Internal Revenue Manual 4350: Chapter 600 Valuation Of
Real Property
610 (12-16-87) Introduction
The appraisal of real estate is not an exact science. It is the estimate of value
of property as of a certain date. Real estate is unique. There are no parcels of property
really identical; they may be similar. The differences in opinion of value reflect the
individual interpretation of appraisers.
620 (12-16-87) Basic
Considerations
(1) Unless special use valuation has been elected under IRC 2032A, the decedent's
interest in real estate must be included in the estate at its fair market value. The
regulations define fair market value as the price at which the property would change hands
between a willing buyer and a willing seller, neither being under any compulsion to buy or
to sell and both having reasonable knowledge of relevant facts.
(2) Inherent in this definition is the
requirement that the highest and best use of the property be considered. Highest and best
use is defined as that reasonable and probable use that will support the highest present
worth of the (improved) property as of the assessment date based on the highest net return
that it can produce over a reasonably foreseeable period of time, such as the property's
probable remaining useful life. Thus, use of the land for farming purposes might not be
its highest and best use it were located within a good business area or within a
substantial residential development area. All zoning, deed restrictions, or other
physical, economic, legal-governmental, or locational restrictions preventing a higher
income-producing use should be considered.
(3) It is your job to recommend the fair
market value of the property. Recognize that in the absence of actual sales the matter of
valuation is one of opinion. Therefore, maintain a sense of proportion and exercise sound
discretion and judgment in arriving at recommendation. Do not recommend extremes! If
investigation shows that the returned value is essentially correct, recommend it. Slight
differences based upon opinions of qualified experts should not be the basis for change.
However, a sale, reflecting fair market value and made within a reasonable time of the
valuation date, would be a proper basis for change even though the change might not be
substantial.
(4) Upon assignment of a return,
determine the need for engineering or collateral assistance. Consult your manager
regarding the proper referrals to be made. Your manager can guide you regarding district
practice on size criteria and other requirements for referrals
630 (12-16-87) Precontact
Analysis
(1) When you make your precontact analysis of the estate tax return, note any real
property interests returned. Real property interests occur where the decedent owned
property individually or jointly and where the decedent had an interest in a partnership,
trust, or corporation which held property the valuation of which might affect the
valuation of the decedent's interest in these enterprises.
(2) Before you undertake any
investigation as to the value of any realty interest in the estate, first determine
whether the property has been sold. If the real property was sold within a reasonable time
of the valuation date in a bona fide arm's-length transaction, then, in the absence of
some unusual intervening event, the sale probably reflects the fair market value To
determine whether the sale was arms-length examine the terms of the relationship between
the buyer and seller. Of Course, if it is not arms-length, do the usual investigation.
(3) If the realty has not been sold,
examine any appraisal submitted If none, try to determine a range of values in the area. A
consultation with a local real estate agent, a local Engineer familiar with the area, or a
telephone call to an examiner in another district might give you an idea of whether the
valuation should be accepted or not. Also check the local assessed valuation, which may or
may not reflect fair market value, depending upon local conditions.
(4) During the initial contact with the
taxpayer's representative determine whether the property has been sold or is subject to a
contract of sale. If so, obtain the details and a copy of either the contractor the
closing statement. If not sold, request the basic information to value the parcel unless a
formal appraisal with the following information as been submitted. For all types of real
estate you should request the following:
(a) taxpayer's basis for valuation
(including comparable sales relied upon);
(b) assessor's parcel number;
(c) address or map showing exact location (if no street address);
(d) copy of the most recent county tax bill;
(e) dimensions or area and topography of the land;
(f) size, age, condition and type of construction of all improvements;
(g) written permission from the estate to examine the county assessor's files on
the parcel, (some regions have pre-printed forms for this purpose.);
(h) copies of all appraisals made within 5 years of valuation date;
(i) copies of all listings on the properties and names of realtors handling within
the past three years;
(j) details of all offers made;
(k) copy of the closing statement if the property was purchased within five years
of valuation date;
(l) any special conditions, restrictions, circumstances, etc., that would relate to
valuation.
