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Faulty Appraisals and The Need To Revisit Appraisal Process Basics

Legend has it that Coach Vince Lombardi, while addressing his Green Bay Packers at half-time, said "Gentlemen, let's get back to basics, this thing in my hand is a football."  My back-to-basics idea arises from my more than 40-years' experience teaching narrative appraisal report writing, teaching USPAP to all disciplines throughout the U.S., Mexico, Canada, and as far away as Lithuania, writing textbooks and teaching expert witness, ASA's 30-hour Appraisal Review courses, and the experience reviewing hundreds of appraisal reports.

Standards of Appraisal Practice have evolved since the 1986 founding of USPAP. Many appraisers have not evolved.  While improving appraisal standards is a positive action, the evolving standards have come with ambiguous interpretations and with appraisers' refusal to accept or otherwise simply ignore USPAP changes. There exists a doctrinaire insistence on the use of archaic terms like purpose-of-the-appraisal, function, and estimate of value. This misuse of long-ago abandoned USPAP terms adds confusion and even anarchy to the appraisal process. Anarchy involves appraisal associations, including ASA, AI, and others who have developed their own proprietary appraisal practice principles that often conflict with USPAP. Business appraisers almost uniformly ignore USPAP and instead rely on IRS Standards or AICPA appraisal standards.

Last year, I reviewed all appraisals involved in the $15 Billion Trans Alaska Pipeline assessor dispute. Similarly I reviewed the appraisals for the $6 Billion assessment dispute of all Verizon real and personal property in California, and a dozen similar machinery and equipment appraisals. In addition, we routinely review complex appraisals of real, personal and intangible property in litigation. Here are two less significant review assignment results used to demonstrate the need to revisit the appraisal process basics.

The first is a 2016 personal property appraisal presented on a Fannie Mae general TADD form. The purpose was described: “the purpose of this report is to estimate the fair market value of the charitable contribution described in this report and defined in the IRS publication 561. The use of this report is limited to decision making only. Any other use is prohibited. Use by persons other than the client is also prohibited”  Scope: This appraisal report is a summary of all information significant to the solution of the appraisal problem. A summary is sufficient information which encompasses the scope of work according to Standards Rules 2-2. The appraisal is concerned with the fair market value of building materials thus the valuation encompasses reusable material which consists of personal property removed from the residence.” The appraiser knew it was a charitable donation appraisal of personal property but cites USPAP Standard 2-2. Then defines the type of value, not as fair market value defined by IRS, but as the market value of the depreciated replacement value. The appraiser defined market value using the OCC definition but did not cite the source. No clear statement of intended use, intended users, appropriate definition of value. No description of the scope of work performed.

I recently reviewed a 2016 decedent estate real property appraisal prepared by two highly qualified MAI designated appraisers. Each appraiser had over 20-years' experience. They wrote, “the purpose of the appraisal is to estimate the market value of the fee simple interest of the subject property. The intended use of the appraisal is for internal use”. What does that mean? The appraisers cited their market value definition as “USPAP Glossary page 199”. They did not cite the appropriate applicable definition of value from IRS § 20.2031. USPAP dropped the Glossary in 2005. 2016 USPAP does not have a page 199. The report did not mention intended users, or intended use. The appraisers said “this report was prepared in compliance with Standard Rule 2-2(b) for a Summary Report. As of 2016, the ASB removed Summary Report from USPAP.  Why did the appraisers not know? If the appraisers take a USPAP update course every two-years, why did they not know of these decade old changes? They knew the appraisal was for an estate tax return as it was addressed to the executor of the estate and named the estate. Why did they not use the applicable definition of value? Is it the lack of competency, insistence on antiquated dogma? Is it improper course instruction?

