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Tackling a common appraisal problem.

CPAs can help quantify the loss when an owner is involuntarily deprived of property.

Businesses of all sizes often are faced with deprivations of their assets through eminent domain condemnations, property damage or infringements and other reasons. Employers or clients turn to CPAs to assemble and interpret data to perform an analysis or to help select independent valuation and economic advisers who specialize in deprivation appraisal. Practitioners work with legal counsel and perhaps with independent experts--to ensure the aggrieved party receives full and proper compensation.

This article describes what CPAs should know about deprivation appraisals to best serve employers and clients. It discusses the valuation aspects of deprivation appraisals, particularly their theoretical concepts and practical applications and how they are affected by an appraisal's purpose and objective. It also describes where CPAs can receive training in this field and how to launch a new practice area.


In a deprivation, the owner of an asset, property or business interest involuntarily loses ownership or other legal or economic rights and typically is eligible for compensation for the economic loss suffered, which usually is determined through an appraisal. Appraisals may involve valuation and economic analysis of a variety of properties, such as business entities and securities, intangible assets and intellectual properties, real estate and real property interests, tangible personal property, etc.

Of course, the definitions of value used, the valuation procedures performed and numerous other factors are directly influenced by applicable laws and regulations. The valuation fundamentals also are affected by the type of deprivation and by the asset, property or business interest involved. Nonetheless, certain valuation principles are universal in deprivation appraisals.


A deprivation appraisal's ultimate objective is to quantify the amount of fair and just compensation due the owner because of the loss. Most often, the amount chosen is designed to restore the property owner to the economic position enjoyed just before the deprivation.

In all appraisals, the term "property" refers to real estate (such as owned land, land improvements and buildings) and real property (legal interests in real estate, such as leases, development rights, mineral and natural resource exploitation rights, etc.). In deprivation appraisals, the term is broadly defined to include things such as tangible personal property, intangible assets and intellectual properties, business entities and interests and direct and derivative security interests.


There are numerous types of property deprivations. The appraisals and analyses vary in every case, but all deprivations may be grouped into one of five categories:

* Eminent domain. In this type of case, a state, municipality or individual asserts dominion over private property in the interests of the public good. The seizure may be accomplished through a municipal condemnation, nationalization of property and industry or an expropriation.

* Property damage. This can be tangible or intangible. Tangible damages are fire, such as arson of a commercial building, theft and other actual or constructive larceny (including any deliberate destruction of or damage to businesses' plants and equipment). Intangible damages include,slander, libel and other damage to a party s name, reputation and goodwill. For example, an individual, professional practice or business may be the victim of defamation.

* Infringement. This covers patent, trademark, copyright and other intellectual property infringements. Before the infringement, the intellectual property owner enjoyed special legal rights and protections-and the associated economic benefits-but was deprived of them through an unauthorized use or other encroachment.

* Squeeze-out transaction. In this type of case, the deprived party owns an interest in a business enterprise and loses the associated legal rights and economic benefits as a result of a squeeze-out or freeze-out. This occurs, for example, when majority stockholders squeeze out minority stockholders through the use of a statutory merger. In such instances, of course, the minority stockholders enjoy stockholders' appraisal rights, which offer them the right to seek compensation for the fair value of their holdings.

* Breach of contract. This covers circumstances in which the deprived party had contracted to receive certain legal rights and economic benefits. The contract may call for the purchase or sale of an asset or the consumption or provision of goods and services. In any event, before the breach, the affected party enjoyed quantifiable economic satisfaction that was lost because of the deprivation.

A judge in these cases may force the defendant to comply with the contract rather than simply compensate the plaintiff, which would be the case in other deprivations. For example, a building contractor who is given the cash value of parts ordered for a construction project may still suffer losses if the project is delayed while he or she solicits new bids and reorders the parts. A judge may order the supplier to deliver the needed parts as promised.


Many definitions of value can be assigned to the same asset, property or business interest. The most important thing to understand about the definitions is that each answers the question: value to whom?

The sidebar on page 92 describes 11 commonly used alternative definitions of value. It is not an exhaustive list, and certainly none is objectively better than any other. Virtually all of them could be estimated for the very same property. The result would be 11 possibly quite different and equally valid values.

In deprivation appraisals, some judicial and statutory authorities require fair market value as the appropriate definition. However, it is much more commonly the case that the judicial, statutory or regulatory authority requires fair value as the appropriate definition.

