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April 4th, 2017
Appraisal Relied on by Estate Undervalued Paintings by $1.77 Million
Recently, in Estate of Kollsman v. Commissioner the U.S. Tax Court held that an art collector's estate significantly underreported the value of two artworks for estate tax purposes. The problem: the estate relied on appraisals by an auction house specialist who had an incentive to "lowball" the appraisals to win the right to later auction the works. In addition to this conflict of interest, the court found that the values reported by the estate were unpersuasive because the auction house specialist exaggerated the dirtiness of the paintings and failed to adjust his appraisals after one of the works sold at auction for approximately five times more than the reported value. Here's what you need to know about the case.
Art collector Eva Franzen Kollsman died on August 31, 2005. Her estate included two 17th Century Old Master paintings known as Maypole and Orpheus, the former created by Pieter Brueghel the Younger, and the latter by Jan Brueghel the Elder, Jan Brueghel the Younger, or a Brueghel studio.
The next month, the Co-Chair of Sotheby's Old Master Paintings Worldwide sent to the executor of Mrs. Kollsman's estate (who was also a residual beneficiary of the estate) a document stating that the fair market values of Maypole and Orpheus, "based on firsthand inspection of the property" (but without further elaboration), were $500,000 and $100,000, respectively. The estate later attached this document to its United States Estate (and Generation Skipping Transfer) Tax Return. He also sent to the executor of Mrs. Kollsman's estate a letter agreement proposing that the executor grant Sotheby's the exclusive right to auction the works for a period of five years. The letter agreement set the values of the works at $600,000 - $800,000 for Maypole and $100,000 - $150,000 for Orpheus. The executor signed the agreement.
Subsequently, the IRS issued a notice of deficiency asserting that the values of Maypole and Orpheus were $1,750,000 and $300,000, respectively. The estate petitioned the U.S. Tax Court for redetermination. (After the estate filed its petition, the IRS asserted that the values of Maypole and Orpheus were $2,100,000 and $500,000, respectively.)
The Tax Court's Decision
On February 22, 2017, the U.S. Tax Court issued an opinion largely sustaining the IRS determination, and giving very little weight to the opinions of the Sotheby's specialist. The court found that the Sotheby's specialist "had a significant conflict of interest" because he provided his fair market value estimates at the same time he was soliciting the executor for the exclusive right to sell the works. Because Sotheby's stood to earn significant commissions from the anticipated sales, the specialist "had a direct financial incentive to curry favor with [the executor]" by providing "'lowball' estimates that would lessen the Federal estate tax burden borne by the estate." The court noted that, even though Sotheby's sold Maypole in January 2009 for $2,434,500, its specialist's valuation opinion remained unchanged in the valuation report he prepared for trial.
Additionally, the court found that the Sotheby's specialist exaggerated the dirtiness of the paintings on the valuation date and the risks of cleaning them. The court noted that the paintings were cleaned with relative ease, and if it truly was very risky to clean the works, the auction house should have, but did not, raise those concerns in the course of its discussions with the executor of the estate concerning the auction of the paintings.
By contrast, the IRS expert's valuations of $2,100,000 and $500,000 for Maypole and Orpheus, respectively, were largely acceptable to the court, although the court applied a 5% discount for the risks associated with cleaning both paintings, a 10% discount to the value of Orpheus by reason of its bowed condition, and an additional 10% discount to the value of Orpheus because of issues surrounding its attribution. Thus, according to the court, the values for Maypole and Orpheus were $1,995,000 and $375,000, respectively (nearly four times the amounts reported by the estate).
In light of the Kollsman decision, estate administrators should proceed with caution when considering for estate tax purposes the use of appraisals prepared by merchants simultaneously seeking to sell the appraised property. To reduce the risk that such an appraisal will later be deemed unreliable, estate administrators instead should retain independent appraisers who are not involved in the intended sale of the properties being appraised. An appraisal report prepared in compliance with the Uniform Standards of Professional Appraisal Practice, the generally recognized performance standards for the appraisal profession in the U.S., includes a certification that the opinions expressed in those reports are the appraiser's unbiased professional opinions, and that the appraiser has no present or prospective interest in the property being appraised or personal interest with respect to the parties involved (or if such interests exist, they must be disclosed). These certifications serve to clarify the parties' relationship and create a paper trail that can help estates avoid problems down the road.
Additionally, for artwork, where a work is dirty or otherwise in questionable condition, a reasonable investigation into the value of the work requires an opinion from a conservator as to the risks involved and the likely outcome of conservation efforts. Finally, collectors should assume that post-valuation date events such as an auction sale will be relevant to the valuation analysis.
If you have any questions about the Kollsman decision, or about other art or tax law matters, please contact Jeffrey Marks at (212) 826 5536 or firstname.lastname@example.org, Amelia Brankov at (212) 826 5574 or email@example.com, or any other member of the Frankfurt Kurnit Art, Tax, or Estate Planning & Administration Groups.
Correction: In an earlier version of this alert distributed on March 31, 2017 there was an error in the headline. The text of the alert accurately reported that the tax court found that the Kollsman estate underreported the value of the two paintings by $1.77 million. However, the previous headline of the alert mistakenly stated that the $1.77 million represented the amount of a tax deficiency instead of the amount of the undervaluation. The court decision that is the subject of the article did not calculate the amount of the estate's federal estate tax deficiency.
Other Art Law Alerts
Recent NYS Sales Tax Law Change Affects Art Sales Between Related Entities
On August 14, 2017, the New York State Department of Taxation & Finance issued a Technical Memorandum, TSB-M-17(4)S, which will be of interest to many New York-area art dealers and collectors.
August 23 2017
Court Holds Art Advisor Must Pay Collector $1.05MM for Fraud
A New York court has ruled that an art advisor who brokered the sale of a collector's painting and secretly pocketed $1 million will have to pay the money back. Because the dispute turned on the advisor's agreement with the collector and what kind of legal duty the advisor owed to the collector, the case offers valuable lessons for people structuring art transactions. Here's what you need to know.
March 21 2017
New Federal Law Clarifies Foreign Governments’ Immunity in Connection with Art Loans to US Museums
President Obama signed the Foreign Cultural Exchange Jurisdictional Immunity Clarification Act into law on December 16, 2016. This new law clarifies when foreign states and fine art carriers can avoid a lawsuit in the US arising from loans of culturally significant artwork to US museums. The new law is important to museums and fine art carriers, and is expected to encourage art loans by foreign states. Here's what you need to know.
January 10 2017