What You Need to Know About Appraisals

Contrary to what some people believe, an appraisal does not give the value of an asset. Given the important role appraisals play in our economic world today, taking this to heart could very well save you a lot of money one day.

Many appraisals are not worth the paper they are written on. So to help you build a framework to more accurately understand appraisals of any type of asset-real estate, autos, boats, jewelry and businesses-here are two important things you need to know:

1.    An appraisal does not provide the value of an asset, but rather a person’s opinion of the value of an asset. The following are as important as the appraisal itself:

a. Experience of the appraiser, including recent experience appraising assets similar to that of the subject.

b. Formal education of the appraiser, including specialized training in appraisal.

c.    Methodologies used in performing the appraisal at issue. The appraisal report should clearly describe the data gathered and considered and the analysis conducted, so that the reader of the report can follow and understand.

d. What methodologies could have been used but were not, and why.

e. What assumptions were made and how might they have impacted the conclusion.

f. How the final value was determined.

g.    Whether the appraisal was performed and value conclusion rendered in an arm’s-length manner in all respects, or whether the appraiser might be biased in some manner.

2.    Generally, anyone can legally offer his/her services as an appraiser. But organizations that rely on appraisals, such as lending institutions and the Internal Revenue Service (IRS), will often establish qualifications that appraisers must meet.

For example, IRS requires that a “qualified” appraisal be obtained to substantiate any non-cash deduction claimed for more than $5,000. IRS defines a “qualified appraisal” as one conducted by a “qualified appraiser” in accordance with generally accepted appraisal standards.

A “qualified appraiser”:

• Has earned an appraisal designation from a recognized professional appraiser organization or has otherwise met minimum education and experience requirements set forth in regulations prescribed by the Secretary of the U.S. Treasury.

• Regularly performs appraisals that he/she receives compensation for.

• Meets such other requirements as may be prescribed by  the Secretary of the U.S. Treasury in regulations or other guidance.

Critical to understanding the value conclusion in an appraisal is to understand the definition of value used by the appraiser for the appraisal. Typically, the definition will be fair market value (FMV). You should review the definition. It is specific  and informative:

Fair market value (FMV) is the price that property would sell for on the open market. It is the price that would be agreed on between a willing buyer and a willing seller, with neither being required to act, and both having reasonable knowledge of the relevant facts.

Example 1: If you give used clothing to the Salvation Army, FMV would be the price that typical buyers actually pay for clothing of this age, condition, style and use. Usually, such items are worth far less than what you paid for them.

Example 2: If you donate land and restrict its use to agricultural purposes, you must appraise the land at its value for agricultural purposes, even though it would have a higher FMV if it were not restricted.

Whether you are obtaining an appraisal for yourself or interpreting one provided to you on a business matter, keep these things in mind, particularly that the appraisal is just one person’s opinion of value and that the appraiser’s opinion is never more valid than the facts it is based on. Without a disciplined review of relevant facts, the appraisal opinion is simply a guess.