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You’ve got a great relationship with your rich Uncle Bob. He has explained which of his assets he wants you to inherit. You both hope that won’t be for a long time. Meanwhile, you both want to trim any tax his estate will have to pay. That will leave more for you and other family members.

For deaths in 2008, that tax hits estates that leave more than $2 million to heirs other than a spouse or charity. In 2009, that $2 million exemption goes up to $3.5 million.

And the estate tax rate is a punishing 45%.

You’ll also have to deal with some knotty details concerning Uncle Bob’s property. Many are illiquid, hard-to-value assets such as real estate and interests in private companies.

You may need help putting a value on them. Mistakes can be costly.

Audits of estate tax returns are more common than income tax audits. The IRS eyeballs about half of all estates over $5 million.

It may come up with a valuation that’s larger than the one you claim. That jacks up the tax bill. It also exposes the estate to potential penalties, ranging from 20% to 75%.

But you can win. Success starts with picking an appraiser with expertise in your type of assets.

That’s what happened recently in the case of Frederic Kohler. He was the grandson of the founder of the namesake company that makes plumbing fixtures such as faucets.

Frederic died in 1998. He owned 13% of the stock of the family firm.

There was no public trading in the stock so valuation was difficult. An appraiser hired by Frederic’s estate valued his stock at $47 million. That was reported to the IRS.

But the IRS came up with a very different amount. Its appraiser valued Frederic’s shares at $144.5 million.

So the IRS asked for another $54 million in estate tax. Plus an $11 million penalty.

The matter wound up in Tax Court in 1998. The IRS lost in 2006.

“The Tax Court absolutely hammered the IRS’ valuation expert,” said Blanche Lark Christerson, managing director, Deutsche Bank Private Wealth Management.

Industry Standards

That appraiser didn’t prepare his report in accord with normal appraisal standards, the court said. He admitted overstating the stock’s value by $11 million.

The court said this supposed expert didn’t understand Kohler’s business. He met with Kohler management only once, for a few hours. His valuation method was wrong.

“The court stated that it was not obligated to pay any regard to an expert opinion that lacks credibility,” Christerson said. It placed “no weight” on the IRS’ price tag on the stock and its tax bill.

On the other hand, the Tax Court found the estate’s experts thoughtful and credible, Christerson says. It was impressed with their methodologies and conclusions.

The IRS expert used a discounted cash flow method. Tax Court said he should have used a dividend-based method. Dividends were the primary way that shareholders got a return on their investment.

For real estate, valuation techniques might be based on cost (new property), comparable sales (active market), capitalized income (rental property) or some combination. You might get multiple appraisals if the estate has more than one type of property or if the estate is very large, such as Kohler’s.

Tax Court wound up accepting the estate’s $47 million valuation. No extra tax or penalty was owed.

Even if you don’t inherit a $47 million estate, the same principles apply to smaller estates. Valuation of illiquid assets can hinge on knowing how to interpret subtle details.

Having a solid appraisal may sway the IRS to settle before a dispute goes to court.

You may have to deal with valuation issues if you inherit assets from someone whose estate is in estate tax territory.

Appraisals are vital for gifts, too. If you give more than $12,000 to anyone but your spouse or a charity this year, you’ll need to file a gift tax return and value assets you give away.

To find a bulletproof appraiser, ask your attorney and accountant. Someone at their firm may have a designation — accredited in business valuations, as a certified valuation analyst, an accredited senior appraiser, or certified business appraiser.

If not, they may be able to refer you to such an expert.

Expertise Exploration

When you meet with an appraiser, ask about his area of expertise. That could be an area like real estate, private businesses, oil and gas reserves or artworks.

Look for someone who’s an expert in the type of assets you’re inheriting or giving away. Ask to see a sample appraisal.

It should include the qualifications and the education of the appraiser.

Read the valuation report to see how persuasive the appraiser can be. If he’s prevailed over the IRS in court, so much the better.

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Tags: Finance, Mutual funds, Personal Finance