The need for appraisals for estate and probate purposes is expected to increase. Estimates of the billions of dollars to be inherited by baby boomers are regularly featured in newspapers and the financial press. Much of those assets are in real estate. With the recent popularity of living trusts, and sophisticated tax avoidance methods for affluent individuals, appraisals are needed both for tax planning purposes prior to a property owner’s death, and for settling an estate after death.
These are a popular method of avoiding probate fees and hassles, but don’t help avoid estate taxes. Living trusts were formerly used mostly by the wealthy, but have now filtered down to the middle class, and are becoming more popular.
Typically, no appraisal is done when the trust is established. Whether or not an appraisal is needed when the person dies depends on how the trust is set up and what is in it. The typical issue is the stepped-up basis if the property is not sold. Of course, that’s assuming the real property is transferred into the trust before the person dies (funded).
If a decedent has a fractional interest in real property, typically less than 50% interest, that portion must be valued. The value of the interest is usually less than its pro-rata share. For example, the decedent owns a 10% interest in a shopping center worth $1,000,000. The value of the interest is less than $100,000, as they are very hard to sell, with a limited market.
Fractional interests are very difficult to value. Fractional and partial interests are a ‘red flag’ to the IRS, so be sure the value is as well supported as possible.
Federal estate (death) taxes
If the fair market value of the gross estate is over $600,000 (one person) (1999 NOTE: this limit increases every year), an estate tax return must be filed. Attorneys we spoke with said this often triggers one or more appraisals for each property, as these returns have a very high audit rate. Improper valuations can have high penalties. In community property states like California, if one spouse dies often no return is filed if the total value of the spousal property is under $1,200,000, although technically a return should be filed.
Every Federal estate tax return is hand screened by experienced estate tax examiners to be classified for audit. The overall audit rate is approximately 20 percent for federal estate tax returns, almost 10 times the audit rate for income tax returns.
Tax rates are from a low of 37 percent to a high of 55 percent. A 20 percent penalty applies to overvaluations (trying to get the basis as high as possible) where the correct value or adjusted basis of any property claimed on a return is 200 percent or more of the correct value. An overstatement of 400 percent of the correct value has a 40 percent penalty.
A 20 percent estate tax penalty applies for estate gift tax understated valuations, if the value is 50 percent or less of the correct value. If 25 percent or less of the correct value, a 40 percent penalty applies.
The IRS’s examiner’s handbook says that they should request copies of appraisals done within five years of the death and copies of listing information on the subject property within three years of the death.
Date of value and retrospective appraisals
The executor can choose either the date of death, or a date six months later for the effective date of valuation (alternative valuation date). Our appraisers will let the executor know which would provide the more appropriate value (higher or lower) if prices are not stable.
Appraisals done as close to the required date as possible are more accurate and reliable than those done sometime later. If challenged by the IRS, a current appraisal is more credible than one done at a later date.
If the property is held in joint tenancy and an estate tax return is not filed, an appraisal may not be done at the time of the death of the first joint tenant. Later, when the surviving joint tenant (typically the spouse) dies, the estate needs to establish the basis as of the date of the death of the first joint tenant. This may be many years later.
Executors and administrators
The executor sometimes needs values to partition an estate. For example, the decedent has two children, one gets the house and the other gets the stocks, but the estate is to be divided equally between them.
Sometimes the beneficiaries can’t agree on ‘how much they can get’ from the property. One of them may not trust real estate agents and think they ‘will try to list it low.’ The executor gets an appraisal.
If a relative or a private party wants to purchase the property from the estate, the executor will probably want an appraisal as part of his or her fiduciary duty.