Fine Art Appraising #1:

Appraising for Fine Art Value: Process, Issues, and Problems

This is the first in a series of articles about appraisal and appraisers. This article provides an overview of the appraisal process, its structures, system, issues and the nature of its problems. Upcoming articles will focus on authentication and appraisal value, legal and ethical standards, IRS expectations from appraisers, the appraiser credential, expert/specialist, the appraisal instructor, limitations of appraising, and the appraiser protecting himself versus his or her client.

Introduction

As Fine Art Registry® has taken the sellers of questionably authentic art into the gladiatorial arena, another group involved in the coliseum of fine art has emerged. Juxtaposed alongside the authenticators, those offering opinions of value regarding works of art (appraisers), have been taken to task by the Internal Revenue Service (IRS) as having a poor record of appraisal report submissions for donations or estate values regarding fine and decorative arts, such as paintings, furniture, silverware, rugs, etc . The IRS Art Review Panel has noted that from the years of 2004 to 2008 many appraisals used for tax write-offs have been found to be unacceptable. Depending upon the years noted, the rate of rejection is at least 50-70%. For example, if 1000 items are valued, 500 to 700 of these would be thrown out as over - or under - valued in favor of the client, or incorrectly presented. The consequences of such poorly developed appraisals are that clients may be required to pay increased taxes, penalties and interest as well. It is not clear to what extent the reports were poorly developed according to appraisal standards or whether the IRS found fault with them because of an interest in promoting report unacceptability since unacceptable reports generate more tax money from the taxpayer. To understand why such appraisals fall short of the mark, it is necessary to examine the process, structures, system, issues and problems endemic to the appraisal industry.

The Appraisal Process

The appraisal is essentially a process carried out by an appraiser to provide an opinion of value of a subject property (the item being appraised). Properties can be personal, business or real estate. For the purposes of this investigation business and real estate will not be examined since such properties do not fall under the purview of the IRS Art Review Panel. Personal property can consist of furniture, glass, rugs, prints, paintings, sculptures, porcelain, silverware, and many other personal items of value. The process begins with a client wishing to secure an appraisal for a given item or group of items. The client contacts an appraiser with a request for an appraisal. The appraiser sets up a meeting to view the items. A letter of agreement is signed by both parties outlining the costs of the appraisal. The client informs the appraiser what the intention of the report is, and the appraiser identifies the type of report to be provided. If the client is looking for a report of items to be appraised for insurance purposes, the appraiser provides a replacement summary appraisal report. This report does not require a significant quantity of detail. The appraiser researches the items in terms of comparables found in the most relevant market – the market the client frequents – e.g. Sears, John's store, or Ebay – and provides three values from these markets. The three values are called comparables. The highest value is chosen because it represents the solution to satisfying the criteria of replacing the item quickly.

If the client requires a donation/estate report valued at $5,000 or above, much detail is required to satisfy the criteria of the IRS/Art Review Board. Such details include the name of the client, name of the appraiser, type of subject item, description of the item, where it was produced, provenance documents and so on. Only certified appraisers may provide reports, and they may not produce reports if they have been forbidden to practice before the IRS. The opinion of value here is the highest price of three prices the item recently sold for at auction (comparables). The detailed report filed by an accepted IRS appraiser is reviewed by the Board.

The question that arises at this point is: Why is it the case that there is such an egregious rejection rate of donation/estate reports prepared by certified and accepted appraisers?

Subject Items and the Failure to Authenticate

In various cases of non-acceptance of the appraisal, the Board has noted that the reason for the non-acceptance was the fact that the appraiser failed to provide evidence that the appraised piece/s were authentic. This note is somewhat ironical in that appraisal societies demand that appraisers limit their reports to appraising and not authenticating. The issue of authenticating is costly for the client, and since appraisers are not trained in art authentication, appraisal societies warn appraisers to provide a clause in all reports indicating that the item appraised is assumed authentic. It would seem from various IRS court cases that rejection of appraisals for failure to authenticate stems from appraisers not providing any evidence at all, including ownership documents such as sale slips, taxes paid by the client when purchased, etc.

