“While it’s good to learn from your mistakes, it’s better to learn from other people’s mistakes.” – Warren Buffett.

Businesses of all sizes can, and should, be appraised regularly. “Qualified appraisals,” as defined under the Internal Revenue Code (IRC), are commonly sought by higher-income taxpayers and estates and attached to Internal Revenue Service (IRS) submissions for tax purposes. And—it might not come as a surprise—some of the IRS’s favorite items to audit are private business and closely-held entity valuations.

A recent U.S. Tax Court case highlights the importance of keeping these facts top-of-mind. In Estate of Hoenshied v. Commissioner, T.C. Memo. 2023-34 (1), the Tax Court’s decision resulted in a large, unexpected tax bill. A key to the decision: The taxpayer failed to acquire a qualified appraisal. While no extra penalty was levied, potentially millions of dollars in tax deductions were lost.

Case Background

As noted in a summary of the case in Business Valuation Law News, what went wrong for the taxpayer occurred admittedly by their own actions. The case focuses on two issues: anticipatory assignment of income doctrine and what constitutes a qualified appraisal. In short, the owners of a private company attempted to make a charitable contribution of appreciated shares of stock to a charitable organization that administers donor-advised funds (DAFs) prior to a sale. This can prove to be a tax-efficient gifting strategy when structured properly: The taxpayer recognizes the income tax deduction for the gift at the time it was made and avoids paying capital gains on the appreciated stock when the sale occurs.

But the Tax Court first found the taxpayer failed to make a gift in a timely fashion, disallowing the gift of private company stock prior to the sale (and losing the charitable tax deduction for income taxes(2). The Court then turned to whether the taxpayer was allowed to make a charitable contribution deduction for the gifted stock. While it ruled a valid gift had been made, it left open the question of whether the gift was accompanied by a qualified appraisal of gifted stock.

According to Business Valuation Law News, the taxpayer “decided to use the ‘cheaper chicken’ for the appraisal,” a free appraisal provided by the financial advisor to the transaction rather than by a qualified appraiser. The result? As the saying goes, “Pigs get fat, hogs get slaughtered.”

Do I Really Need a Qualified Appraisal?

Under Section 170(f)(11) of the IRC, taxpayers are required to obtain a qualified appraisal for noncash contributions valued over $5,000 for charitable tax deductions. In this case, the estimated contribution was in the millions, warranting a qualified appraisal from a qualified appraiser.

Treasury Regulations outline specific criteria for an appraisal to be deemed “qualified.” Quoting directly from Hoensheid (3):

Treasury Regulation § 1.170A-13(c)(3)(ii) requires that a qualified appraisal itself include, inter alia:

(1) [a] description of the property in sufficient detail for a person who is not generally familiar with the type of property to ascertain that the property that was appraised is the property that was (or will be) contributed;
(2) [t]he date (or expected date) of contribution to the donee;
(3) [t]he name, address, and . . . identifying number of the qualified appraiser;
(4) [t]he qualifications of the qualified appraiser;
(5) a statement that the appraisal was prepared for income tax purposes;
(6) [t]he date (or dates) on which the property was appraised;
(7) [t]he appraised fair market value . . . of the property on the date (or expected date) of contribution; and
(8) the method of and specific basis for the valuation.
To further cite Hoensheid in regard to a qualified appraiser (4):

Turning back to the statute, section 170(f)(11)(E)(ii) provides that a “qualified appraiser” is an individual who:

(I) has earned an appraisal designation from a recognized professional appraiser organization or has otherwise met minimum education and experience requirements set forth in regulations,
(II) regularly performs appraisals for which the individual receives compensation, and
(III) meets such other requirements as may be prescribed . . . in regulations or other guidance.

In short, a qualified appraisal is a specific document with specific criteria and items that must be included. It must be performed by a qualified appraiser, that is, someone who has valuation credentials and regularly performs appraisals for compensation.

The appraisal in this case did not describe the method for the valuation, did not include appraiser qualifications, and did not use the correct date for the valuation, among other deficiencies. As such, the taxpayer and the financial advisor failed to provide an appraisal that met the standard of a “qualified appraisal,” and the advisor himself did not meet the definition of a qualified appraiser.

The result: a double whammy. The IRS disallowed the entire charitable deduction related to the stock donation, and the taxpayer was unable to claim the over $3 million deduction for tax purposes after having to recognize a gain on the sale of the same stock due to not gifting the stock in a timely manner.

Lessons for Estate Planners and Business Owners

Hoensheid teaches a simple lesson amidst a detailed legal analysis: Do not cut corners when the taxman is involved. Hoensheid is a useful case for estate planners to use with reluctant clients, highlighting the importance of careful planning in the pre-transaction process. A qualified appraisal from a qualified appraiser would have likely paid itself back 50 to 100 times after considering the lost tax deductions.

HBK is here to help. Please give one of our tax or valuation professionals a call to discuss your family’s situation and needs. You can contact me at 941-909-7194 or by email at afrank@hbkvg.com.

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(1) Full case available, T.C. Memo 2023-34; 2023 Tax Ct. Memo LEXIS 33

(2) Anticipatory Assignment of Income Doctrine and whether the taxpayer had a fixed right to income arising from the sale is beyond the scope of this article.

(3) T.C. Memo 2023-34; 2023 Tax Ct. Memo LEXIS 33, page 38

(4) T.C. Memo 2023-34; 2023 Tax Ct. Memo LEXIS 33, page 39