In the last several years, we have seen more negligence claims relating to appraisals performed for tax purposes, especially appraisals for conservation easements, charitable deductions, and estate or gift tax. The IRS is particularly focused at this time on scrutinizing appraisals of conservation and preservation easements submitted for the purpose of substantiating a charitable deduction by the property owner/tax payer. Here, the property owner is generally proposing to record an easement over his property to protect a natural aspect or preserve historic features like a building facade. The easement typically will be donated to and held by a charitable organization, such as a land trust or historic preservation trust, or by a government agency. The appraisal will then be used by the property owner to claim a charitable deduction or other tax incentive. The owner obviously will hope for a valuation that maximizes these benefits.
Most appraisers who perform appraisals of conservation and preservation easements are aware of the penalties that the IRS may assess against appraisers under Internal Revenue Code sections 6694 and 6695A for valuation misstatements. These penalties are usually addressed in the relevant appraisal courses. Have we seen the IRS impose penalties against appraisers? Yes. Far worse, however, and a subject that is often not addressed by the appraisal coursework is the prospect of a professional liability claim against the appraiser by the taxpayer for damages. When the IRS has determined that a taxpayer has underpaid taxes based on deficiencies with an appraiser’s valuation, the taxpayer may blame the appraiser for the lost tax benefits and for the substantial penalties and interest being demanded by the IRS. Have we seen such claims? Unfortunately, yes.
Another common tax-related appraisal claim area is the valuation of assets for gift or estate tax. Here, the client will probably be hoping for a low valuation that will minimize gift or estate tax. A case filed recently in the Northwest involves an appraiser who appraised various business assets for gift tax purposes. The client planned to give assets away to relatives with a value below the individual gift tax exemption and the appraiser delivered a report valuing the assets below that threshold. The IRS determined that the appraiser greatly understated the value. As a result, the IRS imposed gift taxes, penalties and interest against the taxpayer totaling several hundred thousand dollars. The taxpayer sued the appraiser for the tax headache.
Any appraiser venturing into tax work obviously should be well-versed in the appropriate methodologies and specific tax agency requirements. I suggest that appraisers performing appraisals for federal tax purposes search review the latest applicable Tax Court decisions involving such appraisals. An appraiser can search for tax cases at http://www.ustaxcourt.gov. Also, I would suggest that any appraisers performing conservation easement work read the IRS’ publication “Conservation Easement Audit Techniques Guide.”
Beyond education, however, an appraiser performing tax-related work should give special thought to the engagement agreement and consider ways to address the risk of an adverse tax determination. A well-written engagement agreement, from the appraiser’s point of view, will advise the client that the IRS or other tax agency may disagree with or not accept the valuation, that the appraiser cannot guarantee the outcome or be financially responsible to the client for any taxes, penalties or interest imposed, and that the appraiser’s liability will be limited in an appropriate manner. The following is an example engagement agreement provision addressing these concerns:
Client intends to utilize Appraiser’s appraisal(s) and/or report(s) prepared under this Agreement in connection with a tax matter. Appraiser provides no warranty, representation or prediction as to the outcome of Client’s tax matter. Client understands and acknowledges that the taxing authority (whether it is the Internal Revenue Service or any other federal, state or local taxing authority) may disagree with or reject Appraiser’s appraisal(s) and report(s) or otherwise disagree with Client’s tax position, and further understands and acknowledges that the taxing authority may seek to collect from Client additional taxes, interest, penalties or fees. Client agrees that Appraiser shall have no responsibility or liability to Client or any other party for any such taxes, interest, penalties or fees and that Client will not seek damages or other compensation from Appraiser relating to any taxes, interest, penalties or fees imposed on Client or for any attorneys’ fees, costs or other expenses relating to Client’s tax matter.
Peter Christensen is an attorney who advises professionals and businesses about legal and regulatory issues concerning valuation and insurance. He also serves as general counsel to LIA Administrators & Insurance Services. He can be reached at [email protected].