Estate Tax Liability: The
Fine Art of Determining Fair Market Value Almost 250 sections of the Internal
Revenue Code require stating something known as Fair Market Value (FMV),
in order to determine tax liability. In the auction world, FMV is used
to illuminate sage auction estimates for everything from Picassos to Pez
dispensers. The term Fair Market Value however, and the concepts behind
it often cause a great deal of confusion, prompting one U.S. tax court
judge to lament: "Value, like beauty, is in the eye of the beholder."
Fair Market Value is a complex
determination of value framed by the U.S. Federal government for tax
liability assessment, be it estate tax, gift tax, or income tax. The
good book when it comes to FMV is the U.S. government's tax regulation
Sec. 20.2031-1(b). Many estate attorneys and appraisers can recite by
heart the first part of this regulation: The Fair Market Value is
price at which the property would change hands between a willing buyer
and willing seller, neither under any compulsion to buy or sell...
While this is certainly the right chapter, it is not the only verse, and
it behooves us to look at the regulation in full. Failure to consider
the totality of the FMV definition may lead to inaccurate valuations.
The regulation also states FMV
is not to be determined by a forced sale price . So, while the U.S.
government may consider the sales price reached for liquidated estate
assets the most probative evidence of its FMV, the relevant regulation
specifically recognizes an owner's right not to sell, due to the
benefits attendant to retained ownership. Fair Market Value therefore
can describe the value of property unsold. Without the actual sale price
of subject property indicating FMV, appraisers typically rely on the
Market Comparison Approach to arrive at values.
This appraisal method entails
determining the FMV of an object by relating it to past retail sales
results of items of similar qualities . Similar qualities for
property may include: maker, size, age, materials, and subject matter.
This method is problematic however when it comes to appraising hand-made
antiques and fine art, due to the unique nature of such property.
Determining appropriately diagnostic comparables for such unique objects
is inherently subjective. Other factors such as provenance (ownership
history) and vendor status, e.g. high-end gallery, are equally
unscientific, yet may also impact value.
The sale of chosen comparables
must also have occurred in a relevant marketplace, that is, where such
property is generally obtained by the public in the retail market .
The regulations cite a theoretical example of a used car having the FMV
equal to what a used car with comparable qualities could cost the
general public if purchased from a used car dealer (the typical market
for such items). It is critical to note here that FMV is not determined
by the amount that might be obtained from the sale of such a car, but
rather from how much it would cost to purchase a comparable one.
Determining the appropriate
marketplace for a piece of property occurs on a case by case basis, as
no one marketplace necessarily qualifies a priori. Retail market
transactions, which involve the ultimate consumer, occur at dealerships,
stores, and auction houses. However, wholesale transactions may occur at
all of these venues as well. Both layers of the marketplace may operate
simultaneously, depending on the nature of the property, and the status
of the buyer. What a jewelry dealer pays for a diamond from a jewel
importer, could not be taken for the FMV of the same stone after it has
been retailed to the general public. Or, to use an example one court
chose, the FMV of a head of cattle sold at a cattle auction could not be
used as the FMV of a cow's worth of steaks at the supermarket.
Finally, the market comparison
approach is predicated upon sales of comparables with a reasonable
length of time prior to the appraisal's effective date. Anticipation of
future value is generally dismissed as unreliable and unknowable. FMV is
only meaningful when tied to the effective date of the appraisal, as the
market can fluctuate significantly due to changes in supply and demand,
fad and fashion.
The determination of FMV is a
complex process, best suited to auction house specialists and
professional appraisers, who are actively in tune with the current
marketplace. Even then experts can differ widely; ten appraisers looking
at the same item might come up with ten different opinions of value, and
arguably, all of them could be correct and defensible. There is no
irrefutable right answer for Fair Market Value, but there are some
recognized processes and standards that can be followed in striving to
determine it.
The Appraisal Foundation, a
not-for-profit organization authorized by Congress, was created in 1987
to support the appraisal profession by creating method standards and
codes of ethics. These are published in the Uniform Standards of
Professional Appraisal Practice (USPAP). Appraisal organizations, such
as the American Society of Appraisers and the Appraises Association of
America, require adhering to USPAP standards as a requirement for
membership.
Following the complete FMV
definition prescribed by the Treasury Department, and adhering to USPAP
keeps the problematic process of FMV determination manageable.
