Fair Market Value

“Fair market value” is one of the most commonly used terms in appraisals. Fair market value appraisals are required for all work submitted by a taxpayer to the Internal Revenue Service – for estate taxation; for donations of art given to qualifying charitable institutions; and, for gift tax purposes, when there is a tax to be paid for gifts given to a family member or friend which are worth more than $5,000.

The IRS has defined fair market value as “The price that property would sell for on the open market. It is the price that would be agreed on by a willing buyer and a willing seller, with neither being required to act and both having reasonable knowledge of the relevant facts.”

In other words, the fair market value is the price which would be paid by the purchaser, and not necessarily the price for which a similar object is “offered” for sale in a shop, since there is no guarantee that a work of art being offered by a dealer would ultimately be purchased at that price. There must be a sales record to substantiate the fair market valuation.

There are three essential components to fair market value: first, the willingness on the part of both the buyer and the seller to enter into the commercial transaction; second, the lack of compulsion forcing one or the other either to buy or to sell the property; and third, that both parties have full knowledge of all the facts concerning the object being offered for sale.

The fair market value, according to the IRS, is the amount of money the buyer would pay for the object. This may not necessarily be the amount of money the seller receives. For example, at auction, buyers frequently pay a buyer’s premium to the auction house; and the seller frequently has to pay a commission to the auction house or to a dealer brokering the art. This means the proceeds of the sale received by the consigned will be less than the actual sales price.

Fair market value is also founded on the premise that the works are sold at an “orderly sale.” This means that the auction house, or the dealer acting as an agent for the seller, will have time to catalogue the works properly, place them in the most appropriate sale, publicize the sale and pay the owner in a timely fashion after being paid by the buyer, which can frequently be as long as 30 to 45 days after an auction. Since valuation is not a precise science, fair market value, more often than not, can be a range of value determined by the circumstances of the presumed sale (e.g. estate or donation valuation), and the market in which the object is being offered for sale (e.g. auction or dealer market).

Appraisers using the comparative market data approach to structure value, and those who use comparable auction sales as the building blocks of this structure, should be very careful to make sure that the buyer’s premium is included in the auction comparable(s) used in the appraisal.

The interpretation of the nuances of fair market value has been the subject of much litigation in tax court and of lengthy judicial decisions. However, one can see from this brief summary that both the definition of fair market value and its application have very specific meanings for the IRS.

With this knowledge both the appraiser and the client should bear in mind that the term “fair market value,” is one that has been defined by the courts and the IRS; and that this type of valuation should only be used for appraisals which will be submitted to the IRS. Other types of appraisals require other types of value, which will be discussed in future columns.

The correct definition of value is just one of the many elements of a correctly prepared appraisal. For a complete list of the “Elements of a Correctly Prepared Appraisal”, please contact the Appraisers Association of America.

This article appeared in the Antiques and The Arts Weekly, November 17, 1995, page 28 and was written by Victor Wiener.

Choosing the Most Appropriate Market for Valuation

Appraisers frequently decide how much an object is worth by comparing it to similar and like objects that have recently been sold. This is the comparative market data approach to valuation, which was discussed in our last column.

Choosing the market from which these comparables should be selected, however, is one of the most difficult and challenging tasks for any appraiser. For example, one may ask is it best to chose comparables from auction sales or from the retail market of private gallery sales?

To complicate matters even further, the courts, the IRS and appraisers have identified other “markets” which may not be obvious to anyone except the most knowledgeable professional. These include the wholesale market, for bulk purchases; the middleman’s market, for purchases among dealers; the glamour market, where the notoriety of a sale may contribute to inflate prices; the collectors market, where knowledgeable collectors may be given discounts routinely by dealers; and even the discreet retail market, which is a euphemism used recently by the IRS to describe the market for stolen goods or illegal narcotics which have a certain street value.

There are three major factors which determine the market from which the appraiser should choose comparables: the market in which the collector normally would purchase a work of art; the market in which a work of art is normally sold; and the market which must be chosen because of the circumstances of the appraisal.

In the case of Chou v. Commissioner Mr. Chou, a prominent collector, had made a donation of opals to a museum, and his appraiser had used comparables drawn from gallery sales of similar opals. However, the value for Chou’s donation was lowered significantly when the court supported the IRS contention that since Mr. Chou was a prominent collector, known to all dealers, the opals that he donated could only be valued using comparables chosen from “the collector’s market” where a dealer’s sale price to a collector/client would be significantly discounted.

