Some tax results depend on what an asset is worth or what you paid for it. A charitable deduction for donated property, the gain on a sale, the value of a gifted business interest and the pricing between related companies all rest on a number. If that number is far from the truth, the IRS has a specific penalty for it. This page explains the valuation misstatement penalties, which are part of the accuracy-related penalty family in Internal Revenue Code section 6662.
Income tax: overstated value or basis
The test compares the value or adjusted basis you claimed on the return with the correct figure.
| Level | Claimed value or basis is | Penalty rate |
|---|---|---|
| Substantial | 150% or more of the correct amount | 20% |
| Gross | 200% or more of the correct amount | 40% |
The penalty applies only if the underpayment of tax caused by the misstatement is more than $5,000 for most taxpayers, or more than $10,000 for a corporation that is not an S corporation or personal holding company. If the percentages are met, the penalty is charged on the portion of the underpayment tied to the misstatement.
Example (hypothetical). You claim a charitable deduction of $90,000 for donated artwork. The IRS decides it was worth $50,000. The claim is 180% of the correct value, so it is a substantial valuation misstatement. If the resulting tax underpayment is $12,000, the penalty is 20%, or $2,400. If instead you had claimed $120,000, which is 240% of $50,000, the 40% rate applies to that underpayment, or $4,800 on a $12,000 shortfall.
Related-party pricing
Prices charged between related companies, often across borders, have their own tests under section 482. A price that is 200% or more, or 50% or less, of the correct price is substantial. For gross misstatements the figures are 400% or more, or 25% or less. There are also net-adjustment tests based on the lesser of a dollar amount or a share of gross receipts: $5 million or 10% for the substantial level, and $20 million or 20% for the gross level. These rules matter to owners of businesses with affiliates in India or elsewhere, and the documentation requirements are separate and detailed.
Gift and estate tax: understated value
On a gift or estate tax return, the concern is a value that is too low. A valuation understatement is substantial when the value claimed is 65% or less of the correct amount, and gross when it is 40% or less. The same 20% and 40% rates apply, the underpayment must exceed $5,000, and the IRS applies the percentage test property by property. Families that transfer a closely held business interest, real estate or partnership interests should plan for a documented valuation. See our estate and gift tax basics.
Charitable deduction property
Noncash gifts carry a special rule, and the reasonable cause defense is more limited here. For a gross valuation misstatement of charitable deduction property, the reasonable cause exception is not available. For a substantial misstatement, the exception may apply if the value was based on a qualified appraisal by a qualified appraiser and you made a good-faith investigation of the value. The appraisal requirement is why getting an independent appraisal before you file is worthwhile. Our guide to charitable giving covers the substantiation rules.
Related 40% penalties
Section 6662 also doubles the rate to 40% for understatements tied to an undisclosed foreign financial asset and for transactions without economic substance that were not adequately disclosed. For the foreign asset rule, see foreign reporting penalties overview.
How to avoid it
- Use a qualified independent appraiser for property where value drives the deduction.
- Keep records of basis: closing statements, purchase confirmations, and improvement receipts.
- For related-party transactions, document how the price was set before the return is filed.
- For gifts, get a valuation report before the gift tax return is due.
Disputing the penalty
Challenge the valuation first. A penalty falls if the claimed value was within the thresholds. Then raise reasonable cause and good faith, with the limits described above. The IRS looks at factors such as the steps taken to determine value and the advice received. Our page on reasonable cause penalty relief lists evidence that tends to help. If you disagree after the IRS review, you can ask for an appeal as described on the accuracy-related penalty page.
How we can help
We can review appraisals and basis records, test the percentages against the penalty thresholds, and prepare the response if a notice proposes a valuation penalty. When a gift, sale or donation is still ahead, we can coordinate with a qualified appraiser before the return is filed. Valuation questions are factual, so we cannot promise how the IRS will view them.
See our tax planning service or contact us.
Frequently asked questions
Does a 150% overstatement always lead to a penalty?
No. The underpayment caused by the misstatement must also exceed the dollar floor, and reasonable cause may apply in some cases.
Can I avoid the penalty with an appraisal?
An appraisal helps, especially for charitable gifts, because the exception for substantial misstatements depends on a qualified appraisal. It does not help for gross misstatements of charitable deduction property.
Does the penalty apply to a low value on a gift?
Yes, the gift and estate version applies when the claimed value is 65% or less of the correct amount, and the underpayment exceeds $5,000.
Are these penalties the same as the accuracy-related penalty?
They are part of it. The accuracy-related penalty has several grounds, including negligence, substantial understatement and valuation misstatements.
Official sources
- IRS: Internal Revenue Manual 20.1.5, Return related penalties
- IRS: Accuracy-related penalty
- Cornell Legal Information Institute: 26 U.S.C. 6662
This page is a plain-language summary. The official source controls if there is any difference.
General information only, not tax, legal or accounting advice for your situation. Rules, limits and deadlines change; confirm the current rules with the official source or a qualified professional before you act. Reading this page does not create a professional relationship with CPA Tax Payroll and Accounting Corp.