Sotheby's Suggests Changes to Appraisal Compliance Guidance for Charitable Contributions

In response to the request for comments in Notice 2006-96, I.R.B. 2006-46 (October 19, 2006) (the "Notice"), Sotheby's, Inc. ("Sotheby's") respectfully submits the following comments on the Notice's proposed temporary definition of the term "qualified appraiser" under section 170(f)(11)(E)(ii) of the Internal Revenue Code (the "Code"), as that section was amended by the Pension Protection Act of 2006, Pub. L. No. 109-280, 120 Stat 780 (2006) (the "Act"). This letter also provides comments on the effective date provision of section 3.03(3)(b)(ii) of the Notice.

Background

Sotheby's is one of the world's two largest and most prominent auctioneers of fine art, jewelry, decorative arts, and collectibles. The auction house has been operating for more than 250 years. Today, it handles approximately $3 billion to $4 billion in total sales annually, in 70 distinct collecting categories. Sotheby's currently employs approximately 100 specialists who regularly value and appraise artwork and other collectibles. Valuation and appraisal services are a significant element of Sotheby's business. In addition to the valuations that Sotheby's conducts on a daily basis in connection with its ongoing auctions, Sotheby's specialists annually perform hundreds of formal appraisals of billions of dollars worth of property for a wide variety of purposes, including valuations associated with insurance, charitable contributions, and estate and gift taxes. Sotheby's specialists are regarded as among the most knowledgeable and skilled valuation experts in the world. Indeed, when taxpayers submit valuations performed by Sotheby's specialists to the IRS Art Advisory Panel, the Panel rarely disagrees with the conclusions reflected in those valuations.

Beyond having an in-depth understanding of the myriad artistic elements that add to or detract from an item's value -- something that is of course crucial, though not sufficient, for an expert appraiser -- conducting these appraisals requires intimate knowledge of how fine art and similar objects are priced generally, what comparable sales have recently been concluded (whether they are publicly announced or not), and what recent market trends might affect the value of an item. Sotheby's specialists possess all these qualifications. In light of their expertise, and given Sotheby's preeminence in the art and antiques world more generally, it should come as no surprise that museums, art dealers, and sophisticated collectors all frequently turn to Sotheby's for accurate and reliable valuations that will be accepted and trusted throughout the art world and beyond. In particular, taxpayers often request that Sotheby's appraise their art or other objects to substantiate a charitable contribution deduction under section 170 of the Code.

Section 170(f)(11) of the Code, as amended by the Act, sets forth certain requirements with which an appraisal (such as those provided by Sotheby's specialists) must comply for the appraisal to support a section 170 deduction. Sotheby's applauds the Internal Revenue Service (the "Service") for prompt issuance of the Notice, which provides temporary rules under which appraisals will satisfy the new requirements contained in section 170(f)(11).

We are concerned, however, that certain provisions of the Notice, and especially those regarding the requisite experience and education of a qualified appraiser, may unintentionally prevent many Sotheby's specialists from being able to provide such appraisals in the future. Given that our specialists have decades of experience in selling and valuing particular types of art, they are uniquely qualified to appraise those items. We assume that the Service did not intend to adopt a rule that might preclude experienced and expert appraisers, such as Sotheby's specialists, from continuing to provide qualified appraisals.

Accordingly, we offer the following comments, which are not intended to be exhaustive, and respectfully request that the Service amend the Notice, and draft any future regulations issued under section 170(f)(11), to clarify the nature of the experience and education that is required of appraisers that they may be treated as "qualified appraisers." We believe that the test that we propose below, which involves only a minor change to the guidance in the Notice, is straightforward and easily applied.