While the nature of the deprivation determines which definition is used, fair value generally is considered to give the property owner the most fair and equitable treatment in an involuntary transaction, a taking or a conversion of the property. The specific definitions of fair value are as numerous as the number of court cases and government statutes in which the term is mentioned. However, there are a number of basic tenets that are universal to the concept of fair value (at least in terms of how they affect the appraisal).

* There is no transaction between a willing buyer and seller. Most deprivation appraisals do not involve a "willing" seller-- the deprivation is clearly involuntary. And, other than the party responsible for the deprivation, there may not be a willing buyer for the subject property.

* The objective is not to estimate likely marketplace effects but to restore the property owner to his or her economic status before the deprivation.

A more descriptive but less frequently used definition is compensatory value, which is, in most respects, analogous to fair value. However, the term "compensatory value" is a more straightforward description of the reason for conducting the appraisal and of the answer to the basic definition of value question: value to whom?

Compensatory value is clearly the properry's value to the property owner. And the general interpretation of compensatory value is: the value that will result in a fair and reasonable compensation for the deprived property and restore the property owner to the level of economic satisfaction that was enjoyed just before the deprivation. Such a definition of value is intuitively the proper measure of compensation in deprivation appraisals.


In any appraisal, the appraiser does not have to choose the appropriate definition of value, description of property or valuation date. These fundamentals already are decided by the appraisal assignment.

However, one of the first valuation fundamentals any appraiser must decide on is the premise of value to apply to the property. There are four choices that cover virtually any type of asset, property or business:

* Value in continued use, as part of an assemblage of assets and a going concern enterprise.

* Value in place, as part of an assemblage of assets but not part of a going concern.

* Value in exchange, sold by itself as part of an orderly disposition.

* Value in exchange, sold by itself as part of a forced liquidation.

While virtually any type of property can be appraised under each of these four fundamental premises, the results under each for the same property may be dramatically different.

The appraiser selects the appropriate premise based on the appraisal's purpose and objective and the property's actual condition. In deprivation appraisals, it is accepted universally that the appraiser applies the premise of value that would have been appropriate on the day before the deprivation occurred. For example, if the property was all or part of a going concern business just before the appraisal, it should be appraised under the fundamental premise of value in continued use. It is possible and often likely that the deprivation could change the property's functional status.

For example, let's assume a hotel property was a viable business just before an eminent domain condemnation. At the moment after the condemnation, the hotel property ceased its hospitality operations. Clearly, in this example, the property should be appraised under value in continued use (as part of a going concern business) since that was its functional status just before the deprivation.

To appraise the hypothetical hotel property under any other premise would unfairly disadvantage the property owner economically and benefit the taker because the taker could restore the hotel to operation and profit from it without having paid the appropriate amount for it.

In a deprivation appraisal, applying a premise of value that was not appropriate before the deprivation does not achieve a fair or compensatory value.


As implied above, there are a number of special considerations for appraisers preparing deprivation appraisals. Of course, various judicial decisions, statutes and scholars articulated different factors, based on the specifics of individual cases. The following is a consensus of several special general valuation factors in virtually all deprivation appraisals. The appraiser should ignore

* The deprivation itself and all its effects in the appraisal. In other words, the property should first be appraised as if the deprivation and any resulting property value decline had not occurred.

This assumption may be the basis for a comparative analysis to quantify one measure of compensatory value--the fair value of the property before the deprivation less the fair value afterward.

* All events after the deprivation (that is, after the valuation date). This normal practice should be obvious, but in deprivation appraisals ignoring the substantial economic effects of time and the deprivation on the property is often difficult.

* The deprivation and its effect when selecting the appropriate premise of value. Generally, this selection is a threshold test. If a property is a going concern, it should be appraised under the premise of value in continued use.

* The actions of those responsible for the deprivation, both before and after the deprivation. In a condemnation, for example, the state's actions before issuing the condemnation notice may have hurt the property's value. In the hotel example, these actions may have included closing most access roads, changing the zoning, starting major highway construction directly adjacent to the hotel, etc. Certainly, the appraiser should factor out all these effects.

* Many of the valuation discounts that would normally apply in a willing buyerwilling seller market value appraisal. To illustrate, let's assume the hotel is a closely held corporation, with a number of shareholders. Let's also assume it is condemned by a government authority and that one of the four equal shareholder owners is seeking compensation.

