S2, E6: Donating complex assets: Qualified appraisals

This is the final episode in this second series of Philanthropic Insights making the most with gifts of complex assets. Throughout this series, we discussed the various areas of complex assets such as real estate, business interest, passion assets, alternative investments, and qualified appraisals – and brought in top experts in these fields. 

In this episode we talk about qualified appraisals with some of our friends from Scalar, Steve Lindsley and Matt Fix. 

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Transcript

Kim Ledger:

Welcome to Ren's Philanthropic Insights video podcast series made to help financial advisors make the most of their client's charitable giving. I'm your host Kim Ledger, Ren's VP of Complex Assets. In this series, we will share everything you need to know about making the most with gifts of complex assets. Throughout this series where we will be discussing the various areas of complex assets such as real estate, business interests, passion assets, alternative investments, and qualified appraisals, and we're bringing in some of the top experts in these fields.

In this episode, we're going to get into the topic of qualified appraisals with Scalar's season leaders, Steve Lindsley, Director of Business Development, and Matt Fix, Director of Valuation. Gain insights from their expertise as they discuss the intricacies and the importance of qualified appraisals in the world of business development. Steve and Matt, thanks so much for being here. I am so glad you guys are here. This is a topic, anytime we do a business interest or an alternative investment, this is always a big topic that we have usually in the first conversation. I'm so glad you guys are here because I don't answer a lot of those questions.

Steve Lindsley:

Yeah, we're happy to be here.

Kim Ledger:

Yeah, so welcome. I'm going to jump right into it. First of all, what is a qualified appraisal?

Steve Lindsley:

Yeah. A qualified appraisal is really simple. It's a valuation performed by a qualified appraiser, and the appraiser should have relevant experience and education as well as regularly perform valuations and engage in those activities. Then I would say the actual qualified report should contain a written document that specifies how you arrive to the value of the gift or of the value of an asset, and it should follow the IRS guidelines. Each individual that performs the gift should have their own report.

Kim Ledger:

Well, I think that's a good point. If you've got multiple donors from one business, each individual is going to need their own report.

Steve Lindsley:

Correct. It's a question that we get asked often.

Kim Ledger:

Yeah. Me too. Yeah.

Steve Lindsley:

We have three people making a gift. Can we just rely on one valuation? We can definitely leverage the valuation work, but it's important that we engage and then as well as provide each individual with their own custom report.

Kim Ledger:

Now is that your rule or is that the IRS rule?

Steve Lindsley:

That's the IRS.

Kim Ledger:

It is.

Steve Lindsley:

Yeah, it's the IRS, so we're not the bad guys there.

Kim Ledger:

This is the question I get a lot from business owners. All right, so we're in the process of selling our business, or we've just sold our business, we made this charitable gift. Isn't that the fair market value price of it? Why do I need a qualified appraisal? I get that a lot.

Matt Fix:

Yeah, so do we. The short answer is that the IRS requires the appraisal if you're pursuing that deduction via form 8283. But the long answer I would say, and the reason why the IRS requires these appraisals is because you're making this contribution of the property before the transaction is closed so there is some risk that the transaction may not go through.

Kim Ledger:

You want that risk, right? To get your charitable deduction, there has to be some risk.

Matt Fix:

Exactly. Then also transactions are all structured in different ways. Some transactions are going to be in cash. Those cash transactions might have installment plans from the purchaser. There might be earnouts in the transaction. The transaction might be all stock from the purchaser or a combination of cash in stock. There's a lot of ways in which the headline figure on the transaction may not be the fair market value assigned to the transaction.

Kim Ledger:

As you look at earnouts and installment plans, how do you work through that from your perspective in valuing those?

Matt Fix:

From my perspective and from Scalar's perspective, it's all just a matter of risk of those installment plans and of those earnouts. For an installment plan specifically, that's typically going to be a time value of money or a present value type calculation and maybe a risk adjustment to that calculation. Then with earnouts, there's either an operating milestone or an operating metric that is typically factored in to that transaction document, and that's typically going to require a unique analysis. That could be somewhat simple like a scenario analysis, or it could be relatively more complicated like a lattice model or a Monte Carlo simulation. It's all just a matter of what's been put to paper and how we have to look at it.

Kim Ledger:

Okay. Then do people typically get the valuation before the transaction or after the transaction? Can you guys speak to how that works and maybe pros and cons of before and after? I know I always suggest that people at least have conversations prior to.

