The IRS and the taxpayer in the case of Estate of Kollsman v. Commissioner, TC Memo 2017-40 had wildly different values that each ascribed to two paintings. In the view of the estate the paintings in question were valued at $500,000 and $100,000 respectively. But the IRS position was that the paintings were far more valuable, arguing at trial that the proper values were $2,100,000 and $500,000 respectively.

One reason the IRS was skeptical of the estate’s value was the that the more valuable of the two paintings was sold 3 ½ years later for a $2,100,000 hammer price and a full price paid by the buyer of $2,434,500, well above the estimated $500,000 value.

Both the taxpayer and the IRS put forward experts to justify each party’s claimed value. The taxpayer had consulted with an individual associated with the auction house that eventually held the auction at which the paintings were sold.

While the value at which an asset is sold after the date of death does not necessarily establish the value at the date of death, generally it is considered potentially useful information and normally it is important to explain why the value had changed from the date of death until the date of sale.

The paintings in question had apparently suffered from the fact that the decedent was a heavy smoker, and so a layer of dirt covered each of the paintings. The taxpayer’s expert held that this dirt made it very difficult to determine the true quality of the paintings, but that a cleaning of the paintings would be a risky affair. Risky or not, the estate did have the paintings cleaned following the decedent’s death, and the cleaning was successful. The taxpayer’s expert argued this significant improvement in the quality and condition of the painting from the successful cleaning and a large influx of Russian buyers for Old Masters paintings accounted for the nearly five-fold increase in value.

However, the Tax Court did not find the analysis persuasive. The Court, considering the testimony of the organization that cleaned the paintings, found that this was not a very high risk operation—certainly not enough to justify a discount of the type necessary to explain the price change:

Bill Santel, chief conservator at Lowy who performed the initial examination of the paintings, testified that when he first examined Maypole it was dirty, appeared to have been cleaned previously but not recently, and was “a pretty good painting to be cleaned”. He testified that if he had owned it he would have cleaned it, as doing so seemed “reasonably safe”. Mr. Santel similarly stated that Orpheus was dirty but not the dirtiest painting he had ever seen. Even Mr. Shar—the estate’s own witness—contradicted Mr. Wachter’s assertions about the risk of cleaning the paintings, testifying that although both paintings were quite dirty and discolored, it appeared the dirt and grime could be removed easily, and he therefore recommended to Mr. Hyland that he have the paintings cleaned. The condition report for each painting, prepared after a window test, recorded that the dirt on each was “surface” rather than “embedded”, an important distinction according to Mr. Santel, because the former is generally much easier to clean.

The cleaning process itself corroborated the Lowy witnesses’ precleaning assessments. Mr. Santel and Mr. Shar both explained that only the mildest detergents used for cleaning paintings, Wolbers and naphtha, were required to clean Maypole and Orpheus. Mr. Shar testified that this was unusual and that typically stronger detergents are required. The success of these mild detergents, according to Mr. Santel, confirmed that the paintings were covered in surface dirt only; he testified that if the dirt had been heavily embedded in the varnish or the paint, the mild detergents “could not possibly have achieved the results that they did.” Mr. Santel further testified that the duration of the cleaning processes, recorded in the Lowy treatment reports as three hours for Maypole and two hours for Orpheus, indicated that these cleanings were comparatively easy and problem free. There is no dispute that the paintings’ cleanings were unqualified successes.17 On balance, the Lowy condition and treatment reports and the testimony of the Lowy personnel who also examined the paintings in their precleaning condition convince us that Mr. Wachter exaggerated both the dirtiness of the paintings and the risks inherent in cleaning them.

The taxpayer’s expert also cited no comparables to justify the amount of discount that would have been justified even if his premise was accepted.

Similarly, the Court did not find convincing the evidence offered for a large increase in demand for Old Masters’ paintings during the period in question.

As for his claims regarding market demand, the estate introduced aggregate auction sales results demonstrating that 5 of the 10 highest sale totals for Old Masters auctions at Sotheby’s and Christie’s occurred after 2005 and included the January 2009 Sotheby’s Old Masters auction. However, because these are only gross sales figures, they do not demonstrate the extent of appreciation in individual paintings, as the sales figures may reflect a larger volume of paintings sold rather than an increase in sale prices. Consequently, the aggregate sales volume figures fall considerably short of persuading us that either Brueghel paintings, or Old Master paintings generally, experienced a nearly fivefold increase in value between August 2005 and January 2009.

The Court was troubled by what it labeled a conflict of interest for the estate’s expert:

Mr. Wachter first gave his fair market value estimates for the paintings at the time of decedent’s death (in amounts that remained unchanged in his expert report prepared for trial). His correspondence with Mr. Hyland during that period demonstrates that the two had previously discussed the disposition of Maypole and Orpheus upon decedent’s death and that Mr. Hyland was considering selling the paintings. Mr. Wachter provided his fair market value estimates at the same time he was soliciting Mr. Hyland for the exclusive rights for five years to auction the paintings in the event they were sold. Under Sotheby’s terms at that time, an auction sale would have entitled Sotheby’s to a 20% commission on the first $200,000 of the hammer price and 12% of the remainder.15 Thus, Mr. Wachter, on behalf of his firm, had a direct financial incentive to curry favor with Mr. Hyland by providing fair market value estimates that benefited his interests as the estate’s residual beneficiary—that is to say, “lowball” estimates that would lessen the Federal estate tax burden borne by the estate. The fair market value estimate letter Mr. Wachter provided to Mr. Hyland was in fact used by him as the basis for the values reported on the estate tax return. The fact that Mr. Wachter simultaneously presented Mr. Hyland with these fair market value estimates and his pitch for exclusive auction rights for Sotheby’s gives rise to an inference that the latter affected the former.

This case presents a “bad facts” situation for the estate and its expert. The actual sale by the organization that provided the low value estimates created a fact that needed to be explained. Whether fair or not, the Court effectively decided the explanation it found most plausible was that the low estimate was given as an incentive to get the right to sell a highly valuable painting.

Having effectively decided that it didn’t buy the theory that the paintings had greatly appreciated following the date of death, the Court had little trouble finding the IRS’s expert persuasive—his value for the painting that was sold was much nearer that eventual sales price and the Court accepted as well his higher value for the other painting.