Case In Point: Hindsight in Valuation? No. Yes. Maybe.
In the previous issue of Case In Point (published May 4, 2016), the featured case, Sumner Redstone v. Commissioner of Internal Revenue (“Redstone Decision”) focused on the tax court’s decision to deny the petitioner’s valuation of the closely held shares at issue based on a transaction nearly 12 years after the valuation date. In other words, the court rejected a valuation based on hindsight given the significant period of time that elapsed between the valuation date and the proposed comparable transaction, along with significant changes that occurred in the relevant industry over that time.
Only two weeks after the Redstone Decision, however, the United States Tax Court issued an opinion in the matter of the Estate of Bernice Newberger, et al., v. Commissioner of Internal Revenue (“Newberger Case”) finding in favor of valuation analyses that relied on information post-valuation date.[ 1] How can these two cases, decided only two weeks apart, be reconciled?
On July 28, 2009, Bernice Newberger died (“date of death”), leaving three paintings to her estate: 1) Tête de Femme (Jacqueline) by Pablo Picasso (“Picasso”); 2) Untitled by Robert Motherwell (“Motherwell”); and Elément Bleu XV by Jean Dubuffet (“Dubuffet”). According to the Court, after the financial crisis of 2008 the market for fine artwork declined substantially, citing that 44 percent of artwork up for auction in October 2008 failed to reach minimum prices and was returned to the auctioneer or owner.  However, the sale of fine artwork regained momentum by 2010 with auction revenue nearly doubling 2009 sales and effectively returning to pre-financial crisis levels. 
Ms. Newberger’s estate was appraised with the following valuations calculated for the three pieces of artwork:
1. Picasso: In December 2009 the estate rejected an offer by Sotheby’s for a guaranteed auction price of $3.5 million and agreed to sell the Picasso through Christie’s at a London auction in February 2010. Christie’s provided the following to the estate: a) a guaranteed sales price of $4,784,689 plus 60 percent of the difference between the actual sales price and the guaranteed price; and b) a date of death value of $5 million. The estate subsequently reported the date of death value of $5 million to the IRS. 
2. Motherwell: Based on a date of death appraisal by Sotheby’s, the estate reported to the IRS a valuation of $450,000 for the Motherwell. 
3. Dubuffet: Based on a date of death appraisal by Sotheby’s, the estate reported to the IRS a valuation of $500,000 for the Dubuffet. 
In August 2013, the IRS issued a notice of deficiency to the estate, noting that each of the three paintings was undervalued. In particular, the IRS determined that the value of the paintings were as follows: 1. Picasso: $13 million; 2. Motherwell: $1.5 million; 3. Dubuffet: $750,000. The estate filed a petition with the Tax Court objecting to the notice of deficiency.
In most instances, fair market value is defined as the price at which an asset would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts. In the instant case, the Tax Court relied on the “preponderance of the evidence” in determining fair market value. 
Regarding the Picasso, while the estate’s expert supported a date of death valuation of $5 million, the IRS’s expert ultimately adjusted its date of death valuation to $10 million. The IRS arrived at this figure by using a February 2010 sale of the Picasso for $12,927,874 as a benchmark value and adjusted downward for the economic environment that was prevalent in July 2009. The estate argued that the February 2010 sale should be disregarded as it could not have been reasonably known or knowable nearly six months earlier at the date of death. The Tax Court, however, found that the sale of the Picasso may be taken into account as evidence of the fair market value of the painting as of the valuation date.  In fact, the Court stated that the estate’s expert’s refusal to account for the sale in February 2010 resulted in a “wholly unreliable” valuation. The Court found in favor of the IRS’s $10 million valuation of the Picasso.