Normally, the appraiser discounts the closely held corporation's overall value due to the illiquidity of its shares and the owner's pro rata share because of the difficulty of selling blocks of stock in close corporations. Another discount applies because it's a minority ownership that doesn't control hotel operations. The appraiser also considers any other sale restrictions, such as buysell agreements.

In a deprivation appraisal, however, none of these discounts are applied, If they are, the four owners collectively will receive much less than the hotel's total market value and would be economically disadvantaged, while the party responsible for the deprivation receives a benefit by "buying" the hotel for much less than its total market value.


While CPAs already have many skills necessary for appraisals, they need additional training to perform them. Two professional organizations offering training nationwide are the American Society of Appraisers (ASA), Post Office Box 17265, Washington, DC, 20041, and the Institute of Business Appraisers, Post Office Box 1447, Boynton Beach, Florida 33435.

Once practitioners take and pass exams for five ASA courses and satisfy certain experience requirements, they are eligible for the ASA designation. This certification adds credibility in court, especially since opposing expert witnesses usually are either investment bankers or other certified appraisers, both of whom have demonstrated valuation experience.

CPAs in public practice should market their appraisal services to large law firms' litigation, expropriation or international law departments or to small law firms that specialize in these areas. The steps are to contact state bar associations for member directories and to send introduction letters to attorneys specializing in expropriation cases in particular and, perhaps, litigation or damages in general.

The best marketing tool is one success. CPAs might open their introduction letters by saying, for example, "I just performed an appraisal that helped the ABC law firm win the XYZ case. I would like to offer the same services to your firm."


CPAs who understand the key factors of deprivation appraisals can provide the kind of informed advice and counsel that clients or employers need to receive the maximum compensation in a deprivation. Practitioners with the proper training and credentials will be able to use them to expand into a new practice area.


* BUSINESSES OF ALL sizes often are faced with deprivations of their assets through eminent domain condemnations, property damages, infringement, squeeze-out transactions and breaches of contract.

* IN A DEPRIVATION, the owner of an asset, property or business interest involuntarily loses ownership or other legal or economic rights and is eligible for compensation for the economic loss suffered. Employers or clients turn to CPAs to assemble and interpret data to perform analyses or to help select independent advisers.

* IN THESE APPRAISALS, the appraiser should ignore the deprivation and all its effects, as well as changes that occur after the deprivation. The appraiser should not consider the actions of those responsible for the deprivation and should not apply many of the valuation discounts that are normally used in appraisals.

* CPAs CAN GET the additional training needed to perform these appraisals from the American Society of Appraisers and the Institute of Business Appraisers.

* MARKETING EFFORTS SHOULD be directed at large law firms' litigation, expropriation or international law departments or to small law firms specializing in these areas. The best marketing tool is one success.


Here are some of the numerous definitions of value CPAs might encounter in appraisal services:

* Fair market value: What a hypothetical typical willing buyer will pay a hypothetical typical willing seller for a property.

* Fair or compensatory value: The amount that will compensate an owner involuntarily deprived of property when there is neither a willing buyer nor seller.

* Market value: Same hypothetical willing buyer and seller as in fair market value, with a few additional conditions placed on the arm's-length transaction (for example, the condition that value will be stated in a cash equivalency price and in local currency).

* Acquisition value: The property's worth to a specific, individual buyer.

* Use value: The property's value in a specified use (which may differ from its current one).

* Investment (or investor) value: The property's value based on its investment return to the property owner (without considering a possible sale price).

* Owner value: The property's value to its current owner and in its current use (which may be substantially different from what the property may be worth to any other particular buyer, to any other user or to the marketplace in general).

* Insurable value: The property's value for insurance purposes (usually based on some relationship to the replacement cost of tangible and intangible assets).

* Collateral value: The amount a creditor would be willing to loan against the property.

* Ad valorem value: The property's value to a taxing authority.

* Contributory value: The property's value to the owner of a specified other property that could be operated in conjunction with it.

ROBERT F. REILLY, CPA, ASA, CREA, ia a managing director of Willamette Management Associates, chicago. He is a member of the American Institute of CPAs, the Institute of Management Accountants, the American Society of Appraisers and the National Association of Real Estate Appraisers.
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Title Annotation:losses from involuntary deprivation of property
Author:Reilly, Robert F.
Publication:Journal of Accountancy
Date:Oct 1, 1992
Previous Article:Computers & taxes: a review of the leading tax software programs.
Next Article:The allowance for loan losses: understanding and applying FASB 5.

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