So you want to do an appraisal for the IRS. Are you qualified?

I am a valuation expert who specializes in negotiation and mediation. I receive calls weekly from people seeking advice on various valuation issues. Recently, I received a call from an individual who had a credential in personal property valuation. He asked me if I thought he was qualified to prepare an appraisal with a specific application in mind. He informed me that the client required a fair market value determination for federal gift tax purposes. I would like to share useful information with you that may be beneficial, regardless of your area of expertise in valuation. Additionally, I will provide extra information on business valuation.

I have testified multiple times in the U.S. Tax Court and have been deposed many times. I worked for the IRS for 28 years and headed up business valuation for 11 years, so I have extensive experience in valuation. However, I no longer work for the IRS, and the opinions I express here are based on my own experience of serving hundreds of private sector clients over the last 12 years. Please note that the information provided here is for educational purposes only.

Kohler Case sets a minimum standard

“In the case of Kohler v. Commissioner T.C. Memo 2006-152 (July 25, 2006), the court did not find the IRS outside expert's report to be credible. The taxpayer had engaged two qualified appraisers who provided qualified appraisals and met professional standards. The court gave more weight to the appraisals provided by the taxpayer's appraisers and stated that the IRS outside expert's report was not reliable.”

“The expert's report "...was not submitted in accordance with the Uniform Standards of Professional Appraisal Practice (USPAP)." The court particularly noted that USPAP certification "...assures readers that the appraiser has no bias regarding the parties, no other persons besides those listed provided professional assistance, and that the conclusions in the report were developed in conformity with USPAP."
The expert "...admitted that his original report submitted to the court before trial overvalued the estate's Kohler stock by...more than 7% [due to an error he subsequently corrected at trial]. This is not a minor mistake. When we doubt the judgment of an expert witness on one point, we become reluctant to accept the expert's conclusions on other points."
The expert "...did not understand Kohler's business.... He decided the expense structure in the company's projections was wrong and decided to invent his own.... He did not discuss his fabricated expense structure with management...." In contrast, one of the estate's experts had periodically valued Kohler's stock over several years.
The expert "did not use a dividend-based method under the income approach, although the record reflects that periodic dividends were the primary means of obtaining a return on Kohler stock due to the privately held nature of the company."

In contrast, the court found the valuations of the estate's experts, "thoughtful, credible, ...thorough and consistent with traditional appraisal methodologies for closely held companies.”[i]

In this instance, having no formal training or credential in business valuation from one of the three major business valuation organizations, the court felt an expert in valuation needed to meet a standard.

The American Society of Appraisers (ASA), the National Association of Certified Valuers and Analysts (NACVA), and the American Institute of Certified Public Accountants (AICPA) all offer training, have standards and offer credentials in business valuation. The IRS's outside expert did not have a credential and did not follow any formal standards. The court found it difficult to follow the IRS expert’s report. What did the court recommend?

U.S. Tax Court recommendation on standards

The court recommended that at a minimum an expert in business valuation should follow the Uniform Standards of Professional Appraisal Practice, (USPAP), which are published by The Appraisal Foundation.  Having recently downloaded the 2024 edition as an Accredited Senior Appraiser of the ASA this applies to me as well as the NACVA Standards as a Certified Valuation Analyst (CVA). If you are a CVA with NACVA, an Accredited Business Valuer (ABV) with the AICPA, or a Certified Public Accountant (CPA) without an ABV you should be familiar with your standards.

Here is a comparison of the business valuation standards. If you are not certified with one of these three business valuation accrediting organizations it is recommended as a minimum that you follow USPAP.

This includes the information in the preamble, definitions, ethics rule, record keeping, competency rule, scope of work rule, and jurisdictional exception rule before addressing specific standards.  USPAP also includes great insight with advisory opinions, FAQ’s and a reference index. Why is this important?

Why is this important?

In the Kohler case, the judge specifically stated that as a minimum the USPAP standards should apply. The lack of any certification and following any standard resulted in an unacceptable product for the court. Note that the USPAP standards apply to real property, personal property, business appraisal, appraisal review, and mass appraisals. Note that the ASA designations include appraisal review and management, business valuation, real property, gems & Jewelry, machinery & technical specialties, and personal property credentials.

In the Kohler case besides not having a certification or following USPAP as a minimum there were other concerns. These included significant errors, a failure to understand the business, not reviewing assumptions with management, and ignoring the history of dividends of the firm.

The importance of Revenue Ruling 59-60 for Business Valuation

As a business valuer Revenue Ruling 59-60 is especially important. Revenue Ruling 59-60 is cited in the training of the ASA, NACVA, and AICPA when valuing a business. The revenue ruling addresses eight factors that should be included. These are:

1. The nature of the business and the history of the enterprise from its inception.
2. The economic outlook in general and the condition and outlook of the specific industry in particular.
3. The book value of the stock and the financial condition of the business.
4. The earning capacity of the company.
5. The dividend-paying capacity.
6. Whether or not the enterprise has goodwill or other intangible value.
7. Sales of the stock and the size of the block of stock to be valued.
8. The market price of stocks of corporations engaged in the same or a similar line of business having their stocks actively traded in a free and open market, either on an exchange or over the counter.

As a minimum, these factors should be addressed in the analysis and reporting of a business valuation.

Conclusion

The IRS does not require that an appraisal meet a specific standard. The IRS offers specific guidelines associated with business valuation, real property., tangible personal property, and art, gems and jewelry.  The IRS pays attention to the courts and the interpretation of the court. Check out the IRS guidelines. As a minimum follow USPAP. In the end, the IRS is looking for a qualified appraisal by a qualified appraiser that as a minimum follows USPAP.   

If you are interested in learning more about Business Valuations and the IRS regarding policies and procedures, resolving issues, or the three most audited business valuation issues and how to address them, check out this link.