Steve Lindsley:

Yeah, no, it's a great question. Honestly, we see it both ways. We see them perform the valuation before the gift is made, and typically that's for planning purposes. It's nice to know what the value is going to be, and sometimes that determines how much you're going to give or how little you'll give.

Kim Ledger:

They kind of back into a number of shares once they know what that value is. I use shares, it could be, you know what I mean.

Steve Lindsley:

Yeah, exactly. For planning purposes, it's nice to know. I think the important thing to note there is that if you do perform the valuation before you make the gift, I believe the guideline is 60 days, so you have 60 days to make the gift after our valuation date.

Kim Ledger:

I've had to rush to get gifts completed for people to meet that 60 days.

Steve Lindsley:

Because they're coming on close to the 60-day window. Then after, it's very common as well. You could make the gift in the calendar year, and we can go back and we would use the date of the gift as our valuation date to value the asset or the security. Then you just need to have that completed by the time you do the tax filing or by the time you do your return.

Kim Ledger:

If you file your taxes in April, you have until then to get that completed. Or if you file in October, you have until then to get your qualified appraisal done?

Steve Lindsley:

Yeah, you want, I mean, we need a little bit of time to complete the analysis, so I would say just give us that buffer.

Kim Ledger:

But the donor doesn't need to have it done prior to that. I mean, they don't have to have it done prior to making the gift.

Steve Lindsley:

Correct.

Matt Fix:

Correct. Yeah.

Kim Ledger:

That's good.

Steve Lindsley:

Yeah. Gives you a little bit of time.

Kim Ledger:

But you probably get really busy that first two weeks of October.

Matt Fix:

Oh, definitely. Yeah.

Steve Lindsley:

It's the tax deadline ...

Kim Ledger:

They are for long days for us as well.

Steve Lindsley:

Yeah, year-end and getting close to that extension deadline are definitely busy times for us.

Kim Ledger:

With that comes the form 8283, and so that's signed by the appraiser and the charity. From our perspective, we're signing saying, yes, we received this, and you guys are signing that you have appraised it. What is it on the 8283 that you guys are doing?

Matt Fix:

On that form specifically, we'll fill out our information. That'll include an IRS identification number for us, but also it will include what number of shares or what type of property was included as part of the deduction and what we appraised that property at, and then we add our signature to it.

Kim Ledger:

Got it. Now, I know that there was this one that we worked on that was one of our gifts that I know you guys performed the valuation on, and there were multiple entities. While it was one donor, they were selling a whole, quite a few, I don't want to say, they were probably selling 20 different entities, and I think they might have gifted a portion of maybe 12 of them. Now, for those 12 entities, you had to complete a qualified appraisal for each one. Isn't that correct?

Matt Fix:

Yeah, that's true.

Kim Ledger:

Yeah, so it's not just a bottom line number. You had to look at each entity. I think that people get caught a little off guard on that one. They were a little surprised. What are some of the most popular questions you guys get when you're working on, when someone calls you, what are some of the most popular questions or some of the first questions people are asking you?

Steve Lindsley:

Yeah, I mean, I think we get a lot of general questions, right? Often it's the first time someone's making a gift, so they just want to understand how long does it take, what does it cost, what does the valuation process look like? Then often what we get is if there's a transaction that's taking place, it's like, "Hey, why do I need one? Why do I need a valuation? I kind of know what my business is worth. I have this LOI."

Kim Ledger:

Or I have a business valuation.

Steve Lindsley:

Or I have a business valuation.

Kim Ledger:

It's different. Right? What you guys are looking are a little different.

Steve Lindsley:

Yeah, it's a different purpose. You may have valued your business for issuing stock options, or maybe you have an investment in a venture fund and they provide a valuation on an annual basis for financial reporting. This is a different exercise. It's attached to an individual filing, and there's liability associated with that. You want to make sure that you go throughout the right steps. We make sure to capture that and make sure that it's in compliance with form 8283, non-cash charitable contributions.

Kim Ledger:

Yeah. You talked about venture. Let's talk about alternatives because I think that surprises people too, that there are a lot of popular real estate investment trusts. There are a lot of popular alternatives that are out there. Let's define them real quick, hedge funds, venture capital, real estate, investment trusts, and what am I missing?

Steve Lindsley:

Private equity.

Matt Fix:

Private equity.

Kim Ledger:

Yeah, private equity. Okay. Those are what I typically see from a gifting perspective. Talk to me about what you do with alternative investments. What does that look like?