Specialist

The IRS Board requires that donation/estate reports flow from those individuals having a specialty in the subject item in the report. A donation report of a piece of furniture must be authored by an appraiser whose specialty and experience is in furniture appraising. It is not expected nor accepted that painting or print appraisals will be provided by appraisers specializing or experienced in rug values.

Appraisers and their Connection to the Client

Appraisers are warned that they must be neutral and objective when providing reports of any sort and especially IRS reports. Appraisers who generate reports even though an existing familial or business relationship exists will have their report questioned if not thrown out. The IRS looks upon such reports as biased and, as such, will penalize the appraiser maximally. Performing appraisals for family members, business partners or close friends represents ethical violations of USPAP and violations of the review panel standards.

The Timing of the Appraisal

IRS appraisal reports have windows for submission and must provide the most up-to-date information to establish accuracy. For estate appraisals there is a window within which comparable values may be submitted. The 2008 rule is that estate reports must be filed within nine months of the passing of the decedent. For donations, since the market may go up or down, the appraisal must be based on the most up-to-date information. It would be incorrect and hence unacceptable to provide comparable prices reflective of the beginning of 2008 for a 2009 donation report. Such prices were much higher than the third quarter of 2009 where prices dropped by more than 30-40% on average.

Hands-on Observation

Although it is not expected that the IRS review personnel actually see in person the subject property being appraised, it is expected that appraisers base their values on items that they have personally examined. It is not acceptable that an appraiser base his opinion of value on a photograph provided by the client. It is a must that the appraiser view the item in person so as to confirm that the item exists.

Scholarship

The IRS review board consists of 21 individuals from all parts of the art world. These individuals are respected for their experience, knowledge, training and education. They come from auction houses, galleries, universities and museums. They do not accept shoddy scholarship, poor research or illogical conclusions. It is no longer possible to appraise via the "connoisseurial eye." Assertions must be based on facts and data referenced in the report.

Appraisal Fraud

In 2008, federal authorities seized 750 objects from various museums in California and Chicago. These objects were confiscated due to import violations and tax fraud. Such items were representative of a larger fraud taking place whereby appraisers inflated values of art works to obtain a reduction of taxes. It is alleged that since the IRS does not have the manpower to audit all donations and estate write-offs, individuals via appraisers send in such donations knowing that the chances of being caught are almost nonexistent. In another example, in Albany New York, a case has been filed whereby an art appraisal was provided to a convent of Catholic sisters. Here the claim focused on a low-ball appraisal provided by an appraiser who subsequently purchased and resold the item for a much higher price. The appraiser is being sued for fraud and breach of contract.

The IRS Art Panel

It is noted here that while appraisers have been taken to task by the IRS, this is not to say that the IRS is always correct in its review, or that the rulings are strictly impartial and disinterested. After all the IRS makes money from identified bad reports. It is not clear exactly how the review panel reaches a decision. Suffice to say that the above points are red flags initiating a negative decision. The IRS has provided some information but is not at liberty to divulge matters related to the privacy of the taxpayers.

Conclusion

It has been argued by some appraisers that their field is looked upon as a "gaggle of old fogeys who do not know what they are doing." The IRS has the numbers of unacceptable reports to confirm not that the above assertion is correct, but that there are serious problems with the present state of appraising which must be identified, and corrected. The IRS has admitted that since they cannot examine all the appraisals they receive, many unacceptable reports fall through the cracks at a significant cost to the taxpayer. Questionable donations and estates allow some taxpayers to avoid paying taxes amounting to millions of dollars.

Besides tarnishing the reputation of appraisers, bad reports, even when backed by a myriad of stated qualifications, leave clients exposed to unnecessary tax penalties. Appraisers providing such reports often find themselves accused of ethics violations, malpractice, and even facing criminal charges.

[Stay tuned for further articles from Dr. John Daab in this series on appraiser, appraising and related subject matter – Ed.]

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— by John Daab Ph.D.  |  February 16, 2010

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