I regret to announce that Robin Erdmann, ASA in RP and our former ASA NorCal Chapter President (2008-2009), passed away unexpectedly on Thursday, December 22, 2011, after a very short illness. He had just turned 60 a few days before.

Robin is credited with the resurgence of our ASA NorCal Chapter; we remain very grateful to him.

Our profound condolences to Irene, Robin’s companion of many years, and to Robin’s father. No services are planned.

What was this equipment appraiser thankful for in November? I got to spend most of Thanksgiving week working in & enjoying California’s Central Coast. Did a cost segregation study inspection of some recently acquired farmland near Fillmore, a machine shop inspection for tax estate purposes in the Salinas Valley area and one very long day of ASA meetings in Costa Mesa. The non-work related part? A camp-out at Eureka Dunes in Death Valley and some El Capitan Beach days near Santa Barbara. We also had a personalized tour of a surfboard manufacturing shop in Ventura! You can take a similar tour by watching this video.

You may remember my mid-summer ode to the Central Coast. During November, I enjoyed working the farms and manufacturing shops along Hwy 101 & I-5 just as much.

What kind of work takes me into the Central Coast? Ag equipment is the most obvious draw: the Central Coast is reportedly one of the most highly mechanized agricultural areas in the world and a lot of that mechanization needs to be appraised for a variety of reasons. It’s not just the spinach harvesters, though, or the fleets of agricultural transportation trucks and trailers that draw me out to the Central Valley. There’s the accompanying food processing equipment, cold storage facilities, and fertilizer production as well!

Non-ag is just as important. Manufacturing and construction industries are big players in the counties of Santa Barbara, San Luis Obispo and Monterey. Businesses in Salinas, Santa Cruz, Santa Barbara, Monterey, SLO, San Simon, Cambria and Lompoc need equipment appraisals for their construction equipment or manufacturing and plant equipment, whether for collateral lending, due diligence and management decisions, insurance, tax appeals or estate reasons.

And almost everyone who owns income-producing property could benefit from a cost segregation analysis.

If you haven’t taken advantage of this IRS-approved tax-saving tool yet, be sure to talk to your CPA or tax professional. We’re busy this month finishing up cost seg reports for apartment buildings in Sacramento, office complexes in Santa Rosa, a motel in Stockton, and that aforementioned agricultural property on the Central Coast, but call me now so I can schedule your inspection for our next long business trip through the Central Coast.

Jack Young, ASA CPA
Central Coast Equipment Appraisal
NorCal Valuation

I got an email from the folks over at the Air Resources Board & thought I’d just pass it along here:

The Air Resources Board staff has posted a Staff Report for the
proposed December 2011 funding awards for the Proposition 1B:
Goods Movement Emission Reduction Program. The Board hearing to
consider these funding awards will be held on December 16, 2011.
Please see the Program website at  http://www.arb.ca.gov/gmbond
for more information.

The $1 billion Proposition 1B:  Goods Movement Emission Reduction
Program is a partnership between the State Air Resources Board
and local agencies (like air districts and seaports) to quickly
reduce air pollution emissions and health risk from freight
movement along California’s trade corridors.

The December 16 meeting will be held at the Cal/EPA Building on the 2d floor of the Byron Sher Auditorium, 100 I Street, Sacramento, and will also be webcast. To access the webcast, go to http://calepa.ca.gov/broadcast.

Jack Young, ASA, CPA
Rolling Stock Appraiser
NorCal Valuation

Like most equipment appraisers, I generally discourage equipment desktop appraisals. Most folks who ask for one are making an assumption that a desktop appraisal, since it wouldn’t include a physical inspection of the equipment, would be less expensive, or at least quicker, and usually, it’s not.

