The biggest risk is obviously one where your deduction is disallowed in it’s entirety; you are subjected to penalties, and interest is assessed for a two to four year period. In rare cases of alleged extreme tax evasion, a taxpayer can find themselves facing the threat of incarceration.
None is a pleasant outcome.
Most negative effects fall into the one or more of the first three items noted above.
“How can we avoid or minimize risks while still taking the deductions that we are legally entitled to?”
- Obtain a truly impartial opinion of fair market value
- Insure your appraisers knows the difference between fair market value and traditional real estate related market value
- Assure that adequate time has been allowed for completion of your appraisal and report. Remember, the IRS has months to complete their review, and as many experts as the issue dictates.
- Insist on minimal boilerplate from your appraiser / valuator. Agree beforehand on what specific areas may or may not include boilerplate comments.
- Insure that your appraiser has been certified for at least ten years
- Discuss the nature of the specific report format to be used; obtain concurrence that boilerplate is generally unacceptable as filler (not to exceed 20% of the total report content)
- Require a fully USPAP compliant appraisal and report for real property; compliance with IRS business valuation guidelines for business valuations.
- Insist that real property fractional interest discounting be based mostly, or at least equally on costs to partition. Non partition agreements are likely to be disallowed when accompanied by typical trust arbitration clauses
- Cite the Treasury (or IRC) code section that the appraisal is to comply with. Simply stating FMV per IRS guidelines is not specific enough to assure compliance.
- Require that a range of value also be provided in the reconciliation statement, and that specific comments directly related to how the final opinion of FMV was derived, are provided. These should be clear enough that a lay person can follow the calculations to arrive at final value.
- Do NOT ‘push or constrain’ value unreasonably. If disagreement arises over the final value between the taxpayer and IRS, the taxpayer will certainly lose in terms of time; money for attorneys & CPA ‘negotiation’ costs, penalties and interest. It is only a question of ‘how much’ rather than ‘what if’ the taxpayer will lose. Even with a near perfect appraisal, defending your position can be costly (though not as costly as not being able to defend that position).
- Remind your appraiser that while the IRS cannot report them to state regulatory agencies for bad work; that you can!
While the answers to the question may seem obvious, that is not always the case. Most taxpayers are honest, hardworking people; or conscientious corporations that want to pay what they owe, but not one dollar more.
They hire tax consultants, CPAs and tax attorneys toward that end. Many areas of the tax code are at best, admittedly ‘murky’. The taxpayers trust that their attorneys, CPAs, and consultants are among the best they can afford, and will in turn hire or recommend the best appraisers and valuators available.
That is one of the big challenges. Many simply look for a designation such as an MAI; SREA, SRPA, SRA, ASA, IFA, CVA, AVA, IBA, SCREA, SCGREA, etc.. Others look only to the State Certification; and others look to people who have traditionally performed valuation and appraisal roles PRIOR TO FIRREA and USPAP.
None of these methods is proof against an unfavorable audit.
The Financial Reform, Recovery and Enforcement Act of 1989 (FIRREA), also specifically prohibits requiring designation or membership in a particular professional peer organization as a condition for appraiser selection in appraisals for federally regulated institutions and transactions.
Traditionally, the better known ‘designation’ appraisers have relied extensively on boilerplate narratives as much as on individually researched and reported market conditions and data specific to a given assignment. Their broader-market approach to property may be more suited to very large projects, with nationwide, or even worldwide market areas. It is rarely suited to single family housing - even luxury housing.
The use of narrative style reports as opposed to form reports conveys the perception that a ‘complete appraisal’ and ‘self contained’ appraisal and report have taken place.
My experience as an IRS Senior Appraiser and Appraisal Reviewer, is that this is no longer true. The narrative style report format is also more likely to be subject to abuse, than a form report supplemented with narration, as required.
The narrative report does not visually identify which techniques, conditions, analyses, or data has been omitted. This allows for a great amount of ‘leeway’ for appraisers that believe their work will only be seen by lay-people. A narrative report can be visually outstanding, yet contain little or no support for the conclusions reported.
It is rarely a self contained report. Most are called summary reports; the same as form reports.
Form reports on the other hand typically identify far more required value related elements of analysis at a glance. The reader can tell at a glance which areas have been extensively developed, and which areas have been given cursory attention.
Properly supplemented with as much text addenda as needed, these can provide a more sound vehicle for communication of appraisal results. It assures the reader that a very thorough analysis has taken place.
Forms on the other hand are not suited for all property types.
My experience is that a hybrid of form and narrative is the best solution for most appraisals. Most of the better reports I analyzed at IRS, used some degree of hybridization for estate and gift tax issues. Conversely, most of the narrative reports were among the worst I have seen in twenty five years of appraising!
If it were not for strict privacy act prohibitions against even peripheral taxpayer information disclosure, the appraisers and valuators preparing those reports would be censured by their state licensing agencies.
As it stands, it is against the law for an IRS employee to turn a bad appraisal and or appraiser in to state agencies for USPAP non compliance.
Because of this, the IRS has also traditionally been uncooperative with state agencies investigating bad appraisals, even at the request of taxpayers themselves.
In 2011, a concerted nationwide policy and plan has been implemented by the IRS to prosecute bad appraisers / valuators under the Federal Pension Plan Protection Act. The IRS is actively seeking exemplary cases of error or abuse for referral to the Office of Professional Responsibility (OPR) to start penalizing bad appraisal / valuation work. A finding against a valuator or appraiser can result in preparer penalties equal to 125% of the fee the appraiser originally collected and debarment from doing future work for clients before government agencies.
High, Low and “Safe” Values:
Traditionally we seek a point specific value as of a given date for appraised values. Since real estate markets work imperfectly, a range of value is usually more discernible than a point value.
On more modest, “predominant value” housing this range is presumed to be up to approximately 5% above or below a specific number. This stems from Appraisal Institute publications that appraisers cannot claim a degree of accuracy of adjustments greater than 95%. Most appraisers concur that it is a wider range in substantially higher cost / value property.
Given this, it is common that taxpayers usually seek the highest possible value for conservation or other donation purposes, and the lowest possible value for estate or gift tax purposes.
On a value of $400,000 a total five percent variance is only $20,000. If the value is bracketed there is little probability that reconciliation at one end of the range or the other would trigger an adjustment.
On a ten million dollar property interest if the point value were either 5% to 10% high or similarly low, and not bracketed in the middle somewhere, then a combined variance of up to 20% could result. A two million dollar adjustment potential would definitely be pursued in both SB/SE and LB&I estate or gift cases; and all facade or conservation easement cases.
Until proven wrong, IRS position would be that a two million dollar adjustment is due.
It is critical that a fully supported, USPAP compliant appraisal be on hand to fend off any IRS claim of adjustment.
Unless data strongly indicates reconciliation at one end the value range over another, a “safer” bet would be reconciliation in a bracketed range of the most probable and predominant similar property indicators.
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