On the other hand, in the case of pre-Columbian art, taxpayers have successfully challenged the IRS using the second determining factor of valuation by arguing that comparables should be chosen from the market in which specific objects are normally sold. The plaintiffs in both the Ferrari Case and the Biagiotti Case convinced the court that the IRS was wrong in relying on comparables selected from auction sales for donated pre-Columbian art rather than selecting comparables from gallery sales. They successfully argued that pre-Columbian art is normally purchased by the consumer from galleries which will offer firm guarantees of authenticity and uncontested title and, therefore, this was the most appropriate market.

By looking at estate valuations for tax purposes, we can see the best illustration of the concept that the circumstances of an appraisal may dictate the market from which comparables should be chosen. Estate taxes must be paid on a timely basis and executors are frequently hard pressed to produce capital to meet the estate’s financial obligations. Auction sales for estates are, consequently, the most appropriate venue of sale, because they offer the strong possibility of relatively quick sales while removing any suggestion of conflict of interest or collusion from the executor, since all sales are open to any member of the public who wishes to participate.

As one may imagine from our brief overview, selecting the most appropriate market for valuation is one of the most challenging aspects of an appraiser’s job and one which leaves both the appraiser and the client most vulnerable to legal challenge – especially when the IRS is involved. For this reason all clients should be well advised to select the most qualified appraiser who is knowledgeable of all the nuances of appraisal methodology and art law.

The choice of the most appropriate market for valuation is just one of the many elements of a correctly prepared appraisal. For a complete list of the Elements of a Correctly Prepared Appraisal, please contact the Appraisers Association of America, Inc.

This article appeared in the Antiques and The Arts Weekly, July 21, 1995, page 35 and was written by Victor Wiener.

Cost Approach

The Valuation Approach is the general orientation or economic point of view an appraiser uses in formulating a specific appraisal and arriving at a value each object.

There are three approaches to valuation used in most types of appraisals, whether for real estate, business valuation or personal property.

The three approaches are: the cost approach, how much it cost to manufacture an object; the income approach, how much income an object can generate or produce; and the comparative market data approach, how much the object appraised is worth when compared to similar and like items offered on the market place.

An object valued according to the three different approaches may be determined to have three distinctly different values. For example, a drawing, which is valued at $300 using the cost approach, may be worth $25,000 under the comparative market data approach, and, $150,000 when the income approach is applied. Consequently, it is important that the appraiser, when determining the scope of the appraisal, chose the appropriate valuation approach. This is generally determined by the specific nature of the object and the purpose for which the item is being appraised.

The Cost Approach refers to the valuation method used by the appraiser to determine how much it cost to manufacture or recreate an identical object such as the one under consideration.

Generally this valuation approach is not applied to fine arts for several reasons. First and foremost, paintings, drawings, prints and sculptures are, for the most part, unique items, and the creator, if still alive, would probably be hard pressed to recreate them exactly as they now exist.

In addition, the cost of materials and labor usually does not determine the value of the piece – e.g. the cost of the canvas and paint has no influence on the valued of the paining; the cost of charcoal, pencil and paper does not determine the valued of a drawing,; the cost of the printing and paper does not determine the value o a dine art print.

Within the decorative art, however, when hand crafted objects are created more than once by the same artisan, the cost approach may be appropriate for the appraiser to apply, after due consideration. There may be instances where it mat be possible to recreate a specific object; and the cost of labor and materials may be the determining factors in the pricing of that object.

Even within the area of fine arts, there may be instances in which the appraiser may use the cost approach. When valuing motion pictures, for example, the cost of creating a new print from an existing negative, (i.e. laboratory costs and copyright payments), may be considerably more that the price a vintage copy in poor condition, of the same movie, would fetch on he open market.

From examination of this approach to valuation, one can begin to understand that the job of the appraiser can frequently involve the expertise of an economist, who is required to analyze market conditions and economic theory, together with the skills of a museum curator, who is required to make assessments of quality and artistic merit when considering works of art.

This article first appeared in the Antiques and The Arts Weekly, April 28, 1995, p.42 and was written by Victor Weiner.

The Income Approach to Valuation

In the last column, we discussed the Cost Approach to valuation as one of three approaches an appraiser can chose in writing an appraisal which includes all of the essential “Elements of a Correctly Prepared Appraisal.”

Another valuation approach is the Income Approach. Although this approach is more frequently used by business valuers than appraisers of personal property, it is an approach that all appraisers should consider – especially as the world of fine arts becomes increasingly linked to that of big business.