Section 170(f)(11)(E)(ii)(I) and Notice 2006-96

Section 170(0(11)(E)(ii)(I) of the Code provides that for an individual to be a qualified appraiser, he or she must, inter alia, have "earned an appraisal designation from a recognized professional appraiser organization or . . . otherwise met minimum education and experience requirements as may be prescribed by the Secretary in regulations or other guidance." Because Sotheby's specialists are already employees of one of the leading appraisers of art and antiques in the world, they generally do not also seek recognition from a separate appraisal organization. Therefore, for them to satisfy the section 170(0(11)(E)(ii)(I) test -- and thereby to continue to be able to offer taxpayers appraisals of the highest quality and accuracy -- they must demonstrate that they have met the "minimum education and experience requirements." Section 3.03(3)(b)(i) of Notice 2006-96 provides that through February 16, 2007, this test will be met if appraisers comply with the criteria that currently appear in Treas. Reg. § 1.170A-13(c)(5). Sotheby's specialists have satisfied, and continue to satisfy, this test. However, as the Notice's temporary definition of "minimum education and experience" that is applicable after February 16, 2007 is currently drafted, it is not clear that Sotheby's specialists would be treated as qualified appraisers.

Section 3.03(3)(b)(ii) of the Notice proposes that, for returns filed after February 16, 2007, "minimum education and experience requirements" include "(A) successfully complet[ing] college or professional-level coursework that is relevant to the property being valued, (B) obtain[ing] at least two years of experience in the trade or business of buying, selling, or valuing the type of property being valued, and (C) fully describ[ing] in the appraisal the appraiser's education and experience that qualify the appraiser to value the type of property being valued." Though Sotheby's has no objection to parts (B) and (C) of this test, part (A), and the formula as a whole, fails to reflect the factors that are most relevant in identifying a well-qualified art appraiser.¹

Education Required of Qualified Art Appraisers

The definition of a qualified appraiser in section 3.03(3)(b)(ii) of the Notice places undue emphasis on classroom training, without putting appropriate emphasis on experiential learning. A test that requires college or professional-level coursework does not make sense in the context of art appraisals. Very little coursework -- at any level -- exists that is relevant to valuing rare art or collectibles. For many of the specialists' areas of expertise, there is no coursework at all. To the extent relevant coursework might exist, Sotheby's specialists would be among the small universe of people competent to teach such coursework. Moreover, specialists may have received a college or professional degree in art history or another related field, but they may not have been in a classroom for decades. Thus, qualifying coursework might be "relevant" only in a cursory sense, and an individual who took art history courses decades ago may have no greater skill or knowledge than someone who majored in engineering.

More important, in the world of art and collectibles valuation, the most beneficial "education" is learning on the job under the tutelage of a recognized expert. No coursework can train a person for the job of a Sotheby's specialist. To become a specialist, a person needs experiential training as an art or collectibles dealer, or as a "cataloguer" who daily watches and assists senior specialists in valuing and auctioning art. The training required to become an expert in valuing art and collectibles is essentially an apprenticeship. In most cases this educational field work will be much more beneficial than comparable time spent in the sterile environment of a classroom.

For these reasons, Sotheby's disagrees with the Notice's requirement of coursework as the exclusive means of fulfilling the "education" requirement of section 170(f)(11)(E)(ii)(I), particularly for persons who are appraising artworks and other collectibles every day and who are recognized as among the most expert in their specialized fields. Perversely, an absolute coursework requirement would disqualify many skilled art appraisers -- including those who would be qualified to teach the very coursework referred to in the Notice -- while possibly authorizing relatively inexperienced, recent graduates to perform art appraisals. Indeed, there may even be members of the IRS Art Advisory Panel, whose valuations of art are authoritative for the Service, who would not be able to satisfy a coursework test.

Proposed Amendment to IRS Guidance

Thus, we suggest that the definition of "minimum education and experience requirements" be expanded to reflect that education that an individual gains in the field, being taught by experts and actually working with objects to be valued every day, can also satisfy the "minimum education" requirement of section 170(f)(11)(E)(ii)(I).²

In particular, we propose that as an alternative to having undertaken relevant coursework, an appraiser may demonstrate that he or she has received the requisite education through at least two additional years of relevant, hands-on training. For example, a person with 2 years of experience and 2 years of training should be deemed to have the same qualifications as a person with 2 years of experience and 40 credit hours of coursework. We respectfully request that the Notice be amended to reflect this rule and that any future guidance, such as proposed and final regulations, incorporate this alternative test. To this end, we further propose that the following example be included in future regulations:

Section 3.03(3)(b)(ii) of the Notice is effective for returns filed after February 16, 2007 a date that is fast approaching. We view this effective date provision as problematic for several reasons.

