Lack of Qualified Appraisal Sinks Charitable Deduction

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By Deborah M. Beers  

Buchanan Ingersoll & Rooney PC, Washington, DC

Alli v. Commissioner, T.C. Memo 2014-15

Background  

During 2008, Dr. Ben Alli, through his wholly-owned S
Corporation, BSA Corp. (BSA), contributed an apartment building in
Detroit, Michigan, to Volunteers of America, a charitable
organization recognized as exempt from federal income tax under
§501(c)(3).  Dr. Alli and his wife (Petitioners) claimed a
noncash charitable contribution deduction of $499,000 on their 2008
joint federal income tax return, which they carried over in full to
their 2009 return. The government disallowed the deduction and the
carryover in full.

BSA is a Michigan corporation that owned several apartment
buildings (Pingree and Gladstone) in Detroit, Michigan that were
purchased at a HUD auction for a total of $353,000.1 Pingree and
Gladstone participated in HUD's Section 8 housing program pursuant
to which, in 1983, Dr. Alli entered into an agreement requiring him
to keep the properties in a decent, safe, and sanitary condition.
In 1988, Petitioners transferred Pingree and Gladstone to BSA.

HUD Complaints and Litigation  

After numerous unaddressed complaints by HUD of problems at the
two properties, HUD, in 1999, classified Pingree and Gladstone as
"troubled property" and referred the properties to HUD's Department
Enforcement Center (DEC). A team from DEC "inspected the properties
and found the conditions to be deplorable-e.g., severe water
damage; sink and shower units separating from the walls; actively
leaking plumbing; damaged or inoperable appliances, doors and
lighting; and roach infestation." In 2000, HUD notified Petitioners
that they had violated the regulatory agreement and defaulted on
the Pingree/Gladstone contract for failure to maintain the
properties. When Petitioners again failed to correct the
violations, HUD began relocating tenants and initiating foreclosure
proceedings. Before HUD completed the foreclosure, however,
Petitioners paid off the balance of the HUD mortgage. On October
16, 2000, HUD recorded a "Discharge of Regulatory Agreement," which
canceled the regulatory agreement that petitioners and HUD had
entered into in 1983.

On November 29, 2001, Petitioners and BSA sued the United States
and the Secretary of HUD for breach and termination of the
Pingree/Gladstone contract, and the United States counterclaimed
for breach of that contract. In an opinion entered on August 26,
2008, the U.S. Court of Federal Claims held in favor of the United
States and the Secretary of HUD and held against petitioners and
BSA. The court further held that the corporate veil of BSA should
be pierced.

The Donation and Deduction  

Shortly thereafter, on September 29, 2008, BSA, Petitioners and
their son executed one or more quitclaim deeds of Gladstone to
Volunteers of America for nominal consideration (i.e., $1). On
October 29, 2008, Volunteers of America acknowledged the
donation.

Volunteers of America wished to sell the property quickly and
entered into a contract on September 10, 2008, to sell Gladstone to
an investor in California for $60,000. This investor was the only
person who expressed interest in purchasing Gladstone.

Petitioners reported the charitable contribution of Gladstone on
Form 8283, Noncash Charitable Contributions, of their 2008 return.
On the Form 8283 petitioners described Gladstone as a "34 Unit
Apartment Building" in "Good Condition" with an appraised fair
market value of $499,000. Petitioners further reported that they
had acquired Gladstone in June 2000 and that their basis in
Gladstone was $1,200,000. Petitioners' Form 8283 did not include an
appraiser's name, address, or identifying number, nor did it
include an appraiser declaration. In addition, Petitioners' Form
8283 did not include the donee's signature, its taxpayer
identification number, or its statement (which had been provided)
regarding whether the donor had received any consideration for the
contribution.