In 1990, USPAP defined an APPRAISAL as the act or process of ESTIMATING value. Ten years ago, 2005, USPAP appraisal definition changed, making an Appraisal an OPINION of Value. In 2004, USPAP required the appraiser to identify the PURPOSE of the assignment. A year later, in 2005 and more than 10-years ago, USPAP changed the term “PURPOSE” and replaced it with the requirement to IDENTIFY THE INTENDED USE, INTENDED USERS, and IDENTIFY THE APPLICABLE TYPE OF VALUE and SOURCE THE DEFINITION. Why did the ASB change the terminology? Because appraisers were routinely stating, “the purpose of this appraisal is to estimate the fair market value of the fee simple interest in the subject property as of x date.”  The appraisal was not always for fair market value, not always fee simple interest, and the effective date changes along with the intended use of the appraisal. Appraisers were then required to identify the intended use, users, and appropriate definition of value. That change was more than ten-years ago.

Appraisal courses and USPAP insist that the first task of an appraiser is to identify the appraisal problem. The common dictionary definition of “problem” is a puzzle or difficult situation requiring algebraic or other mathematical solution. A hypothetical client telephones the appraiser and states,  “I need an appraisal”. The appraiser responds, “What's your problem?” The client retorts, “I don't have a problem, why do you know my family?”  The appraiser may not know or comprehend the meaning of “identity the appraisal problem” More important, the client does not comprehend their need for an appraisal as a ‘problem'. Please work to change the term “problem” to something more clearly, possibly identify the appraisal issue or appraisal question.

The basics of the appraisal process. Determining the appraisal problem (or issue or question) is accomplished by important steps in the appraisal process. Think of a the appraisal process as a set of stairs. Where do we begin. The first step in the process is to identify the intended use of the appraisal. Why? Because identifying the ‘intended use' of the appraisal limits the appraisal's use and leads the appraiser to identifying the apposite applicable definition of value. There are dozens of definitions of economic exchange value. The IRS has three definitions of FMV, one for decedent estates, one for gift taxes, and one for non-cash charitable donation. The U.S. Bankruptcy Code has 34 definitions of market value. Shareholder disputes and divorce use fair value. In Massachusetts, fair value is the applicable definition of value in an equitable division of marital assets. [Bernier v. Bernier, 449 Mass. 774, 799 (2007) Bernier II) 82 Mass. App. Ct. 81 (2012)]. Fair value is also the appropriate term for business asset allocation in mergers and acquisitions. [Accounting Standard Code 820].The banking business uses the term market value defined at 12 C.F.R. § 34.42(g). Choosing the correct and applicable definition of value is a vital element in the appraisal process.

Similarly, Identify the Client and other Intended User(s) by name or type is also vital. Why? To whom are you writing?  Because identifying your client is important for confidentiality and identifying the other intended users helps you know to whom you are writing and the identity of intended users limits the end user of the appraisal. Adding a restrictive clause is good practice, “This appraisal was prepared for exclusive use (in an equitable division of marital estate, or support for filing a decedent estate tax return, or for lending, insurance, etc.), and use for any other purpose is unintended, and may be misleading.

The use of a Fannie Mae form in a divorce, IRS gift tax return, or IRS decedent estate issues is risky appraisal business because the form is preprinted and does not address the appropriate definition of value or properly describe the intended use or user(s). Did you know that under the IRS regulations, 31 CFR Part 10, commonly known as Circular 230, you can be fined, penalized or disbarred for providing a misleading or otherwise faulty appraisal report.

Appraisers of real and personal property are required to practice in accordance with USPAP. Nearly all appraisers sign a certification statement acknowledging the report was prepared in compliance with USPAP. Typically, the statement of compliance is the basis used to demonstrate that the appraiser did not comply with USPAP. USPAP Rules guide the appraisal process. Somewhere along the way, appraisers have forgotten that USPAP is rules-based and not open to whimsical interpretation. Non-compliance with USPAP can be a negligence tort. Appraisers can be sued for negligence. A simple solution is to revisit the USPAP Rules governing the appraisal process and write your appraisal report following the elements of USPAP to the appraisal process.

Roger Durkin is a Boston based attorney and appraiser.

Footnotes:

1 Competency Rule states, “Competency requires recognition of, and compliance with, laws and regulations that apply to the appraiser or to the assignment.”

2 Decedent Estate appraisal is typically the decedent's date of death

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