That’s not to say that I never do a desktop equipment appraisal. Some situations are fine for desktop appraisals and I have some examples of these in my records:

• Bankruptcy appraisal for a small pizza kitchen with limited, standard-issue restaurant equipment
• Amiable divorce appraisal for small farm with a small inventory of standard, well-maintained equipment
• Large trucking fleet appraisal of identical, nearly new vehicles with comprehensive documentation, complete with photos and maintenance records, for a collateral lending situation where a bank officer verified the physical inventory with a site visit

So what circumstances do make a desktop appraisal a good idea? These are some of questions I ask when folks request a desktop equipment appraisals:

1. Is timing is very short or the equipment location is prohibitively distanced?
2. Is the equipment is fairly standard?
3. Can I get a well-detailed asset list and excellent photographs?
4. Will an authorized person familiar with the equipment be available to answer questions?
5. Who is the user of the appraisal and does the user clearly understand the limitations of a desktop appraisal?
6. Is the user or users confident that such an equipment appraisal would be appropriate for the purpose of the appraisal?

If the answer to all of these questions is yes, then a desktop equipment appraisal could be appropriate.

It’s critical, however, to be sure that the user of the appraisal is absolutely confident that a desktop equipment appraisal will be suitable for the use of the appraisal, and to establish that, it’s important that the user understand the limitations of a desktop appraisal.

Especially in the case of a collateral lending appraisal, the user needs to understand the real possibility of fraud or misrepresentation. The one situation a lending institution must avoid is extending credit on equipment that doesn’t exist or isn’t as represented. You’ll notice that in the one desktop equipment appraisal submitted for collateral lending example above, a bank representative visited the equipment site. In other circumstances, when a deep level of trust has been built between the lending institution and the borrower, such a visit may not be necessary, but it’s my obligation as a qualified equipment appraiser to stress to my client (the lending institution) that without a physical inspection of the equipment, I cannot confirm that it actually exists or is as represented.

On the other hand, misrepresentation of assets is difficult in an equipment appraisal that involves a physical inspection. It’s fairly easy to ascertain, for instance, that there are, indeed, nearly 20 1995 Kenworth trucks, model 16-KW—for which you have VINs, license numbers and odometer readings—in the rolling stock inventory for a transportation fleet. A cursory glance supplies information on tire tread, paint, glass and chrome condition of the fleet, and a discussion with the mechanic in the maintenance shop provides evidence of poor, standard or regular maintenance. Collecting that information for a desktop appraisal is another matter, which is why questions 3 & 4 are important.

So is a desktop equipment appraisal a good idea? Now that you know what questions to ask, you’ll have a better idea. In most circumstances, though, I maintain that no matter what the purpose of your equipment appraisal, the equipment appraisal process is better served with a physical inspection of the property and that desktop equipment appraisals should be used in very select and limited circumstances.

Jack Young, ASA Equipment Appraiser
NorCal Valuation

The Air Resources Board’s (ARB) first diesel filter deadline is January 2012, and as a recent release states, “Owners of heavy diesel trucks [in California] … need to act now in order to comply with the Truck & Bus regulation” since the process of ordering and installing the filters can take a few months.

This first deadline involves fleet vehicles with a Gross Vehicle Weight Rating (GVWR) greater than 26,000 pounds. Lighter diesel trucks (those with GVWR of 14,001 to 26,000 pounds) will have no compliance requirements until 2015.

If you are a fleet owner of heavier vehicles, ARB offers two options to reduce diesel emissions, both of which are subject to a January 2012 deadline:

1. Follow the staggered implementation schedule; this requires that each 1996 -1999 model engines be retrofit with a diesel particulate matter (PM) filter by January 1, 2012; or
2. Use the flexible phase-in option; this requires that any 30% of vehicles in the fleet have a PM filter by January 1, 2012.

If you choose the second option, be sure to report information about all your heavier vehicles to the ARB by January 31, 2012.

Owners of small fleets(1-3 vehicles) can push back the initial PM filter requirements for the heavier vehicles in that fleet until 2014 and delay engine replacements until January 1, 2020, or later. All fleet information, however, must still be reported to ARB by January 31, 2012 in order to receive the extension to 2014.

