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For What It’s Worth: Being Mean About the Average – July 2016

This completes my discussion of certain aspects of the fair market value standard governing tax-related valuations. Its foundation is Revenue Ruling 59-50, a six-page document downloadable free from many sources. My appraisal teachers strongly recommended rereading it often, and I have done that for 30 years, invariably gaining new insights each time I did so,

This Ruling has stood the test of time for 56 years, but one of its prescriptions, Section 7, entitled “Average of Factors,” is incorrect, and is ignored in practice. Section 7 states that:

“No useful purpose is served by taking an average of several factors (for example, book value, capitalized earnings, and capitalized dividends).”

Here, “factors” means indications of value resulting from using different valuation methods. The implication is that one must select a single best indication from them and ignore the others.

That makes no sense!

Appraisers routinely take averages of value indications, for many good reasons:

  1. Willing buyers do this all the time.
  2. Value indications using market comparables, expected income or cash flow, and asset-based values may all be reasonable and have strong support, but use different premises. A market approach value implies a sale, an income approach value implies continued ownership, and an asset approach implies liquidation. There may be some chance that each premise is correct, and a proper valuation should judge those chances by weighting them as an average.
  3. If the value indications are similar, they are mutually reinforcing.
  4. If they differ, facts and circumstances may suggest which ones are the most probable and should receive the most weight.
  5. To select only one probable value out of several reasonable ones is illogical.

Valuations play a part in all tax, transaction, and litigation matters. For additional information or advice on a current one, please do not hesitate to call.

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