The Sanna Appraisal  

On May 26, 1999, nearly a decade before the contribution of
Gladstone, Anthony Sanna, MAI, conducted a market rent survey of
the Pingree/Gladstone apartments (Sanna appraisal). Using the
rental rates for five comparable apartment buildings, Mr. Sanna
concluded that Pingree and Gladstone had an annual gross income
potential of $390,840. Mr. Sanna did not estimate the fair market
value of the Pingree/Gladstone apartments. The Sanna appraisal was
not performed for income tax purposes, but rather for the purposes
of HUD's Section 8 housing program. Finally, the Sanna appraisal
did not include the date or expected date of Gladstone's
contribution, nor did it include the terms of agreement regarding
Gladstone's disposition.

The Jones Appraisal  

On April 24, 2008, approximately five months before the
contribution of Gladstone, Darvin Jones made an appraisal of the
Pingree/Gladstone apartments as an update to the 1999 Sanna
appraisal (Jones appraisal). Mr. Jones determined the "market
value" of Pingree to be $898,437 and the "market value" of
Gladstone to be $664,062, for a total of $1,562,500. Mr. Jones
defined "market value" as "the highest price estimate in terms of
money which a property Will [sic] bring, if exposed for sale in the
open market, allowing a reasonable time of [sic] Find [sic] a
purchaser who buys with knowledge of all uses of which it is
adapted, and for which it was capable of being used."

The Jones appraisal stated that the purpose of the appraisal was
for establishing the properties' values "after the renovation
and remodeled [sic] condition
." (Emphasis added.) The
appraisal elaborated that the "[v]aluation premise [sic] will
assume a renovated market position
. Also, assumption will
be made
 that normal management will be implemented." In
describing the exterior condition, the appraisal states: "Condition
will be projected as good. Exterior painting, tuck
pointing, and necessary repairs will be made [sic] good marketing
position."2

In appraising Pingree and Gladstone, Mr. Jones used the cost
approach and the income approach. The "Reconciliation and
Conclusion" section of the appraisal stated that the value of
Pingree/Gladstone was $1,562,500 under each of the income approach,
the market approach [which, the court noted, was not in fact used],
and the cost approach, and thereby yielded a final "reconciled"
value of $1,562,500. [The Tax Court noted numerous "errors" in the
Jones appraisal, including the fact that "the reconciliation
section stated that both the cost approach and the income approach
yielded valuations of $1,562,500, when in fact, the cost approach
actually yielded a valuation of $1,250,000 according to the body of
the appraisal."

Finally, like the Sanna appraisal, the Jones appraisal omitted
the date or expected date of Gladstone's contribution, the terms of
agreement regarding Gladstone's disposition, a statement that the
appraisal was performed for income tax purposes, and Mr. Jones'
qualifications and identifying number.

The Court's Opinion  

The primary issue was whether Petitioners were entitled to a
deduction for the charitable contribution of Gladstone.  The
court determined that they (Petitioners) were not entitled to the
claimed deduction.

In the Deficit Reduction Act of 1984 ("DEFRA"),3 Congress directed
the Secretary of the Treasury to prescribe regulations under
§170(a)(1) that would require any individual, closely held
corporation, or personal service corporation claiming a charitable
deduction under §170 for a contribution of property with a value in
excess of $5,000 to comply with certain appraisal and reporting
requirements. In response to this directive, Treasury issued
regulations governing record-keeping and return requirements for
deductions for charitable contributions.4

Property worth more than $5,000 is referred to in DEFRA as
"charitable deduction property." If the taxpayer contributes an
item, or a group of similar items, worth more than $5,000 in the
aggregate to a charitable organization he or she must, in order to
claim the deduction, comply with three requirements in addition to
the information required to be provided for property of a lesser
value:

(i) The taxpayer must obtain a "qualified appraisal" of the
property;

(ii) The taxpayer must attach to his or her return a fully
completed appraisal summary (Form 8283); and

(iii) The taxpayer must maintain adequate records containing the
information required for contributions of other property as
described above.