With respect to the Motherwell, the estate’s expert’s valuation of $800,000 was met with a valuation of $1,500,000 by the IRS’s expert. Both parties’ experts used as a basis for their respective valuations the November 2010 sale of a comparable Robert Motherwell painting titled “In Black and White No. 5,” which sold for $1,426,000. The estate’s expert adjusted the sale price downward to account for the weaker contemporaneous conditions in the art world as of the date of death, resulting in the $800,000 value for the Motherwell.  Unlike the valuation performed for the Picasso, however, the IRS expert not only neglected to adjust for the more anemic market in July 2009, but put forth a valuation of the Motherwell that was greater than the sale price as of November 2010. The Court agreed with the estate’s expert’s adjustment for market conditions and found in favor of the estate’s $800,000 value for the painting.
The closest comparable relating to the Dubuffet was the sale of a similar painting by the artist in November 2007 titled “Elément Bleu XIII,” which sold for $825,000. Given the decline in the market since 2007, the estate adjusted its valuation downward to a value of $500,000 as of July 2009. The IRS, however, settled on a value in July 2009 that was higher than the 2007 value, suggesting a price of $900,000. The court found the higher price to be “nonsensical” as the market in 2007 was significantly stronger than that in 2009. The court, therefore, agreed with the estate’s value of $500,000.
Given the Tax Court’s allowance of hindsight in the Newberger matter and its rejection in the Redstone Decision, the question posed at the beginning of this article can be asked again: how can the opinions in these two cases be reconciled? First, in the Redstone Decision, the Tax Court rejected the valuation approach of the petitioner citing the fact that the comparable transaction utilized in the market approach analysis was executed nearly a dozen years after the relevant valuation date in that matter. In the present case, the Tax Court found that transactions that occurred within approximately six months of the date of death not only could be taken into account in the process of valuing the assets, but are a necessity for a relevant valuation. The time period between transactions in the present case was viewed as being narrow enough for comparison purposes. Further, since the market for artwork experienced such significant changes within a short period of time before and after the financial crisis, the Court found that such factors must be taken into account in determining an appropriate value for the three paintings.
Second, in the Redstone case, the asset being valued was closely held securities of an ongoing business whereas in the Newberger case the asset was art. The reliance on post-valuation transactions in Newberger may be due not only to the more limited time frame between the valuation date and the latter comparable transaction, but to idiosyncrasies in the art industry or the frequency of sales transactions in that particular market. This highlights the importance of the potential impact of differences in market context and inherent characteristics of the particular assets being valued.
In general, however, the Tax Court has reiterated through Newberger, that while events or transactions that occur after the valuation date should not affect a determination of value, it can and should be considered as evidence of value.  The opinion in this matter firmly demonstrates as well that as with any great work of art, hindsight in valuation can matter, and its meaning (and value) is open to interpretation.
 Estate of Bernice Newberger, deceased, JP Morgan Chase Bank, N.A., Susan Newberger, and Nancy Newberger, co-trustees, v. Commissioner of Internal Revenue, Memorandum Findings of Fact and Opinion, T.C.M. 2015-246, Dec. 22, 2015 at 2.
 Estate of Bongard v. Commissioner, 124 T.C. 95, 111 (2005). Preponderance of the evidence requires that a jury in a civil case “find for the party that, on the whole, has the stronger evidence, however slight the edge may be.” Black’s Law Dictionary (7th ed. 1999).
 It is interesting to note that unlike the valuation of the Picasso where the estate relied on the date of death valuation rather than adjusting the February 2010 sale of the Picasso, the estate applied hindsight in arriving at a valuation for the Motherwell using the November 2010 sale of a comparable painting.
 The Tax Court referenced the opinion in Estate of Jung v. Commissioner, which stated, “‘for purposes of determining fair market value, we believe it appropriate to consider sales of properties occurring subsequent to the valuation date if the properties involved are indeed comparable to the subject properties’….Of course, appropriate adjustments must be made to take account of differences between the valuation date and the dates of the later-occurring events….When viewed in this light—as evidence of value rather than as something that affects value—later-occurring events are no more to be ignored than earlier-occurring events.” Estate of Jung v. Commissioner, 101 T.C. 412, 431-432 (1993).