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INSIGHT: Expectation of Tax Deduction for Charitable Contribution Not ‘Quid Pro Quo’

March 8, 2019, 2:04 PM

A Bethesda, Md., couple won the battle to deduct a payment to a charity to salvage building materials prior to the demolition of their house but lost the war to deduct the value of the house.

Lawrence and Linda Mann were entitled to a charitable contribution deduction for the $10,000 they paid to Second Chance Inc. to salvage materials from the house, because there was no cognizable benefit to the Manns from the deconstruction services other than the potential for a tax deduction on the donated house and personal property, the U.S. District Court for the District of Maryland ruled in Mann v. United States, No. 8:17-cv-00200, 2019 BL 31731 (D. Md. 2019).

However, the Manns weren’t entitled to a deduction for the value of the house, because they never recorded the transfer in the real property records. In addition, although they obtained two house appraisals and one personal property appraisal, none of the appraisals were a qualified appraisal under tax code Section 170.

In April 2011, the Manns purchased real property in Bethesda, Md. At the time the Manns purchased the property, it included a remodeled colonial-style house in good condition. The Manns decided to have the house demolished and to build a new home on the property and hired a contractor to do both.

Prior to the demolition, the Manns contacted Second Chance, Inc. about donating the house. Second Chance is a charitable organization under Section 501(c)(3), which engages in property “deconstruction” and the salvaging of building materials, fixtures, and furniture from properties.

On Dec. 1, 2011, Linda Mann signed an agreement with Second Chance to donate the house for deconstruction. Linda conveyed to Second Chance all of her rights, title, and interest in “the improvements, building, and fixtures located on the Premises.” The conveyance excluded a shed located on the property. That same day, Linda signed a second agreement with Second Chance conveying various furniture and other personal property in and around the house.

The Manns commissioned three appraisals, two of the value of the house, and one of the value of the personal property. The first house appraisal valued the house at $675,000. This first appraisal was based on the value of the house “as moved intact to another site for residential purposes.” The Manns obtained a second appraisal to establish the donation value of the house if it were deconstructed. The second appraisal valued the house at $313,353. The personal property appraised value was $24,206.

On their 2011 federal income tax return, the Manns claimed charitable contribution deductions for the value of the house, the value of the personal property, and $10,000 for a cash donation to Second Chance. All donors to Second Chance were expected, in fact required, to make cash donations to offset the amount Second Chance expected to spend on the deconstruction. On their 2012 federal income tax return, the Manns claimed a charitable deduction of $1,500 for the second installment of the cash donation to Second Chance. The Internal Revenue Service disallowed all of these claimed deductions.

The IRS asserted that in donating the house, the Manns donated only a part of their interest in the property, and that such partial-interest donations are impermissible under Section 170. The Manns assert that they had a discrete interest in the house that could be, and in fact was, donated pursuant to Section 170.

Section 170(f)(3)(A) provides that “in case of a charitable contribution … of any interest in property which consists of less than the donor’s entire interest in such property, no deduction is allowed under Section 170.” In Maryland, real property can consist of land or improvements to land. In Maryland, the rule is that record ownership, not contractual ownership, demonstrates ownership of the improvements for real property tax purposes. In Maryland, then, it is eminently possible to sever the property interest in improvements to real property from the land itself, such that it would have been possible for a donation of the house to be a conveyance of an entire property interest rather than a partial interest in the overall property.

However, Maryland law is clear that the severance would be valid for tax purposes only if that transaction is separately recorded in the land records. The Manns never recorded that transaction in the land records. As a result, for tax purposes under Maryland law, the Manns did not properly sever the house from the property and transfer ownership of the latter to Second Chance; the Manns’ donation was comparable to granting a license to Second Chance to access and use the house for salvage and training purposes. Having failed to make a valid transfer of an entire interest in real property, no deduction was permitted.

Even if the court were to find that the Manns had effected a proper severance and had properly donated the house to Second Chance, the Manns would still not have been entitled to their claimed charitable deduction. Charitable contributions of property for which a deduction of more than $5,000 is claimed must be accompanied by a “qualified appraisal.” See Section 170(f)(11). Because the Manns donated the house for the “express purpose” of having Second Chance engage in deconstruction and workforce training, the valuation methodology used in the first appraisal was invalid, because it did not take into consideration the condition on the conveyance that necessarily reduced the value of the donation. The second appraisal suffered from the same infirmity.

A qualified appraisal, the court noted, must include the method of valuation used by the appraiser as well as the specific basis for the valuation. Here, with respect to the personal property, the appraisal failed in several ways. It did not provide the specific basis and documentation for valuing all of the 40 items of household furniture and instead included fair-market comparators for only a few items. The appraisal, therefore, was not a qualified appraisal. Accordingly, no deduction was allowed for the conveyance of the house and the personal property. What about the cash?

No Specific Benefit

The IRS asserted that the Manns’ deductions of their cash payments to Second Chance were properly denied because the payments were a quid pro quo for Second Chance’s deconstruction services and thus not proper charitable donations. Second Chance, as indicated, required donors of structures and their contents to make a cash donation “to defray the cost of deconstruction.”

It is undisputed that the Manns were effectively required to make a cash donation in order for Second Chance to accept the donation of the house and its contents. However, the court observed, the Manns received no “specific benefit in return.” The Manns gave a required cash contribution in order to secure Second Chance’s agreement to accept its donation of the house and its contents. The Manns did so not to secure some tangible goods or services in return (for example, the deconstruction did not reduce the cost of the demolition), but to secure the ability to make a donation to a charitable cause and to obtain a tax deduction, which is not a specific benefit from Second Chance.

The court referenced Scheidelman v. Commissioner, which said “a donee’s agreement to accept a gift does not transfer anything of value to the donor, even though the donor may desire to have his or her gift accepted, and may expect to derive benefit elsewhere (such as by deductibility of the gift on her income taxes). … It is true the taxpayer hoped to obtain a charitable deduction for her gifts, but this would not come from the recipient of the gift. It would not be a quid pro quo” (emphasis added).

The court noted that the deconstruction services actually benefited Second Chance, not the Manns, by allowing the charity to administer the Manns’ gift by converting the overall donation into components that could be sold for value. “When a cash contribution (even mandatory in nature) serves to fund the administration of another charitable donation, it is likewise an unrequited gift.”

“Where the only arguable benefit from the cash donation and the deconstruction work was the expectation of a later tax deduction, this case is distinguishable from other examples of required cash donations made in exchange for an actual good, service, or other definable benefit provided by the recipient of the donation,“ the court said. Because the record established no cognizable benefit to the Manns from Second Chance’s deconstruction services other than the potential for a tax deduction on the donated house and personal property, the court concluded that the cash donations were not a quid pro quo but were, instead, properly deductible.

Robert Willens is president of the tax and consulting firm Robert Willens LLC in New York and an adjunct professor of finance at Columbia University Graduate School of Business.

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