Briefly, the Income Approach establishes the value of a work of art by determining how much income an object can generate for its owner over a certain period. This is especially applicable when an image or a specific work of art is leased or rented to produce income. Picasso handbags and Miro T shirts, created from images of specific paintings, are two examples that come to mind immediately.

The Income Approach should only be employed when the appraiser is valuing a business enterprise and should never be applied when a normal piece of fine or decorative art is being appraised. The following example should clarify this point.

In a hypothetical scenario, Mrs. Smith has donated a Rembrandt to a major art museum and has contracted with an appraiser to prepare a donation appraisal, which will allow Mrs. Smith to deduct the painting’s full fair market value when she files this year’s tax return.

She is thrilled to learn from the appraiser that, based on an analysis of recent sales of similar Rembrandts, an appraised value of $10 million can be justified easily. Delighted with this information, she can’t wait to tell her sister-in-law, Mrs. Jones.

However, she is less than delighted when her sister-in-law tells her that both she and the appraiser are fools. “Don’t you realize,” Mrs. Jones explains to her, “that once the Museum is given title to your painting, they will be able to use its image on note cards, posters, ash trays, scarves, calendars, postcards and T shirts? Your Rembrandt must be worth at least $200 million.”

Horrified with this news, Mrs. Smith confronts her appraiser. But the appraiser patiently explains that what Mrs. Smith has donated is a work of art only and must be valued as such. A higher valuation may be justified if she were a publisher and had donated a silk screen master or a lithographic stone of a Rembrandt painting, from which all sorts of commercial products could be made. In this particular case, the only appropriate valuation approach, however, is one in which the painting is valued as a painting created by Rembrandt, who, surely, had never dreamed that his image would, centuries later, have a commercial life of its own.

In the occasional case where the appraiser feels that it is appropriate to apply the Income Approach, the appraiser must also have a complete knowledge of copyright law. And, unless the art appraiser has been trained as an economist or an accountant, it would be advisable for the appraiser to write the appraisal in collaboration with a business valuer. Just as it would be impossible for a business valuer to appraise the holdings of an art gallery or the inventory of a manufacturer of fine art products without the help of an appraiser of fine arts, it is equally impossible for the art appraiser to write an appraisal using the Income Approach without the help of a business valuation expert.

The next column will discuss the third approach to valuation, the Comparative Market Data Approach.

For a complete list of the “Elements of a Correctly Prepared Appraisal” please contact the Appraisers Association of America.

This article appeared in the Antiques and The Arts Weekly, April 28, 1995, page 42 and was written by Victor Wiener.

What Is An Appraisal?

“What is an appraisal?” is a question frequently asked by clients of appraisers as well as appraisers themselves.

Although one can find many different definitions when consulting the dictionary, the appropriate way to define the term is to consult professional appraisers. Most will agree that an appraisal is a statement of value which is arrived at through a thorough analysis of the market in which an object is normally sold. Most appraisers will also agree that an appraisal is a written document and as such will assume legal significance and may ultimately be called upon to be defended in a court of law.

The appraisal is a valuation in which a diverse number of factors are considered by the appraiser and analyzed in written form. These factors include the purpose of the appraisal, the market in which the object is being valued, the market in which the object was purchased, the market in which the client may want to sell the object, the type of valuation applied and the valuation approach employed by the appraiser.

An appraiser must be knowledgeable in valuation theory. This will allow one to consider and select, for the appraisal, one of the commonly used valuation approaches, such as the cost approach, the income approach or the comparative market data approach in which similar and like items previously sold are compared and contrasted to allow the appraiser to make an informed choice about an item currently under consideration.

In brief, the professional appraiser must rely upon a detailed understanding of the art market for the type of object being valued and must articulate this understanding in a written document which leaves no factor open to ambiguous interpretation.

Among the many purposes requiring appraisals are insurance, charitable donation for which a tax deduction can be claimed, estate tax, gift tax, equitable distribution in divorce, or liquidation.

Each of these purposes may require a different type of value such as replacement value, fair market value, marketable cash value and liquidation value. Legal requirements vary about what each type of appraisal should contain.

Appraising is a complicated field practiced by trained professionals. Consequently, one should be circumspect when considering the “verbal appraisal,” which may be little more than an informal estimate of what one could expect an object to fetch at an auction or what a dealer would probably pay to purchase it.

These and other issues will be discussed in future columns. In the meantime, a list of “Elements of a Correctly Prepared Appraisal” is available free of charge by writing to the Appraisers Association of America, 386 Park Avenue South, Suite 2000, New York, N.Y. 10016.

This article appeared in the Antiques and The Arts Weekly, December 9, 1994, page 39-B and was written by Victor Wiener.