Getting to the Root of Correctly Donating Appreciated Property to Charity

SEPTEMBER 2013

 

Getting to the Root of Correctly Donating Appreciated Property to CharityThe tax law imposes stringent requirements for deducting charitable gifts of property, and they are especially tough when appreciated property is donated. Failing to observe all of the rules can reduce or eliminate the tax deduction.

The recent U.S. Tax Court case of Mohamed v. Commissioner dramatically illustrates the roots of potential issues. The taxpayer donated property worth tens of millions of dollars—which the IRS readily acknowledged—yet his final deduction was zero because he’d failed to obtain an independent qualified appraisal.

Meeting Requirements to Reap Tax Benefits

When property that would have qualified for long-term capital gains treatment if sold—in other words, the property has been owned for more than one year— is donated, then it’s generally allowable to deduct an amount equal to the property’s fair market value (FMV). Conversely, if the property has been held for a year or less, then the deduction is limited to the taxpayer’s basis (generally, the original cost of the property).

This situation provides a unique planning opportunity for some taxpayers. Notably, property that has significantly appreciated in value can be contributed—such as real estate or securities—and then a large deduction based on the FMV may be claimed. The appreciation in value in the property remains untaxed forever.

Generally, the current charitable deduction for appreciated property can reach up to 30% of a taxpayer’s adjusted gross income (AGI). There is an overall limit of 50% of AGI for all charitable (cash and noncash) deductions. Any remainder above these limits may be carried forward for up to five years.

However, the tax law imposes several other requirements when property is given to charity. These include:

• If tangible personal property is donated that isn’t used to further the charity’s tax-exempt function, then the deduction is limited to the taxpayer’s basis in the property.

• An IRS requirement for a written description of property valued at more than $500.

• If a taxpayer claims a deduction exceeding $5,000 (or $10,000 for closely-held stock), then an independent written appraisal must be obtained-except for donations of money or publicly traded securities. Note: that was the taxpayer’s undoing in Mohamed.

• In instances where an independent appraisal is required, there are very strict rules on the qualifications of the appraiser and on the contents and timing of the appraisal.

Root of the Case: Mohamed v. Commissioner

The taxpayer was a real estate broker, certified real estate appraiser, and entrepreneur. He and his wife set-up a charitable remainder Unitrust (CRUT). Over a two-year period in 2003 and 2004, the couple contributed five properties and a shopping center to the CRUT.

The taxpayer appraised the properties himself and used the values established in the appraisals to claim deductions on IRS Form 8283, “Noncash Charitable Contributions.” But he later admitted in court that he’d never read the form’s instructions and therefore thought a self-appraisal would suffice.

Besides failing to obtain an independent appraisal, the taxpayer omitted information required on Form 8283, such as the basis of the properties he had donated to the CRUT. For four of the five donated real estate properties, he claimed a combined FMV of just more than $1 million. He claimed a FMV of $14.8 million for the fifth property, which he said he undervalued because he didn’t want to risk an inflated deduction. For the shopping center, he used a FMV of $2 million. The taxpayer also left the “Declaration of Appraiser” section on Form 8283 blank.

After the IRS audited the taxpayer and questioned the self-appraisals, he hired independent appraisers to value the properties. Their appraisals resulted in FMVs similar to the ones the taxpayer had claimed. Furthermore, subsequent sales by the CRUT provided prices close to the values he’d used. But the IRS continued to object that the values were excessive, so the taxpayer appealed the case to the Tax Court.

The Tax Court spoke sympathetically about the situation, pronounced that the taxpayer had probably undervalued the donations, and even acknowledged that Form 8283 could be misleading. But the Tax Court still disallowed any deduction because the taxpayer failed to follow the rules when he didn’t obtain any written independent appraisals (those he obtained while being audited were too late) and omitted other required information from Form 8283.

Avoid growing the same mistakes.

When you donate property to charity, the stakes are simply too high for any missteps. Stick to the strict letter of the law and make sure that all the proper information is entered on Form 8283. Remember that an independent, timely qualified appraisal is needed for a gift—other than cash or publicly traded securities—valued at more than $5,000. CRI can provide the necessary assistance to ensure that you can maximize your deductions for your charitable gifts of property without running into trouble with the IRS.