Last month, in Estate of Newberger v. Commissioner,1 the U.S. Tax Court found that a collector’s estate grossly underreported the value of an artwork for estate tax purposes by ignoring the fact that, in early 2010, less than seven months after the collector’s death, the artwork fetched at auction more than twice the amount the estate was claiming the work was worth at the time the collector died in mid-2009. The court rejected the estate’s claim that the post-death sale, which occurred when the art market was rebounding from a recession, was irrelevant because the art market rebound wasn’t foreseeable at the time of the decedent’s death. The court sided with the estate on the valuation of two lower-priced works, finding that the IRS’ appraisals overvalued the works by failing to account for the adverse market conditions that existed at the time of the collector’s death. The court’s decision is a cautionary tale illustrating that valuations should account for post-valuation date sales and market conditions if they are reasonably proximate in time. Here’s what you need to know about the case.
The Estate and Its Form 706 Filing
Art collector Bernice Newberger died on July 28, 2009. Her estate included the following three artworks: Tête de Femme (Jacqueline) by Pablo Picasso (the Picasso), Untitled by Robert Motherwell (the Motherwell), and Elément Bleu XV by Jean Dubuffet (the Dubuffet) (collectively, the artwork). At the time of her death, the U. S. economy was in a recession, and the art market had suffered a significant downturn. In October 2008, 44 percent (double the October 2007 rate) of the artwork at auction failed to reach the minimum or guaranteed price, and in 2009 the top auction houses’ revenues were halved from the prior year.2 By 2010, the art market rebounded, with auction revenue nearly doubling the 2009 total and almost matching the 2007 revenue figures.3
In December 2009, the estate consigned the Picasso to Christie’s for a Feb. 2, 2010 auction in London. The consignment agreement provided the estate with a guarantee of $4,784,689 and 60 percent of the hammer price (that is, the amount of the winning auction bid) exceeding that amount.4 In its sales catalogue, Christie’s sales estimates for the Picasso ranged from $4,784,689 to $6,379,585. Christie’s also provided the estate with an appraisal report indicating that the Picasso had a $5 million date of death value. At auction, the Picasso sold for much more than the auction estimates—a total price of $12,927,874 ($11,484,000 hammer price and a $1,443,874 premium paid by the buyer to Christie’s).5
On Oct. 28, 2010 (eight months after the Christie’s sale), the estate filed its Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return. The estate reported $5 million as the date of death value for the Picasso, relying on the appraisal it received from Christie’s and ignoring the actual auction result.6 The estate reported date of death values of $450,000 for the Motherwell and $500,000 for the Dubuffet, on the basis of appraisals received from Sotheby’s.7
Almost three years later, on Aug. 14, 2013, the IRS issued to the estate a notice of deficiency, claiming that the aggregate value of the artwork was $15,250,000, not $5,950,000, as the Estate contended. According to the IRS, the Picasso, the Motherwell and the Dubuffet had date of death values of $13 million, $1.5 million, and $750,000, respectively.8
In response, the Estate filed a petition with the U.S. Tax Court challenging the notice of deficiency. In the proceeding, the estate and the IRS retained experts to assess the date of death value of each artwork.
The Picasso
The estate’s expert valued the Picasso at $5 million, while the IRS valued that work at $10 million ($3 million less than the value stated in the notice of deficiency to take into account July 2009 market conditions). The estate’s expert argued that the court should disregard the fact that the Picasso sold for over $12 million in 2010 because the sale was a “fluke” and couldn’t have been reasonably anticipated on the decedent’s date of death, when the economy was in recession and the art market was depressed. The court rejected that argument -- even if the post-mortem sale wasn’t foreseeable and thus didn’t affect fair market value (FMV) as of the valuation date, the court held the sale can be taken into account as evidence of FMV as of the valuation date.9 The court found that the most probative evidence of the Picasso’s FMV was its direct sales price, and the estate’s failure to consider the sale rendered its valuation “wholly unreliable.”10 Accordingly, the court concluded that the IRS’ valuation, which adjusted the $12,927,874 auction sale price downward to $10 million to reflect July 2009 market conditions, was proper.11
The Motherwell and the Dubuffet
Both sides’ experts agreed that the best comparable for the Motherwell was a Nov. 11, 2010 sale of In Black and White No. 5 for $1,426,500 because the artist created both works in the same year, with a similar size, style and composition.12 The court concluded that the IRS’ $1.5 million valuation was incorrect because its expert: (1) inexplicably failed to apply a market adjustment, as the expert had done with the Picasso, and (2) illogically valued the work for more than the sale price of the comparable which sold after the market had rebounded.13 By contrast, according to the court, the estate’s expert properly adjusted the comparable’s sales price downward to reflect 2009 market conditions and valued the Motherwell at $800,000.14
The court found the IRS’ valuation of the Dubuffet flawed for the same reasons as the Motherwell valuation. As determined by the court, the best comparable for the Dubuffet was a Nov. 14, 2007 sale of a similarly sized work from the same series for $825,000. The court found the IRS’ valuation of the Dubuffet at $900,000 “nonsensical” because the comparable was sold before the market downturn, and it made no sense to value the work higher than the comparable.15 Because the estate’s $500,000 valuation reflected a market adjustment for the 2009 economic downturn, the court adopted the estate’s valuation.16
Take-Away Points
The Newberger decision is a reminder to practitioners and appraisers that sales occurring after a decedent’s death are very relevant for purposes of estate tax valuations and should be considered in connection with a Form 706 filing. The court’s analysis shows that actual sales reasonably proximate in time are the best evidence of value and should be the starting point for a determination of value, but appropriate adjustments to take account of market conditions as of the valuation date are justified. The court summarily dismissed the estate’s argument that the Christie’s auction result was unforeseeable at the time of Bernice’s death and thus irrelevant, which suggests that the estate might have fared better had it simply addressed the auction result and advocated for a larger discount for adverse market conditions than the IRS’ $10 million valuation had allowed. Additionally, the court’s rejection of the IRS’ valuations of the Motherwell and the Dubuffet show how important it is to ensure that the appraisal takes account of market conditions existing as of the valuation date.
Endnotes
1. Estate of Bernice Newberger v. Commissioner, T.C. Memo. 2015-246 (2015).
2. Ibid. at *2.
3. Ibid. at *2-*3.
4. Ibid. at *3. That same month, Sotheby’s offered the Estate a $3.5 million guarantee for the Picasso.
5. Ibid. at *4.
6. Ibid.
7. Ibid.
8. Ibid. at *5.
9. Ibid. at *5-*6 (citing Estate of Jung v. Commissioner, 101 T.C. 412, 431-32 (1993)).
10. Ibid. at *6.
11. Ibid.
12. Ibid.
13. Ibid. at *6-*7.
14. Ibid. at *7.
15. Ibid.
16. Ibid.
