Deconstruction and Reuse Appraisal Standards

ISA Core Course Lesson 12:

Under the heading, The Qualified Appraisal from Lesson 12, we find the following statement (bold in the original), “The appraisal will not be given much weight if all factors that apply are not considered, the opinion is not supported with facts (such as purchase price and comparable sales), or the opinion is not consistent with known facts.” In other words, the appraiser’s opinion is never more valid than the facts on which it is based; without these facts, it is simply a guess.”

Again, from Lesson 12, the ISA details when Replacement Cost should be used. The heading provides the qualifier “Replacement Cost (Used Infrequently)” Replacement cost is defined as, “The amount it would cost to replace the donated item as of the date of valuation…Often the replacement cost by reproduction far exceeds the fair market value.” They describe the methodology as, “To determine the replacement cost of the donated property, find the ‘estimated replacement cost new,’ then subtract from this figure an amount to compensate for depreciation of the donated property. You should be able to show the relationship between the depreciated replacement cost and the fair market value, and how you arrived at the ‘estimated replacement cost new’ as well.”

American Society of Appraisers

From ASA’s Monograph 7 Analysis of Research: Approaches to Value Market Models

Market research will be used to gather evidence to come to conclusion using either:

• 1
  Past sales or prices asked (Sales Comparison Approach)
• 2
  Costs to reproduce another comparable property (Cost Approach)
• 3
  Income property generated and future PV (Income Approach)

They state that Sales Comparison Approach is used in most assignments by personal property appraisers. Sales Comparison Approach is used when:

• The property is a non-income-producing property
• When a new or reproduced item would not have the same value or utility
• When the type of value and intended use of the appraisal dictate that the property be valued in its current (used) condition.

Appraisals completed for Fair Market Value are prepared for federal tax filing. Per the definitions in the Code of Federal Regulations, these are based on comparable properties from the market where “such items are most commonly sold to the public.” The appraiser therefore must research all markets in order to make the decision as to where the property is most often traded.

When preparing for insurance, concerned about the owner—where the owner regularly purchases similar items and the owner’s ability to acquire a comparable property. Unlike Fair Market Value, consideration is given to the owner and owner’s convenience. This is the replacement cost using the Cost Approach to value.

In limited cases, the cost or income approach can be used to determine Fair Market Value. Some objects seem so unique that nothing like them has sold, and the appraiser may then also utilize the Cost or Income Approaches, as well. It has been noted by numerous instructors that utilizing these two approaches is rare.

Appraiser’s Association of America

The AAA introductory appraisal text, Appraising Art—The Definitive Guide to Appraising the Fine and Decorative Arts, includes a compendium of articles written by a collection of appraisal professionals. In the article, Guidelines for Writing the Appraisal Report, by Jane H. Willis, AAA, the following information is presented on the purpose and structure of comparables.

The appraiser must be able to support valuation conclusions by providing comparables, the appropriate and verifiable history of marketplace responses to the same and/or similar objects. Critical to the credible appraisal report are the skill in researching these sales or offers for sale: the selection of the appropriate dates, venues, and prices realized for comparables; an understanding of the value of negative information such as buy-ins, annotating of basic comparables to allow for further analysis; and a demonstration of the requisite expertise.

The inclusion of comparables is required for the following reports, both of which must follow IRS guidelines:

• 1
  Appraisals for estate tax purposes, for any object valued at $5,000 or more, or one for which such documentation would be useful.
• 2
  Appraisals for non-cash charitable contributions or donation purposes.

Not only must the comparable sales, market-based approached be used but those researched comparables should be presented within the appraisal report. I thoroughly enjoyed a lecture offered by two IRS attorneys and a member of the Art Advisory Board. During the presentation, they encouraged students to research and present comparable sales data, within the report, and provide justified reasoning with regard to the value opinion.

Another informative article, Basic Methodology, by Gayle M. Skluzacek, AAA:

The “comparative market data” (“sales comparison,” “market data,” or “market comparison”) approach is the most common method appraisers use when ascertaining values. The market comparison allows appraisers to analyze recent sales or offerings of comparable articles in appropriate markets where the article in question would normally be traded. Adjustments are made for each article based on age, condition, rarity, artistic merit, technical workmanship, current trends, and availability of the article as compared to those recent sales.

Further in the article, Skluzacek states, “The IRS likes to see three solid comparables, ideally within a three-year period.”

From Valuation Considerations, again by Skluzacek, various principles of valuation are presented, which are consistent across the three appraisal organizations. The principle of substitution is discussed as follows:

The value of a property in the market is often set by the availability of substitute properties of similar utility and desirability. This is the principle of substitution that is inherent to the development of the market data approach. This principle affirms that a prudent purchaser will not pay more for one item than it would cost to purchase another of like kind in a specific market for a specific purpose.

This underscores how critical comparable sales data research is when we produce our opinion of value and our ability to defend these well-researched opinions.

From the article, Appraising Works of Art for Tax Purposes, by Ralph E. Lerner, Esq., IRS valuation principles detailed herein are also applicable to other personal property besides fine art:

The IRS, being a large government agency, likes to have the determination of fair market value based on a sale of similar property close in proximity in time to the valuation date.

