Undervaluing an Estate during the Probate Process

When the recording artist Prince died without a Will in 2016, aged 57, controversy soon began surrounding the administration of his estate. Fast-forward almost five years and the storm is still raging as the IRS (Internal Revenue Service) has determined that the estate administrators’ original valuation of the estate was woefully low. In fact, the IRS has calculated that the estate was undervalued by approximately 50%.

This means that the federal tax bill on Prince’s estate could double and the IRS has also ordered an “accuracy-related penalty” to be levied due to a “substantial” undervaluation of assets.

Just not worth it

The figures in the probate dispute relating to the Prince estate are eye watering: the original estate valuation was $82.3 million, re-evaluated by the IRS as $163.2 million which will require a further $32.4 million in federal taxes to be paid alongside a penalty of $6.4 million. However, whatever the value of an estate, the story should serve as an unambiguous message that undervaluing an estate during the probate process is not a sensible thing to do.

Taxable estates in the UK run similar risk of penalties if not valued accurately and Her Majesty’s Revenue and Customs (HMRC) has the power to levy a fine of up to 100% of the additional Inheritance Tax (IHT) liable, as well as recovering the IHT at 40%. For example if a house is undervalued by £50,000, this could result in £20,000 additional tax liability and a possible fine of £20,000 on top.

Real estate is probably one of the easier types of asset to value; Royal Institution of Chartered Surveyors (RICS) registered valuers will carry out a “Red Book” valuation for probate purposes ( which may differ from an estate agent’s market value appraisal), but certain other assets are likely to be more challenging.

The problems with Prince’s estate stemmed from the difficulty in valuing his back catalogue and the associated music publishing and recording interests. For non-popstars, however, shares in private companies and similar investments can be problematic for valuation purposes. The value of shares for IHT purposes is calculated based upon the closing share price on the day of death.

Any valuation of such assets provided to the HMRC, should be as accurate as possible, as discrepancies are likely to be investigated by the Share Valuation Division.

Gifts and reliefs will also play a part

When calculating the tax payable on an estate, HMRC will also be concerned with any money or assets given away by the deceased in the seven years prior to death, and if any reliefs and exemptions from Inheritance Tax have been over-inflated this is also likely to be subject to scrutiny.

For instance, if a husband leaves his wife the entirety of his estate in his Will, when the wife dies checks must be made to ascertain the amount of inheritance tax nil rate band used on gifts/bequests made to non-exempt beneficiaries (such as their children), as this will affect the amount of transferable nil rate which can be claimed and, ultimately, the tax due on the estate.

Selling property at reduced value

If land or property is sold for less than the market value within four years of the death of the title holder to a person connected to the estate, HMRC can claim relief for the loss.

In the recent case of the Estate of Douglas Charles Thomas v HMRC [2020], an application was made by estate representatives to the  Upper Tribunal (Lands Chamber) for loss relief in respect of the sale of a piece of land to the deceased’s daughter and son-in-law.

The land had been sold for £500,000 which the HMRC claimed was significantly lower than the market value of £800,000. The Upper Tribunal considered the evidence and found that a reasonable valuation for the land at the time of sale would have been £645,000 – the claim for loss relief was therefore fixed at this amount.

This case highlights the need for correct valuations when selling property to connected persons and that any misevaluation is likely to be investigated. There is a legal obligation to accurately report the value of an estate and if a personal representative of an estate knowingly misleads the HMRC, there is a risk of criminal proceedings for fraud being brought against them.

What if property is overvalued during probate?

If land or property is valued for IHT purposes at the market value prevailing at the time of death and then it is sold for less within four years of the date of the owner’s death, the personal representatives can apply to the HMRC for a refund of any overpaid tax.

How to avoid an HMRC investigation

The HMRC carries out thousands of investigations annually into the valuations of estates for IHT purposes. While the Government obviously wishes to clamp down on tax dodgers, the vast majority of executors and personal representatives do not set out to defraud the HMRC and it is generally due to the complexity of the system that mistakes are made.

Many probate solicitors and tax specialists believe the current IHT system is overly convoluted, particularly in relation to time-limits on gifting, however, there no plans afoot to change the rules and the safest way to ensure that an estate is handled accurately and efficiently is to seek the advice of experienced probate lawyers and tax advisers.

Contact Wellers Law today.