Making a donation to charity has several benefits. Other than the good feeling a donor gets for helping those who are less fortunate, someone or something will directly benefit from her good deed.
Another big positive for many donors is the charitable deduction that results from such philanthropic giving. However, any taxpayer wishing to claim a charitable deduction must be aware that there are specific rules to follow for the Internal Revenue Service to allow such deductions.
For example, if your client donates property and claims a deduction of more than $5,000, she must include a qualified appraisal of the item(s) she donated to substantiate the deduction, according to Internal Revenue Code Section 170(f)(11). Also, under IRC Section 170(f)(3)(A), your client generally can’t get a deduction for donating less than her entire interest in a piece of property. The taxpayers in the recent case (Lawrence P. Mann & Linda S. Mann v. United States of America, No. CV TDC-17-0200, 2019 WL 399902, at *1 (D. Md. Jan. 31, 2019) found out the hard way about the need to comply with these rules.
Building the foundation
In the case, Lawrence and Linda Mann (the taxpayers) filed a tax refund suit challenging the IRS’ disallowance of three claimed charitable deductions. The taxpayers purchased a piece of real property in 2011, which included a house and a shed. Before moving in, they decided to demolish the house and build something more suitable. However, instead of throwing away all of the old housing material, the taxpayers decided to contact Second Chance, Inc. (Second Chance), a public charity that salvages building materials, fixtures and furniture while providing their employees with workforce training. Second Chance requires that donors also give cash to help defray the costs of the deconstruction, and the taxpayers would still have to pay a demolition company to remove any remaining debris that couldn’t be salvaged.
One of the taxpayers signed an agreement conveying all of her interest in the house to Second Chance. She signed a second agreement conveying certain pieces of other personal property in the house to the charity as well. A representative from Second Chance explained to the taxpayers that donors could claim a tax deduction for materials that actually made it back to their warehouse for later resale. The charity would draft a list of everything removed so that a qualified appraiser could determine the fair market value of each item. The taxpayers also agreed to pay $20,000 in cash over two years to supplement their donation.
To substantiate their donation and the resulting charitable deduction, the taxpayers had two separate appraisals prepared for the house. The first valued the gift at $675,000 and was arrived at by valuing the house at its highest and best use (that is, keeping it intact and moving it to a different location). The second appraisal valued the structure at about $313,000 and assumed that the entire house could be used for training purposes and all of the materials could be salvaged and resold. A separate appraisal valued the personal property at about $24,000 by taking the cost of each item as new and depreciating it.
Ultimately, the taxpayers claimed a $675,000 deduction for the house, $24,000 for the personal property and $10,000 for the cash distribution on their 2011 returns. In 2012, they only contributed $1,500 of cash to Second Chance and claimed that as a charitable deduction. The IRS disallowed all of the claimed deductions. After their appeal was denied in 2015, the taxpayers filed claims for a refund. They also filed an amended 2011 return reducing the deduction for the house to $313,000.