Because retrofitting a fleet can be an expensive proposition, Assistant Chief of Mobile Sources Erik White invites fleet owners to visit ARB’s Truck Stop or call the Diesel Hotline at 866 6 DIESEL (866-634-3735) to investigate options available for funding, including

• The Carl Moyer Program offers incentive grants for buying cleaner-than-required engines yielding early or extra emission reductions
• Proposition 1B funds are available under the Goods Movement Emissions Reduction Program

Because almost all our equipment appraisals–whether for construction, ag, manufacturing or food processing–involve at least some diesel equipment and fleet vehicles, I’ve been following the development and implementation of CARB regulations with some interest. It’s especially important to be aware of diesel regulations when appraising large transportation fleets of heavier vehicles as we often do. So far, these regulations have not had any measurable effect on diesel values. In order to ensure, however, that the regulations are taken into account for equipment appraisals, I have been including the following paragraphs in any applicable equipment appraisal report, under the heading of Regulatory Factors:

Within a few years, California Air Resources Board (CARB) Diesel Risk Reduction Plan (RRP) could make some diesel equipment economically obsolete. CARB recently approved significant changes in the timing and phase-in of the regulations.

Regarding the impact of compliance on equipment valuation, all indications support the conclusion that the current market has, in fact, assimilated the economic obsolesce information regarding the CARB RRP and therefore current values reflect that information. This assimilation of regulation information is supported by the lack of consensus among dealers regarding the financial weight of the regulations in the marketplace. It is worth reiterating, however, that valuations provided in this report are considered viable for the effective date only.

When any of your fleet vehicles are appraised in 2012, it will be important for the equipment appraiser to know whether your larger, heavier fleet is being staggered or phased in, and which individual vehicles have already been retrofitted with the appropriate diesel particulate filters or new engines. Be sure to have your paperwork readily available in your maintenance records!

Jack Young
Fleet Vehicle Appraiser
NorCal Valuation

This is the second half of an article on the consequences of the Internal Revenue Service’s new and significant enforcement initiatives that specifically target abusive tax-related appraisals and the individuals who prepare them. The first half was published in a previous post; the article is authored by Jay Fishman, FASA, Business Valuation Review Editor and Chairman of the American Society of Appraisers Government Relations Committee; Bruce Bingham, ASA, former Chairman of the Business Valuation Committee; and Peter Barash, Government Relations Consultant to the Business Valuation Committee.

Internal Revenue Code Section 6701

Internal Revenue Code Section 6701 authorizes the imposition of financial penalties on “any person” providing aid, assistance, or advice with respect to a material tax matter and who knows that the result will be an understatement of tax liability. Earlier this year, the IRS’s Office of Chief Counsel issued a memorandum on how Section 6701 should be applied against appraisers. (Internal Revenue Service, Office of Chief Counsel, Subject: “Section 6701,” Memorandum no. 2005 120 16, UILC: 670 1.00-00, 8 February 2005.) The February 8th memorandum responded to a request for guidance on this subject from the appraisal services unit of the IRS’s Large & Mid-Size Business (LMSB) Division. That unit, which is a past of LMSB’s Field Specialist Program, is responsible for reviewing those tax-related appraisals of tangible and intangible property referred to it (except for fine art items that are reviewed by the Service’s Art Advisory Panel) for the purpose of establishing whether the elements of a 6701 infraction exist and, if so, referring the matter for final determination of liability.

Specifically, the Office of Chief Counsel’s memorandum provides guidance concerning the criteria that Service personnel should consider to determine whether to impose a Section 6701 penalty, the administrative procedures necessary to impose one, and the due-process rights of a person who is the subject of the Section 6701 penalty assessment. In essence, it states that the first element of a 6701 infraction requires assistance in the preparation of a document for a return. A second element requires that a person “know, or have reason to believe,” that the document will be used to establish a taxpayer’s “gross income.” The third element requires that the appraiser “have knowledge” that if so used, the document will result in an understatement of the tax liability of another person. The memorandum states that there is a split among courts as to the “level of proof’ required to impose a penalty. Some courts have held that “a preponderance of evidence” is required, while one court has concluded that only “clear and convincing proof” is necessary.

