ESTATES AND TRUSTS

April 2000

A VALUATION REPORT DOES NOT MEET GIFT TAX DISCLOSURE REGULATIONS

By Philip Drudy, CPA, and Bernhardt Karlitz Hayden & DeCruze

Filing a gift tax return, once a simple task, has evolved into a delicate process that requires a high level of due diligence to comply with the regulations.

On December 3, 1999, the IRS issued final regulations regarding the adequate disclosure of information necessary to trigger the statute of limitations on transfers made after December 31, 1996. The new regulations prescribe how to prevent the revaluation of gifts on later gift tax returns and on the transferor's estate tax return. If the return meets the adequate disclosure requirements of Treasury Regulations section 301.6501(c)-1, then the normal three-year reassessment period applies, and the IRS is time barred from revaluing the gift after the running of the statute of limitations.

Under the final regulations, a transfer is adequately disclosed on the gift tax return if it apprises the IRS of the nature of the gift and the basis for the reported value. The IRS will consider the transfer adequately disclosed [Treasury Regulations section 301.6501(f)(2)] if the return includes the following information or has it attached:

* A description of the transferred property and any consideration paid to the transferor;
* The identity of and relationship between transferor and transferee;
* If the property is transferred in trust, the trust identification number and a brief description of the terms of the trust (in lieu of a description, a complete copy of the trust instrument can be attached);
* A detailed description of the method used to determine the fair market value of the property transferred, including disclosure of any discounts taken and the fair value of the underlying assets (the taxpayer bears the burden of demonstrating that fair market value is properly determined); and
* A statement describing any position contrary to any proposed or temporary Treasury regulations or revenue rulings published at the time of the transfer.

Valuation Report Requirements

A valuation report will suffice in lieu of a detailed description of the method used to determine the fair market value of the property transferred. To qualify, the report must be prepared by an appraiser that is held out in the community as such and performs appraisals on a regular basis. In addition, the report must describe the appraiser's qualifications, and the appraiser must be independent.

The appraisal report must contain the following information:

* Date of the transfer, date the appraisal was performed, and purpose of the appraisal
* Description of the property transferred
* Description of the appraisal process and procedures followed
* Descriptions of assumptions, conditions, or restrictions on the transferred property that affected the analysis or conclusion.
* Information used in determining the appraisal value, and
* Valuation methods used and the rationale for the methods and processes used.

Starting the Clock on the Statute of Limitations

The valuation report, although an integral part of meeting the adequate disclosure regulations, does not itself start the running of the statute of limitations.

The timely filed gift tax return must contain a clear and concise statement that apprises the IRS of the nature of the transfer and any contrary positions. It should also contain a statement that the transferor is not taking a position contrary to any proposed, temporary, or final Treasury regulations or revenue rulings published at the time of the transfer. If the transferor is taking a contrary position, then an attached statement must indicate how the position is contrary. An internal tax opinion memorandum would ensure that the return meets that standard of the adequate disclosure regulations.

For example, a parent sets up a family limited partnership, transfers rental property into the partnership, and takes back a 10% general partnership interest and a 90% limited partnership interest. The parent has the property appraised and transfers to the children limited partnership interests that are less in value than the current unified credit equivalent.

Under the current gift tax return filing requirements, the transferring parent would need to do the following:

* File a gift tax return for the year of the transfer;
* Check the box on page 2 of the return indicating that a discount was taken;
* Attach the appraisal report to the return;
* Attach a statement to the return indicating the relationship between the transferor and the transferee;
* Attach a statement indicating that the transferor has not taken a position contrary to any Treasury regulations or revenue rulings as of the date of the transfer;
* If the transfer is in trust, attach a copy of the trust instrument; and
* Under some interpretations of the regulations, attach a copy of the partnership agreement to the return.

If any of the above attachments are missing from the gift tax return, the IRS may have a basis for disregarding the statute of limitations and revaluing the transfer upon the transferor's death. *