Fair Market Value Is More Than Just Opinion

Fair Market Value Is More Than Just Opinion

Skolnick v. Commissioner indicates that it can be more challenging to determine the fair market value of assets than it is to identify obscene movies.

June 04, 2019

In a rare Tax Court Memorandum decision,[1] the taxpayer’s expert failed the Daubert standard and consequently had his report excluded from testimony.

In determining whether certain horse-related activity constituted an “activity not engaged in for profit” within the meaning of Section 183, Judge Albert G. Lauber needed to know the fair market value of approximately 150 horses. The expert selected by the taxpayer had served as an agent for buyers and sellers of horses for 25 years at both auctions and private sales. His company had participated in auction sales of 20,000 horses generating gross proceeds of more than $500 million.

The expert’s testimony consisted of three-page report, primarily dedicated to his formal qualifications, with two attached spreadsheets showing the concluded values of the horses ranging from one dollar to $1.9 million. The report also stated that the appraisal of horses is not an exact science and is greatly influenced by numerous economic and social factors, including natural disasters, disease outbreaks, global crisis, and governmental actions. The report is devoid of an explanation how the fair market values of the horses were arrived at, instead stating that is was based on 25 years of experience and a database of previous transactions that was not included in the report.

The Tax Court pointed out that its experts are governed by Federal Rules of Evidence 702 and 703. The former provides that a witness who is “qualified as an expert by knowledge, skill, experience, training, or education may testify in the form of an opinion” if his testimony will help the trier of fact and the following conditions are met:

  • the testimony is based on sufficient facts or data
  • the testimony is the product of reliable principles and methods
  • the expert has reliably applied the principles and methods to the facts of the case

Furthermore, with regard to the expert witness report, the report must contain:

  • a complete statement of all opinions the witness expresses and the basis and reasons for them
  • the facts or data considered by the witness in forming his opinion
  • any exhibits used to summarize or support his opinions

The Tax Court ruled that the expert’s report did not satisfy the requirements of the Federal Rules of Evidence, as the report does not set forth any “facts or data” on which the expert relied. In addition, the expert did not identify the valuation “principles and methods” that he employed in his appraisal. The Tax Court invoked Daubert v. Merrell Dow Pharmaceuticals, Inc.[2] as well as Kumho Tire Co. v. Carmichael,[3] stating that an expert opinion has to “rest on a reliable foundation” and be “relevant to the task at hand” – neither of which was achieved by the expert.

In a last-ditch effort to keep the expert report from being excluded from testimony, the taxpayer’s counsel quoted Justice Potter Stewart’s famous quote of “I know it when I see it.” The quote was presented by counsel to suggest that you might not need facts and data when you just know something to be true. The quote stemming from the 1964 case of Jacobellis v. Ohio[4] was in reference to determining whether a racy movie being shown in Ohio rose to the level of pornography and therefore would not be protected by the First Amendment of the Constitution.

Judge Lauber leaves us with an equally memorable quote of “…I know it when I see it may be a practical approach to identifying pornography, but it is not, for the reasons we have stated, an acceptable approach to formulating expert appraisal testimony under the Federal Rules.”

  1. Mitchel Skolnick v. Commissioner; T.C. Memo. 2019-64; June 3, 2019.
  2. Daubert v. Merrell Dow Pharmaceuticals, Inc., 509 U.S. 579 (1993).
  3. Kumho Tire Co. v. Carmichael, 526 U.S. 137 (1999).
  4. Jacobellis v. Ohio, 378 U.S. 184 (1964)