Tax News
Boltar v. Commissioner: A Cautionary Tale About Appraisals
June 10, 2011
As with sausage and law, most taxpayers and their tax lawyers do not want to see how their valuation expert "made" their appraisal report.  In other words, they generally leave the methodolgy to the experts and focus only on the appraised value that will be used to support their return position.

The taxpayer in Boltar LLC v. Commissioner,  136 T.C. No. 14 (April 5, 2011), however, learned the hard way that an appraisal that does not use reliable methods and relies on factual incaccuracies can be as worthless as the paper its printed on.

While the appraisal at issue in Boltar was used by the taxpayer to support a charitable deduction resulting from the donation of a conservation easement, fund participants seek appraisals to support all manner of tax return positions, including worthless security and bad debt deductions, allocations of purchase price to the target's depreciable assets under Section 1060, and fair market value for purposes of gain recognition agreements under Section 367.   The critical importance of appraisals in tax reporting is evidenced not only by the frequency of the term "fair market value" in the Internal Revenue Code, but also by the substantial penalties for valuation misstatements under Section 6662.

In Boltar, as alluded to above, the key issue was the value of a conservation easement donated by the taxpayer to a charitable land trust.  The taxpayer's valuation expert determined that the easement's value was in excess of $3 million, while the government's expert determined that its value was approximately $40,000.  Rather than attacking the qualifications of the appraiser or questioning his independence, the IRS highlighted a number of methodological problems and erroneous assumptions contained in the appraisal report.  First and foremost, the appraisal report did not use the methodology specified by Treasury Regulations. Further, the report (i) assigned a value to the easement that was more than 35 times greater than the value of comparable property mentioned in the report, (ii) assumed a highest and best use of a condominium development that was simply unrealistic given the size and nature of the easement, and (iii) contained numerous factual inaccuracies about the easement's features. 

But, even with this litany of errors, all was not lost--the appraisers could have made adjustments in response to the errors and methodological problems and come up with a more reasonable valuation that was still well above the IRS's valuation.  However, the appraisers stubbornly stood their ground and maintained that the combined effect of the IRS's many gripes was minimal.  As such, the court found itself with no recourse but to grant the IRS's motion to wholly exclude the taxpayer's appraisal report from evidence, finding it neither reliable or relevant within the meaning of Federal Rule of Evidence 702. 

The court's ruling to exclude the appraisal report obviously destroyed the taxpayer's case and the IRS's valuation prevailed.  The only silver lining for the taxpayer was that the court ruled against the IRS's attempts to amend its answer  to assert valuation misstatement penalties.

There are two important lessons to be gleaned from Boltar: First, the taxpayer's tax advisor has to have some understanding of the valuation methodology used by the appraiser and should also provide the appraiser with, or be cognizant of the relevant assumptions used by the appraiser--and should check the accuracy of those assumptions.  At the very least, the tax advisor should be aware of any valuation methodologies mandated, sanctioned by, or prohibited by the Code or Treasury Regulations. Second, the tax advisor needs to have some assurance that the valuation is, although favorable, somewhat reasonable--the Tax Court was clearly offended by the fact that the taxpayer refused to make adjustments to the appraisal  after numerous, significant errors had been pointed out by the IRS in its motion to exclude the appraisal from evidence.  The proper course for the tax advisor would have been to insist that the appraiser make adjustments based on the inaccuracies, even if this led to a significant reduction in appraised value.  This would likely have given the taxpayer at least a fighting chance of obtaining a sizable tax benefit.
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Tags: appraisals, Boltar, Boltar v. Commissioner, valuation