Matt Fix:

Yeah, I mean, I think the main thing we have to think about with alternative investments is how liquid those investments may or may not be. For some alternative investments out there, there is somewhat of a secondary market out there. There are investors that are willing to buy your shares of your REIT or your hedge fund if you're willing to sell them. But those buyers that are in those secondary markets are typically buying those shares at a little bit of a discount, and so there is evidence that even though there is a higher amount of liquidity for those shares that a discount may still be applicable in that situation. But even more generally for any of those alternative investments, typically there is some sort of share redemption policy that's part of the investor documents and the fund offering agreements. Those kind of redemption policies, for example, could determine how liquid your position is. You might not be able to liquidate your position for three months or six months depending on that policy, and that would affect your total liquidity and result in maybe a discount that's appropriate to apply.

Kim Ledger:

Yeah, we've seen a lot of, in the alternative space, I'm thinking of one particular REIT where everybody and his brother was going, everybody's grandmother was going into this REIT and they've slowed what they're going to allow out of the fund on a, is it a monthly or quarterly basis? Yeah, you have to take that into account.

Matt Fix:

Yeah, exactly. I mean, in that specific situation, if that was a publicly traded fund in the stock market, you'd see the stock crash right away. Everybody would be jumping out. But in this case, there just wasn't enough liquidity. I think the discount begins to make sense when you kind of think about it in that other context.

Kim Ledger:

From our perspective as a charity, we have to look at that too and consider that. You've mentioned discounts a couple of times. I'm guessing that this is probably one of your other big questions that gets asked because people ask me that all the time. I got to tell you, I do not want to commit for you on any of that. We're not going to talk today about what specific discounts are, but just I would not want to commit that for you. But how do you think about discounts and what goes into that consideration?

Matt Fix:

Yeah, so I mean, one of the things we just touched on is that liquidity factor, but even before touching on discounts, I think what's important is what is being transferred to the DA. In the case of all those funds we just discussed, it typically is that kind of liquidity discount. Sometimes it might be called a discount for lack of marketability. But in terms of a privately held business, for example, then we're going to be looking at what we consider discount for lack of marketability, and then discount for lack of control.

Kim Ledger:

I was going to ask you about that, if lack of control came into that as well.

Matt Fix:

But when there's a transaction that's already in place, that typically is going to be kind of the lead indication of value, at least the way that we approach things.

Kim Ledger:

Yeah, that's what I wondered. Yeah, so you'll take that transaction into account.

Matt Fix:

Yeah, definitely. For us, it's just a matter of, it's almost a scenario basis that we take to approach this. There's the risk of the transaction not going through for whatever reason, and there, we would apply those discounts for lack of marketability and maybe a discount for lack of control if it makes sense. Then in the other situation, when the transaction closes, that's more of a smaller discount for lack of marketability because we're not looking at this as a private company. We're looking at this as a liquidity event.

Kim Ledger:

Earlier you mentioned, Steve, about liability. What did you mean by that?

Steve Lindsley:

I think anytime you're providing a signature on a tax return, there's some liability and there's audit liability. That's something that we think about. I would say, just as I mentioned, if you have three people that are participating in the gift, there might be, we see it as there's likelihood that, not likelihood, but there's a chance that not just one, but one of the three could get audited. That's what I mean by liability is just from an audit standpoint.

Kim Ledger:

Okay. Does anybody ever get this wrong? When they're doing the qualified appraisals do they ...? Yeah.

Matt Fix:

Yeah. I mean, one of the ways we inform how we approach our valuations is by studying what other people have gotten wrong and kind of reviewing the legal literature.

Kim Ledger:

As stock companies we all do that. Yeah.

Matt Fix:

Yeah, the literature on the subject. I think in our view, there's kind of two buckets of ways that people may have gotten it wrong. The first bucket I would say is when the IRS maybe has an issue with the appraisal itself, and that can even be split into is there an issue with the discount adjustment on that appraisal or is there an issue with the appraisal itself and the data that went into it? Sometimes with a very unique asset, take, for example, someone that collects postage stamps, so something not that's necessarily business. They may have looked at auction estimates, but that might not be the fair market value in the eyes of the IRS and what an appraiser would say. They might challenge it on that basis. The IRS might challenge your valuation for the discount lack of marketability being too aggressive, or in the case of 8283, not aggressive enough typically.