 

The donor must also obtain the contemporaneous written
acknowledgement required under §170(f)(8).

In the American Jobs Creation Act of 2004 (AJCA),5 Congress codified
these requirements as §170(f)(11) and provided a reasonable cause
exception for failure to comply with the substantiation
requirements for charitable contributions made after June 3,
2004.

Although the court found numerous technical deficiencies in the
Petitioners' returns, it observed that "we need not decide [those
issues] because we hold that neither the Sanna appraisal nor the
Jones appraisal is a qualified appraisal under section
170(f)(11)."

Qualified Appraisal  

Under the regulations, a qualified appraisal must be made no
more than 60 days before the gift and no later than the due date of
the return, must be signed by a qualified appraiser, must not
involve a prohibited appraisal fee, and must include certain
specific information, as follows:

  •  A description of the property in sufficient detail for a
    person who is not generally familiar with the type of property to
    ascertain that the property that was appraised is the property that
    was (or will be) contributed;
  •   In the case of tangible property, the physical condition
    of the property;
  •  The date (or expected date) of contribution to the
    donee;
  •   The terms of any agreement or understanding entered into
    * * * that relates to the use, sale, or other disposition of the
    property contributed * * *;
  •   The name, address, and * * * the identifying number of
    the qualified appraiser * * *;
  •  The qualifications of the qualified appraiser who signs
    the appraisal, including the appraiser's background, experience,
    education, and membership, if any, in professional appraisal
    associations;
  •  A statement that the appraisal was prepared for income tax
    purposes;
  •  The date (or dates) on which the property was
    appraised;
  •  The appraised fair market value * * * of the property on
    the date (or expected date) of contribution;
  •  The method of valuation used to determine the fair market
    value * * *; and
  •  The specific basis for the valuation * * *.6

 

The court determined that "[b]oth the Sanna appraisal and the
Jones appraisal, individually and collectively, suffer from a
number of material deficiencies."

Sanna Appraisal  

Critically, the Sanna appraisal failed the "timeliness" element
of the appraisal requirements in that it was made in 1999, nearly a
decade before the contribution of Gladstone in 2008. Under the
regulations, a qualified appraisal must be prepared by a qualified
appraiser no earlier than 60 days before the contribution date and
no later than the extended due date of the return first claiming
the deduction. "[A]n appraisal performed outside of the safe harbor
period provided in [applicable Treasury regulations], prima facie
does not reflect the property's value as of the date of
contribution."

Petitioners argued that although the Sanna appraisal was nearly
a decade old at the time of the contribution of the property, it
was relevant to establishing the value of Gladstone as of the date
of contribution because the Jones appraisal was an update of the
Sanna appraisal. The court noted, however, that the regulations
provide that "where a taxpayer relies on more than one appraisal,
each appraisal must independently comply with the qualified
appraisal requirements."

Further, the Sanna appraisal did not employ the market approach
(comparable sales), the asset-based approach (replacement cost), or
the income approach (discounted cash flow) to determine the fair
market value of Gladstone. "Instead, it merely estimated
Gladstone's annual profit potential using a projected income
stream." Because the Sanna appraisal did not employ any of the
three approaches to determine Gladstone's fair market value, it did
not meet the requirements of the regulations.

Jones Appraisal  

The court found the Jones appraisal to be deficient in numerous
respects, the most important of which may be summarized as
follows:

The Jones appraisal was not an appraisal of the contributed
property but was rather an appraisal of a hypothetical, fully
renovated version of the contributed property.

The Jones appraisal did not determine the fair market value of
Gladstone. Regs. §1.170A-1(c)(2) defines fair market value as "the
price at which the property would change hands between a willing
buyer and a willing seller, neither being under any compulsion to
buy or sell and both having reasonable knowledge of relevant
facts." The willing buyer and willing seller are both considered to
be hypothetical rather than actual persons. Instead, Mr. Jones
defined market value as "the highest price estimate in terms of
money which a property Will [sic] bring, if exposed for sale in the
open market, allowing a reasonable time of [sic] Find [sic] a
purchaser who buys with knowledge of all uses of which it is
adapted, and for which it was capable of being used."