As to administrative procedures for identifying and asserting a Section 6701 penalty, the February 8th memorandum states that it “will usually be identified by examiners through the examination process,” and “as the government has the burden of proof … it can be assessed only by employees who have the requisite knowledge of the facts giving rise to the penalty.” The memorandum cites “revenue agents and office auditors at a Service area office” as the appropriate assessing employees. Although the legal opinion does not specifically mention the “penalty examination” role of the LMSB appraisal specialists in identifying potential 6701 violations, that office would be part of a special examination team responsible for determining whether preparation of the valuation in question aided or assisted in an understatement of tax liability.

The IRS legal memorandum also addresses whether the Service could invoke its civil injunction authority under Section 7408 of the Internal Revenue Code to prevent an appraiser from engaging in prohibited conduct, “including conduct subject to the 6701 penalty.” The Office of General Counsel states that this authority is available if the government can “show that injunctive relief is appropriate to prevent the recurrence of” prohibited conduct. It appears from the memorandum’s discussion of the injunction authority that it might be available against an appraiser without the prior imposition of a 6701 fine (the conduct need be “subject to” a 6701 fine), while a, while a Circular 230 debarment or suspension appears to require a prior actual finding of a 6701 infraction.

The memorandum discusses, at some length, the appraiser’s due-process rights under a 6701 proceeding and the appraiser’s right to challenge the imposition of the 6701 fine after the fact.

The Effect of “Disclaimers”

The Office of General Counsel memorandum does not specifically address two issues: first, the extent, if any, to which the appraisal itself (as opposed to the mindset of the appraiser) affects the question whether a Section 6701 infraction has occurred, and second, whether there is any way in which the appraiser, through use of some type of disclaimer language, can insulate himself or herself from the consequences of an appraisal that is used by a taxpayer to understate tax liability.

As to the first question, the memorandum leaves somewhat in doubt the precise elements of an appraisal engagement that would give rise to a Section 6701 “aiding and abetting” penalty. Does the issue only have to do with the mindset of the appraiser (i.e., knowing that the document will give rise to an understatement of tax liability), or can the penalty be triggered simply because the appraisal is incapable of being substantiated and, therefore, may be used for understatement purposes? Further, is there any circumstance under which an appraiser could be regarded as being in violation of 6701 even if the appraisal itself is capable of being substantiated?

With respect to the second issue, there has been some discussion among tax practitioners covered by the Circular 230 amendments about the use of disclaimer language in communications with clients or in conjunction with tax advice itself that is designed to protect the practitioner (and presumably the client) from violations of the tax laws. Appraisers who provide valuations for tax purposes have also raised this issue. If an appraiser produces, in good faith, an appraisal product for a taxpayer the conclusions of which cannot be substantiated, can the appraiser disclaim “aiding and abetting” responsibility if the appraisal is used by the taxpayer in connection with an understatement of tax liability? Some believe that disclaimers will not trump an otherwise abusive appraisal. We do not know and will not speculate. But additional guidance from the IRS on these questions is necessary and would be appreciated.

Amendments to Treasury Circular 230

In late December of last year, the Treasury Department and Internal Revenue Service issued final regulations, effective 20 June 2005, amending Treasury Circular 230 ”to promote ethical practice by tax professionals who practice before the IRS.” Circular 230 governs practice before the Internal Revenue Service. The revisions provide standards of practice for written advice that tax professionals give to their clients. In the words of a Treasury Department press release, “The final regulations reflect current best practices and are intended to restore and maintain public confidence in tax professionals … The mandatory requirements for written advice that presents a greater potential for concern prohibit practitioners from providing advice that, for example, relies on incorrect factual assumptions or representations, does not consider all relevant facts, or fails to analyze important legal issues.” (IRS and the Treasury Department Amend Circular 230 to Promote Ethical Practice by Tax Professionals, IR-2004- 152, Dec. 17, 2004)

There are two aspects of Circular 230 that should be of particular interest to appraisers providing tax-related valuation services. First, while the terms and conditions of appraiser practice before the IRS clearly are within the authority of the Treasury Secretary (including suspension or debarment), appraisers do not appear to be covered, at least directly, by the Circular 230 amendments affecting “covered opinions” by practitioners.” The term “practitioner” is defined to include “attorneys,” “certified public accountants,” “enrolled agents,” and “enrolled actuaries” but not “appraisers.”