In discussing IRS Publication 561, Determining the Value of Donated Property

Publication 561 indicates that a signed copy of any appraisal should accompany the tax return. The more complete the information filed with the tax return, the more unlikely it is that the IRS will question items on it. The weight given an appraisal depends on both the qualifications of the appraiser and the completeness of the appraisal report. A satisfactory appraisal discusses all the facts on which an intelligent judgement of valuation should be based. The appraisal may not be given any weight in the presence of any of the following issues:

• Not all the applicable factors are considered.
• The opinion is not supported with facts, such as purchase price and comparable sales
• Little more than a statement of opinion is given
• The opinion is not consistent with known factors
• The opinion is beyond reason and arbitrary

In reviewing litigation with regard to appraised valuations, the author presents numerous court cases.

The common thread running through the opinions of the cases described above is that the judges wanted valuation cases to be settled before litigation. If the taxpayer is careful in selecting the appraiser and if the appraisal includes the elements set forth in the regulations about a qualified appraisal—that is, if, among other requirements, there are comparable sales and the valuation methods of the appraiser are set forth—valuation cases can be settled with the IRS.

In the court case Gifford M. Mast, Jr v Commissioner, “the court noted that the fair market value is a question of fact to be determined by an examination of the entire record and that the market data comparison approach seemed the most reasonable.”

As previously stated, all three organizations agree that the Sales Comparison Approach to valuation is to be used for the majority of appraisals when determining the Fair Market Value for income tax purposes.

Current Deconstruction Appraisal Methods and Qualifications of Appraisers

The current pool of deconstruction appraisals often use the cost approach to value, claiming comparable sales data does not exist. The data does, in fact, exist and exists in abundance as online sales of used building materials, furnishings, and fixtures has become an expanding market, especially over the past twenty years.

Two cases recently garnered attention within the deconstruction appraisal community. Mann v. US and Loube v. Commissioner. In both appraisals, which became public record, the appraiser used the cost approach to value citing lack of comparable sales. Both appraisals made use of construction estimating software called RS Means in determining the Fair Market Value of the building materials. Marshall & Swift is a similar software system. The only noted IRS approved use of this software is in determining Cost Segregation Analysis for spreading construction expenses across accounting periods. There is no evidence the IRS approves of this software to provide an accurate opinion of Fair Market Value. Additionally, using this software could turn a two-week long appraisal research project into a 30 minute plug-in of values. Even if the software generates values that are similar to those reached through the Sales Comparison Approach, the IRS could disallow the appraisal because the appraiser used faulty valuation methods. Loube had the deduction disallowed because the appraiser, nonprofit, and client did not fill out form 8283 correctly nor completely and the appraiser made it easy for the IRS to disallow the entire deduction without needing to rule on valuation method.

Due to the relatively obscure market of deconstruction appraisers, the current field is a small and insular group. Not many are accredited members of one of the three appraisal organizations and some lack college education. This does not serve the public interest well and puts taxpayers at risk for having, what would otherwise be a legitimate deduction, disallowed.

Some appraisers openly claim to have been doing appraisals for decades without a single audit. They have not researched the IRS review and audit procedures. The taxpayer is notified of audit, not the appraiser. Taxpayers often accept the disallowance without notifying the appraiser. It makes an appraiser sound foolish and ill-informed when they include metrics like this or claim to be “audit proof.”

A few deconstruction appraisers have started independent groups claiming to be the arbiters of determining who is and who is not a qualified appraiser. The IRS and appraisal organizations have this covered. These new groups are especially odd in light of the very few appraisers who are accredited members of the appraisal organizations and whose academic achievements are not easily discovered online.

The bizarre group of self-proclaimed experts have even produced websites in conjunction with other nonprofits claiming that they will match up a client with a qualified appraiser and qualified nonprofit. The metrics on client-appraiser direct match-ups with the appraiser and nonprofit running the site would be extraordinary to examine. They even added an .org at the end of the website to suggest lack of profit motive, despite the group not being a registered nonprofit on the IRS website.

Finally, real estate valuation methods are still being used despite the case mentioned above, Mann, which disallowed the appraisal because the appraiser used the value of the improvements as real estate rather than detached personal property. The second a piece of real property is broken off, or detached, it becomes personal property and must be valued as such. The fact that this erroneous valuation method continues to be used, encourages us to continue offering our research and insight to CPAs and taxpayers regarding how personal property is to be valued.

Taxpayers, CPAs, and Tax Attorneys Must be Well-informed

CPAs are often the gate-keepers to the deconstruction deduction for their clients. They want to ensure an IRS “Qualified Appraisal” is produced by a “Qualified Appraiser.” We will continue our outreach to taxpayers, CPAs, tax attorneys, and other tax professionals to ensure deductions are not put at risk for disallowance due to poor appraiser training and faulty appraisal work products.

Tax deductions are an incredibly effective motivator for a client to choose deconstruction over demolition. We must ensure this motivation continues to exist. As more taxpayers continue to lose their deductions due to unqualified appraisers, we lose traction in the greater environmental movement of reducing construction and demolition waste.