whether commercial or residential. The IRS's expert had offered a "lease buyout" model on the theory that income capitalization applies only to commercial properties. In the words of Judge Kroupa: "Any property that generates income can be valued using the income capitalization approach."

Fifth, the discussion about valuing two paintings reports that auction sales are more "probative of value than poorly documented private sales." Well-documented private sales will be considered, but, here, the internal IRS expert did not share facts that were well-documented about private sales to which Judge Kroupa referred. The opinion contains information about the IRS's Art Advisory Panel and that the conclusions of the 25 art expert volunteers are submitted to the IRS Appraisal Office, which makes a final determination.  However, if the IRS internal art appraiser does not agree with the Appraisal Office, as was the case here, then yet another valuation may be submitted to the court. To keep the process fair, those art expert volunteers are not told whether the valuations they are doing are for charitable contribution or gift or estate tax purposes.

In summation, the opinion states:We appreciate that valuing real property and art can be an ambitious task. Both real property and art are unique and infrequently exchange hands. Moreover, the value of it, like beauty, often lies in the proverbial "eye of the beholder."

As noted above, this opinion is an interesting and good read. Valuation is an art, not a science, and those experts who do their homework and present opinions based on extensive research and analysis of the particular facts of the interests to be valued fare better in the quest to determine the fair market value of property.  Think about the cost of all those experts and of the attorneys, and the length of time taken to resolve issues of the fair market value (Mr. Mitchell died at the end of January 2005 and the Tax Court's decision was reported more than six years later.) In representing the fiduciary of an estate where values are in dispute, consider having one of those experts prepare a spreadsheet illustrating the anticipated savings in taxes (after anticipated costs) based upon the various proposed fair market values. Then, if necessary, proceed.


For more information, in the BNA Tax Management Portfolios, see Hood, 830 T.M., Valuation: General and Real Estate,  and in Tax Practice Series, see ¶6290, Valuation Generally.