But then there's the other bucket of taxpayers that I would say maybe flaunt the rules, that are not aware of the rules that the IRS has kind of set forth, and they maybe don't get an appraisal or they don't fill out the form correctly. Don't have the right signatures. Maybe their appraiser isn't qualified enough. There's a host of issues that could come into play, and those are instances where the IRS might not allow you to take the deduction at all, whereas in that former bucket, they might adjust your deduction, but at least you still get something.

Kim Ledger:

Yeah, there's some cases out there that reference that. Interesting, interesting. What have I not asked you that you feel it would be important for people to know? Again, questions that advisors have asked, that call and ask you.

Steve Lindsley:

I think you've asked a lot of good questions and covered a lot of it. I think if it is your first time going through the analysis, it's nice to know what you need to perform an analysis or perform evaluations. Happy to touch on that.

Kim Ledger:

That's a great question. What do you need?

Steve Lindsley:

Yeah, depending on what you're transferring or contributing, gifting, I should say, if it's private stock, you're going to want to look at some historical financials of the company or of the asset that we're valuing, so income statement and balance sheet as well as a forecast.

Kim Ledger:

How long? Two years, three years?

Steve Lindsley:

We like three year historical information. Then the forecast often is the tricky one we like as far as a five year, but we understand that depending on the business, they might not carry a five-year forecast, five-year plan. We'll work with you to see what you have. Then the legal, so the cap table, and then the operating agreement or the articles of incorporation. Then as Matt mentioned on this scenario analysis, we'd obviously want to see a copy of the purchase agreement or the LOI, so we can understand the transaction and what's happening there as well.

Kim Ledger:

Do you need that whether the appraisal is done before or after transaction? Is that helpful to see that before or after? It doesn't matter.

Steve Lindsley:

Yeah, exactly. We would ask for the same documents, whether it's before or after. I think that's a good question. If it's happened, if we're performing the valuation after the gift is made, we would still look at the time of the valuation date, which would typically be the date of the gift, like what is known or knowable at the time of the valuation. We would collect those documents and think in that matter at the time.

Kim Ledger:

One of the things I just want to clarify, when you said we would work with you, meaning you as in the donor? It's not something, while we're having great conversation today, it's not something that we as the donor advised fund typically get involved with.

Steve Lindsley:

Oh, yeah, that's a good point of clarity. I do think if you're not transferring private stock, let's say you're transferring interest in a venture fund or private equity fund, the documents are going to change slightly, right, so we'd want to see if you have performed valuations or nav statements as well as the offering document of the fund or whatever it is that we are valuing. But I think we also understand too, that there are folks that don't have access to financials, and that's where it becomes a little tricky. But we do our best to first get all the information that we can, and then from there kind of backtrack and say, "Okay, what information do you have? Where can we ask the company? Where can we ask the CFO to maybe fill in the gaps on some of the other documents?" Matt, I don't know if you have another comment.

Matt Fix:

No, I would just add that for our clients, it's great when they're as forthcoming as possible with us with that information because we are not the IRS. We're trying to help you navigate the IRS and the tax code in a way that's beneficial to you and helps you accomplish your goals. By giving us all the information that you're willing to share with your potential buyer of your company, that helps us perform our appraisal as well.

Kim Ledger:

Got it. One final question. How long does it typically take to get a qualified appraisal completed? Let's start with once you have all of the documentation ...

Steve Lindsley:

Once we have all the documents, yeah. That's a good, I'm glad you clarified that. Our turnaround time is two to three weeks for an appraisal. Matt may not like this answer, performing most of the work, but we're also really good at meeting deadlines as well. If a deadline was coming up, we try to work with you to make sure we hit that deadline. But typical turnaround time is two to three weeks.

Kim Ledger:

Okay. Great. Well, thanks so much for being here today you guys. I know you made a special trip to be in studio with us, and so really appreciate it. Thanks again.

Steve Lindsley:

Yeah, thanks for having us.

Matt Fix:

Thanks for having us.

Kim Ledger:

My pleasure.

Kim Ledger:

Thanks everyone for watching, or if you turned in via podcast, thanks for listening. If you want to learn more about Ren and how we might be able to help with your philanthropic program needs, visit reninc.com or email us at consulting@reninc.com. We'd also love to hear if you have questions or topics about planned giving you want us to talk about. Of course, don't miss the great information we have in our advisors Philanthropic Insights newsletter. Sign up at reninc.com/advisorinsights. Find all the links mentioned in the show in the description, and you'll find expert tips daily on our social channels. Check it out. Until next time, I'm Kim Ledger. Give wisely.