Recently, in Estate of Kollsman v. Commissioner,1 the U.S. Court of Appeals for the Ninth Circuit affirmed the Tax Court’s 2017 ruling that an art collector’s estate significantly underreported the value of two artworks for estate tax purposes. The appellate 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. The case shows that even the opinions of leading industry experts can be deemed unreliable when challenged in court, and those opinions may be subject to increased scrutiny by the Internal Revenue Service when the artwork later performs well at auction, but the estate’s valuations remain unchanged. For some advice on how to avoid this result, see “Best Practices,” p. A9.
Background
Art collector Eva Franzen Kollsman died on Aug. 31, 2005.2 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 Eva’s estate (who was also a residual beneficiary of the estate) a document stating that the fair market values (FMVs) of Maypole and Orpheus, “based on firsthand inspection of the property” (but without further elaboration), were $500,000 and $100,000, respectively.3 The estate later attached this document to its United States Estate (and Generation Skipping Transfer) Tax Return. The Sotheby’s specialist also sent to the executor of Eva’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 to $800,000 for Maypole and $100,000 to $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 $1.75 million and $300,000, respectively. The estate petitioned the Tax Court for redetermination. (After the estate filed its petition, the IRS asserted that the values of Maypole and Orpheus were $2.1 million and $500,000, respectively.)
Tax Court Opinion
On Feb. 22, 2017, the 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 FMV estimates at the same time he was soliciting the executor for the exclusive right to sell the works.4 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.”5 The court noted that, even though Sotheby’s sold Maypole in January 2009 for $2,434,500 ($2.1 million hammer price) against a pre-sale estimate of $1.5 million to $2 million, its specialist’s valuation opinion remained unchanged in the valuation report he prepared for trial.
Additionally, the Tax Court found that the Sotheby’s specialist exaggerated the dirtiness of the paintings on the valuation date and the risks of cleaning them. The Sotheby’s specialist claimed that the painting was one of dirtiest he’d ever seen, and its surface dirt obscured the painting’s underlying condition. The court, by contrast, noted that the paintings eventually were cleaned with relative ease, and if it truly was very risky to clean the works, the auction house should have, but didn’t, 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 $2.1 million and $500,000 for Maypole and Orpheus, respectively, were largely acceptable to the Tax 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 million and $375,000, respectively (nearly four times the amounts reported by the estate).
Ninth Circuit Decision
Eva’s estate appealed the Tax Court’s decision, which the Ninth Circuit affirmed by decision dated June 21, 2019.6 The Ninth Circuit found that the Tax Court correctly applied the law by determining the value of the paintings as the FMV on the date of Eva’s death under the willing buyer/willing seller standard. According to the Ninth Circuit, the Tax Court correctly found that testimony from the IRS’ expert witness and a conservator supported the Tax Court’s finding that as of the valuation date, the hypothetical buyer would have known that the cleaning was “a well advised and low-risk undertaking.”7 The Tax Court didn’t err in finding that the expert retained by Eva’s estate “exaggerated the dirtiness of the paintings and the risk of cleaning them.”8
Per the Ninth Circuit, the Tax Court properly rejected in part the expert valuation submitted by Eva’s estate because Sotheby’s specialist failed to support his valuations with comparable sales data or rely on them—the expert testified that when he arrived at his valuations, he wasn’t interested in comparables.9 The Tax Court also properly found that the estate’s expert failed to explain the nearly fivefold increase in value between his valuation and the sales price. Moreover, the estate’s claim that in 2009, there was a surge in demand for Old Master Paintings was unsupported, and in any event, the estate failed to establish an increase in sales prices for individual paintings at Sotheby’s in 2009.
The Ninth Circuit found that the Tax Court didn’t err in largely accepting the valuations submitted by the IRS’ expert, as the expert explained his methodology, relied on comparables and researched the paintings’ conditions. The Tax Court didn’t wholly accept those valuations but instead applied discounts for both paintings based on the evidence. Because the lower court thoroughly considered the evidence, and its valuation plausibly flowed from the record, the Ninth Circuit affirmed the lower court’s decision.10
Takeaways
Even when an appraisal is prepared by a foremost industry expert, it can nonetheless be deemed unreliable by the courts when procedural safeguards aren’t followed. A topflight expert must still “show her work” by including comparable sales data in her valuation report. Additionally, when an artwork 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. Collectors should assume that post-valuation date events such as auction sales will be relevant to the valuation analysis. Finally, given the Tax Court’s conclusion that the auction house specialist operated under a conflict of interest, 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.
Endnotes
1. Estate of Kollsman v. Commissioner, 777 Fed. Appx. 870 (9th Cir. 2019).
2. The underlying background of the case is set forth in the Tax Court’s opinion. See Estate of Kollsman v. Comm’r, T.C. Memo. 2017-40 (Feb. 22, 2017).
3. Ibid., at *4.
4. Ibid., at *19.
5. Ibid., at *20.
6. See supra note 1, at p. 870.
7. Ibid., at p. 872.
8. Ibid.
9. Ibid. It should be noted that Eva’s estate argued on appeal that, prior to trial, a subordinate of the Sotheby’s specialist prepared an expert report that disclosed the values of comparable paintings. When the subordinate was unable to testify at trial due to a business conflict, the Tax Court expressed discomfort with receiving her report into evidence, even though her supervisor sought to adopt it through his testimony at trial. Consequently, Eva’s estate withdrew its offer of the report, as it was unnecessary to the expert’s opinion given that he was prepared to testify regarding the bases of his opinion, including comparable sales. See Estate of Kollsman v. Comm’r, Brief for Petitioner-Appellant, available at 2018 WL 2299149, at *12-*13 (9th Cir. May 18, 2018).
10. The U.S. Court of Appeals for the Ninth Circuit didn’t address the Tax Court’s finding that the Sotheby’s specialist had a conflict of interest.