(5) In addition to the above, further
information about certain types of property should be considered.
(a) Single family residence - number and
types of rooms; special amenities such as pools, and quest homes.
(b) Residential income property - size and type of units; actual and economic rent
for each unit; actual expenses.
(c) Commercial and industrial property copies of all leases; if not (eased, names
of tenants and terms of occupancy; actual expenses.
(d) Unimproved land - copies of any leases or options; actual usage; description of
growing crops.
(6) In the case of a married decedent it
is a good idea to check the deed on each parcel (copies can be obtained from the
taxpayer's representative) to determine how title was held at date of death. Prepares
sometimes are not careful in distinguishing among tenancy in common, joint tenancy and
community property. The exact form of title determines distribution and can affect the Net
Federal Estate Tax.
640 (12-16-87) Professional
Appraisal
641 (12-16-87) General
(1) When a taxpayer submits a formal or
"expert" appraisal to a returned valuation, you may have a valuable tool to aid
in the audit, whether or not you agree with the appraiser's conclusion. If it is an
acceptable conclusion, the issue may be closed. If not, it is usually a good source of
data regarding the subject property, provides some comparables, and is a good beginning
for your independent investigation, However, do not let it lead you into not looking at
the subject property or at the appraiser's comparables, which sometimes are not as
comparable as he/she claims they are. Analyze and use the appraisal carefully.
(2) In going over the appraisal, consider
the reliability of the appraiser and the approach he/she used, Consider the adjustments
made for the differences between the subject property and the comparables, whether they
are reasonable and have any basis in fact. Often it is a good idea to call the appraiser
to explain parts of the appraisal and perhaps obtain additional information that would be
helpful.
(3) For income properties request copies
of the leases in effect and verify actual expenses, as sometimes the information
summarized in the appraisal is inaccurate. The decedent's income tax returns may be used
to verify rental income and expenses.
(4) If the property is out of your area,
call an examiner or Engineer in the area where the property is located, to get an idea
whether a collateral should be requested.
642 (12-16-87) Outside Fee
Appraisals
(1) Appraisers may be needed for unique
properties not subject to valuation by the usual methods. Contracting this work to experts
takes considerable examination time.
(2) Outside fee appraisals also may be
necessary in unagreed cases in which a large deficiency is involved and the testimony of
an expert witness will be needed for trial. It is an advantage to employ an appraiser who
maintains an office or practice in the local area where the real estate to be appraised is
Situated.
643 (12-16-87) Independent
Appraisers
In making an investigation to determine
the valuation of real property it is generally advisable to seek the aid and advice of
independent realtors, appraisers, or real estate agents who have some familiarity with the
subject property. Ascertain the best qualified, with a good reputation for integrity, and
contact them. Experience has shown that these persons are, for the most part, happy to be
of assistance. When you confer with them, make available all the pertinent information you
have received or developed during your investigation so that they may have the broadest
basis in arriving at an opinion of value.
644 (12-16-87) Local Assessors
Consult with local tax assessors who, in
many cases, can give reliable valuations. Assessor records are good sources of
information. Comparison of sales prices with assessment values in the area under
consideration may give a factor which, when applied to the assessment of the property you
are investigating, will furnish a valuation. Be careful that the actual sales are
comparable (type, age, location, etc.) to the subject and that there are a number of sales
to help establish the relationship between assessed value and sales price. Some local
assessment values are based upon a percentage of fair market value. Application of this
percentage to the local assessment value may give the assessors' opinion of the fair
market value of the property. Most assessor's offices will disclose their records and
worksheets if you obtain written permission from the executor, trustee, joint tenant, or
other appropriate owner. This is a valuable, time-efficient source of information.