This brings us to the second point of interest, which is that the “best-practices” provisions of Circular 230 do appear to address valuation issues. The Treasury’s explanation of its revised regulations states, as to requirements for “covered opinions” involving a “federal tax issue,” that a practitioner providing a covered opinion “must not assume that a transaction has a business purpose…or make an assumption with respect to a material valuation issue.” A “federal tax issue” is defined as including “the value of property for Federal tax purposes.” The Treasury’s explanation further states, as to factual matters, that “a practitioner must not base the opinion on any unreasonable factual assumptions … A factual assumption includes reliance on a projection, financial forecast or appraisal. It is unreasonable for a practitioner to rely on a projection, financial forecast or appraisal if the practitioner knows or should know that the…appraisal is incorrect or incomplete or was prepared by a person lacking the skills or qualifications necessary to prepare such projection, financial forecast or appraisal.”

Although the government expects tax professionals to comply with all its “best-practices” standards, it is not entirely clear which of the amended Circular 230 provisions are regarded by the Treasury and IRS as “aspirational” only and, therefore, not enforceable through disciplinary actions and which ones will be enforced through the use of sanctions. Nor is it clear how Circular 230′s provisions relating to valuations will affect professional appraisers who are not also “tax practitioners,” as well as those who are. And, given the IRS’s extremely loose definition of what constitutes a “qualified appraiser,” we are extremely interested in how it intends to apply the Circular’s prohibition against basing a covered opinion on an appraisal if the practitioner knows or should know that it was prepared “by a person lacking the skills or qualifications necessary to prepare” it. Nevertheless, we do expect Circular 230 to have a significant impact on individuals and firms providing tax-related appraisal services, and it must be regarded as an important piece of the IRS’s enforcement initiatives directed at appraisers.

Summary

As a result of the greater focus of the Department and IRS on professional responsibility and their exasperation with tax-avoidance schemes, which could include the use of advocacy appraisals, those who provide tax-related valuation services will be facing an era of enhanced audits and enforcement sanctions. The new enforcement initiatives, recent changes to Circular 230 involving valuation-related tax advice, and the possibility (some would argue “probability”) that appraisers practicing before the IRS in the future will be subject to penalties for incompetence will be the hallmarks of this new era. There is this additional consideration: If the congressional spotlight continues to shine on tax-related appraisal issues and the Service responds with the ramped-up enforcement initiatives we have described, then the federal government-in the form of the Treasury Department and the IRS-will become a major player in establishing appraiser qualifications and appraisal standards and in sanctioning wrongdoing by appraisers who provide any tax-related appraisal services.

We continue to believe that many of the ills involving tax-related appraisals, both real and perceived, would be greatly mitigated by a requirement that all higher-dollar value Tax Code valuations be performed by professional appraisers who have earned meaningful valuation credentials, who are subject to a code of ethics, and who adhere to the Uniform Standards of Professional Appraisal Practice. While these requirements would not entirely eliminate faulty appraisals, they would ensure a high level of professional responsibility and competence from appraisers who practice before the Service.

As the appraiser-enforcement developments discussed in this article unfold, it is imperative that all professional appraisers monitor them and help shape this changing landscape. We intend to.

Thanks again to authors Jay Fishman, FASA, Business Valuation Review Editor and Chairman of the American Society of Appraisers Government Relations Committee; Bruce Bingham, ASA, former Chairman of the Business Valuation Committee; and Peter Barash, Government Relations Consultant to the Business Valuation Committee, for sharing this information with us!

Jack Young
NorCalValuation