First, as the foregoing discussion demonstrates, the Notice could prohibit taxpayers, after February 16, 2007, from relying on appraisals provided by Sotheby's specialists. This would be an especially anomalous result given the high regard in which Sotheby's appraisals are held in the art world, the fact that other appraisers base their valuations in large part on sales conducted by Sotheby's, and the respect that the IRS Art Advisory Panel itself has shown for Sotheby's valuations. We would therefore hope that the Service would defer the effective date of section 3.03(3)(b)(ii) to allow itself sufficient time to clarify this issue.

Second, and as a related point, we imagine that numerous other parties are providing the Service comments on the Notice, and that the Service will want to spend the time necessary to consider these comments carefully -- more time than is available before the effective date of section 3.03(3)(b)(ii) arrives.

Third, in fixing February 16, 2007 as the date after which the terms of section 3.03(3)(b)(ii) will be effective, the Notice at first blush appears to prescribe rules that are prospective only. A close reading of section 3.03(3)(b)(ii) reveals the opposite, however. Counterintuitively, the Notice actually reaches backwards in time and affects almost all charitable contributions that were made during 2006, prior to the date fixed by section 3.03(3)(b)(ii), and even prior to the Notice's publication date of October 19, 2006. This is so because the Notice is effective not for charitable contributions made after February 16, 2007, and not for appraisals performed after that date, but for tax returns filed after that date. For the unusual taxpayer who files his or her 2006 tax return before February 17, 2007, the Notice's new rules will not pose a problem. For all others, the effective date provision of section 3.03(3)(b)(ii) may unnecessarily force taxpayers to seek new appraisals for property that was already appraised when it was donated in 2006.

For example, a taxpayer who in August 2006 donated property and received a qualified appraisal (as defined under the Code at that time) from Sotheby's would not be able to rely on that appraisal when filing her 2006 tax return in April 2007 if the appraisal did not satisfy the new "coursework" requirement announced in the Notice. The only way for this taxpayer to clear the hurdle established by the Notice would be to get a new appraisal that comported with the new Notice requirements -- even if the property had been appraised in accordance with the Code and regulations and had been donated long before issuance of the Notice. Thus, the Notice effectively imposes a retroactive and duplicative appraisal requirement with respect to taxpayers who donated property in 2006 but who do not file their tax returns until after February 16, 2007. This issue applies not only to appraisals performed by Sotheby's, but potentially to any appraisal performed in 2006 that a taxpayer was planning to attach to his or her 2006 tax return.

For all of these reasons, we believe it would be prudent, and we respectfully request the Service, to delay implementation of the new rules contained in section 3.03(3)(b)(ii) until the Service has had the opportunity to review the public comments that it receives on the Notice and to incorporate them, to the extent the Service deems advisable, in future guidance. To avoid the retroactivity issue noted in the preceding paragraph, we further request that these rules be effective only with respect to appraisals completed after the publication of such future guidance.

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² Though this letter focuses on the education requirement of section 170(f)(11)(E)(ii)(l), we note that similar issues arise under section 170(f)(11)(E)(iii)(I).

³ Absent guidance incorporating this alternative, test, the Notice as currently drafted could lead to perplexing results: Art appraisals are based largely on "comps" -- comparable sales of art that have transpired in the market. Most comps that are publicly known and relied upon by appraisers reflect sales that have taken place at Sotheby's and its peer auction house, Christie's. (Sotheby's specialists base their appraisals on additional factors, such as their extensive training and their knowledge of private sales that are not publicized.) It would be odd indeed if, by virtue of the language in section 3.03(3)(b)(ii) of the Notice, the Service were to begin rejecting appraisals performed by Sotheby's, but would accept others' appraisals that are based on Sotheby's sales.