650 (12-16-87) Valuation
651 (12-16-87) General
It is not the function of this handbook
to explain the classical approaches to real estate valuation Rather, the discussion will
relate to the appropriateness of certain approaches and suggest some specific techniques.
652 (12-I6-87) Market Data or
Comparable Sales
652.1 (12-16-87) General
(1) The main challenge in this approach
is obtaining adequate data that is comparable enough to be useful. Sources of sales
information include:
(a) sales recorded in the public records
of the County Assessor' Offices.
(b) lists of sales published by local multiple listing organizations, realtor
associations, and various commercial services (Locate the ones that cover your local.)
(c) contacts with realtors and appraisers in the area.
(d) inspection of the specific file on the subject property which is kept by the
County Assessor.
652.2 (12-16-87) Adjustments of
Comparable Sales
(1) The greatest skill in this area is
adjusting comparables, which are rarely, if ever, enough like the subject property to
indicate fair market value without adjustments for significant differences.
(2) The comparables, as well as the
subject property, need to be viewed by the person making the adjustments and the
valuation. Adjustments should be specific and be defensible to the taxpayer.
652.3 (12-16-87) Income
Multipliers
(1) Gross rental multipliers are often
used as a measure of value. These are only rough estimates.
(2) Net income multipliers are more exact
and are actually used more frequently by investors. The problem is obtaining and verifying
the accurate data on expenses for the comparable sales, as well as for the subject
property.
653 (12-16-87) Income
Capitalization
(1) Once net income has been determined
for commercial or industrial property, the most difficult problem is the determination of
the correct rate of capitalization to be applied. To obtain the correct rate of
capitalization research the marketplace. Find out what investors were demanding as a net
return on that particular type of property at the valuation date. Contact brokers,
investors, etc.
(2) Do not allow the taxpayer to convince
you that the capitalization rate should be higher than the market would indicate by
arguing that since Treasury Bonds were yielding % plus % for the risk, etc.. that a rate
higher than the market is justified. Remember that potential appreciation and "tax
shelter" aspects, such as depreciation, tax credits, etc., add value to the
investment over and above the net income generated.
654 (12-16-87) Residual Methods
of Valuation
This type of valuation is rare. It is
most appropriate when the value of either the land or the improvements are readily
ascertainable and the net income is determinable. This approach is not of great value for
ascertaining total value for inclusion in the gross estate, but is good for allocating
value between land and improvements.
655 (12-16-87) Replacement Cost
This method is viable only when the
improvements are fairly new and the fair market value of the land is independently
ascertainable. It does not result in a valid value if the improvements are more than
several years old.
660 (12-16-87) Leases
(1) When property is subject to a lease,
obtain a copy of the lease. A taxpayer's brief synopsis is usually inadequate.
(2) If it is a long term lease, the
greatest amount of the value will be in the present value of the lease payments, with the
residual value of the property itself being of little relative significance.
(3) Whenever there are short or medium
term leases on property, determine the value of the property without the leases and adjust
for the positive or negative effects of the leases do this determine the difference
between present value of the payments according leases and the present value of what the
economic rent would have been for that same period of time, if there had been no lease.
(4) Check the tenants on any lease to
mine whether the terms are at arms length if the property is leased to a related person or
entity, compare the terms with going terms at the valuation date. If the terms are not to
market rental the value of the real estate an related close corporation, etc., should be
adjusted accordingly.
670 (12-16-87) Leasehold
Interests
Leasehold interests owned by a decedent
tenant should be returned as assets on Schedule F or debts on Schedule K. These items are
often overlooked by preparers. The value is the difference between the present value of
the payments according to the lease and the present value of the economic rent for that
period of time.
From Internal Revenue Manual 4350,
Chapter 600
Discuss your mineral
property appraisal, mining business valuation, or other mineral industry
related concerns with Mineral Business Appraisal:
Michael R. Cartwright michael@minval.com
Five Claret Court, Reno, NV 89512-4744
Tel/Fax: 775-322-9028
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