Grossly overvalued real estate won’t qualify for charitable tax deduction

Real Estate Tax Talk

Hold key in sky image via Shutterstock.Hold key in sky image via Shutterstock.

What do you do when you own an apartment building that you want to get rid of but no one wants to buy? One strategy owners of undesirable properties often use is to give the property to a charity and take a charitable deduction on their taxes. If the contributed property’s valuation for tax purposes is high enough, the property owner can come out way ahead.

However, the IRS is well aware of this strategy. There are a number of rules in place designed to prevent unrealistically high valuations of dilapidated property for charitable contributions purposes. Run afoul of these rules and you can lose your entire deduction.

This is what happened to Ben Alli, a medical doctor who purchased for $353,000 two large apartment buildings in Detroit, Mich., at a 1983 HUD auction as part of HUD’s Section 8 program. Several years later, HUD inspectors determined that one of the buildings — containing 34 units — was in “deplorable and unsanitary” condition, and HUD subsequently foreclosed on Alli’s loan when he failed to correct the problems.

Alli paid off the loan and in 2008 donated the property to the Volunteers of America in Michigan, a tax-qualified Section 501(c)(3) organization for which donations are tax deductible. He claimed that the building was worth $499,000 and took a charitable deduction for this amount. The charity almost immediately sold the building for $60,000 cash to a California investor — the only person who expressed interest in the property.

It probably doesn’t come as a surprise that the IRS and tax court denied Alli’s entire deduction.

When you donate real or personal property to a charity, its value for tax purposes is the property’s “fair market value” at the time of the donation. This is the amount that a “willing buyer would pay and a willing seller would accept for the property, when neither party is compelled to buy or sell, and both parties have reasonable knowledge of the relevant facts.”

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It makes no difference if this amount is less than the property’s tax basis — in the case of real property, its original cost plus the cost of depreciable improvements. Thus, donors of distressed properties that have gone down in value may be able to deduct far less than what they paid for the property.

There are a number of rules in place designed to prevent unrealistically high valuations of dilapidated property for charitable contributions purposes. Run afoul of these rules and you can lose your entire deduction."

For property donations worth $5,000 or more, the donor must obtain a formal “qualified appraisal” and attach a summary to his or her tax return along with IRS Form 8283, Noncash Charitable Contributions. A qualified appraisal is one that:

  • is made not earlier than 60 days before the property is donated.
  • includes certain specified detailed information.
  • does not involve an appraisal fee based on a percentage of the appraised value of the property (with one narrow exception for certain fees to nonprofit appraiser associations) or the value of the property allowed as a charitable deduction.
  • is conducted in accordance with “generally accepted appraisal standards” and IRS rules.
  • is conducted, prepared, signed and dated by a “qualified appraiser.”

A qualified appraiser is someone who:

  • has an appraisal designation from a recognized professional appraiser organization or has met minimum education and experience requirements.
  • is regularly paid to perform appraisals.
  • can demonstrate verifiable education and experience valuing the type of property appraised.
  • has not been barred from practice by the IRS during the three years preceding the date of the appraisal.

Alli had two appraisals. The first found that the building was worth $390,840; the second concluded it could have a value of $664,062 after renovation. Unfortunately, both failed to comply with most of the requirements outlined above. Neither appeared to be from a qualified appraiser.

In addition, the first appraisal was 10 years old, and, among other problems, did not provide an appraised fair market value. The second appraisal was also untimely, though much more recent, and failed eight other requirements.

Alli also didn’t help his case when he failed to complete Form 8283 correctly. For example, he vastly overstated on the form what he originally paid for the property.

And, of course, though the court didn’t say so in its opinion, the fact that the property was later sold for $60,000 made clear just how faulty the appraisals had been. (Ben Alli et ux. v. Commissioner; T.C. Memo. 2014-15 (Jan. 27, 2014).)

As this case shows, the IRS is on the lookout for property owners who take outrageous deductions for property contributed to charity. Indeed, charitable deductions have long been one of the IRS’ hot-button issues. It is to prevent the type of abuses outlined here that the IRS imposed its strict appraisal requirements for property donations of $5,000 and more.

Stephen Fishman is a tax expert, attorney and author who has published 20 books, including “The Real Estate Agent’s Tax Deduction Guide,” “Working for Yourself,” “Deduct It!” and “Working with Independent Contractors.” His website can be found at fishmanlawandtaxfiles.com.

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