The Jones appraisal did not include Mr. Jones' qualifications.
Nor did it include his identifying number - information that would
allow the IRS "to readily ascertain the identity of the appraiser
and whether he is in good standing with the IRS."

The Jones appraisal, like the Sanna appraisal, did not include
the date or expected date of contribution or the terms of the
agreement or understanding that relate to the use, sale, or other
disposition of Gladstone.

The Jones appraisal, like the Sanna appraisal, did not include a
statement that the appraisal was prepared for income tax
purposes.

Finally, the Jones appraisal failed the timeliness test in that
it was performed on April 24, 2008, approximately five months
before the donation of Gladstone on September 29, 2008.

 

Qualified Appraiser Requirements  

A qualified appraiser is an individual who: (1) "has earned an
appraisal designation from a recognized professional appraiser
organization or has otherwise met minimum education and experience
requirements set forth in regulations prescribed by the Secretary";
(2) "regularly performs appraisals for which the individual
receives compensation"; and (3) "meets such other requirements as
may be prescribed by the Secretary in regulations or other
guidance."

Section 170(f)(11)(E)(iii) further provides that "[a]n
individual shall not be treated as a qualified appraiser with
respect to any specific appraisal unless": (1) "the individual
demonstrates verifiable education and experience in valuing the
type of property subject to the appraisal"; and (2) "the individual
has not been prohibited from practicing before the Internal Revenue
Service by the Secretary … at any time during the 3-year period
ending on the date of the appraisal."

The court noted that Messrs. Jones and Sanna both met the
definition of "qualified appraiser. However, in Mr. Sanna's case,
while his qualifications were included as part of his appraisal
report, he did not include on the appraisal summary a declaration
that he holds himself out as an appraiser, that he is so qualified,
that he is not an ineligible individual, and that he understands
the consequences of a fraudulent overvaluation. Mr. Jones neither
included his qualifications on the appraisal report, nor did he
make the required declaration.

Form 8283 (Appraisal Summary)  

Per the court, "Petitioners' appraisal summary omits at least
four categories of information. In addition, petitioners provided
false information in at least four instances. Collectively,
petitioners' appraisal summary suffers from at least eight
deficiencies."

Most importantly, Petitioners misrepresented the basis of the
property and its character. On their Form 8283, Petitioners
reported that Gladstone was acquired in June 2000 and that their
basis was $1,200,000. The record, however, as noted above, showed
that petitioners purchased both Pingree and Gladstone for $353,000
in 1983. Further, since, pursuant to §170(e)(1)(A), the deduction
amount for a charitable contribution of property must be reduced by
the amount of gain which would not have been long-term capital
gain, had the property been sold at its fair market value, and
since Gladstone was "real property used in * * * [a] trade or
business," and not a capital asset, the deductible amount for its
contribution should have been reduced by the amount of ordinary
gain that would have been recognized had Gladstone been sold at its
fair market value.

Moreover, Petitioners misrepresented the physical condition of
the property and its fair market value. Petitioner's claimed value
of $499,000 was supported by neither appraisal. The appraisers'
declarations and the statement of no consideration also were
missing from the Form 8283. Nor was the donation receipt included
as part of Petitioners' tax return.

No Substantial Compliance  

The court rejected Petitioners' claims that they had
"substantially complied" with the qualified appraisal and other
documentation requirements. The court explained that the key
question in substantial-compliance cases is whether "the taxpayers
had provided most of the information required, and the single
defect in furnishing everything required was not significant."7 Moreover, the court
observed, "the substantial compliance doctrine should not be
liberally applied."8

The court found that the Sanna appraisal fails at least two
substantive requirements for a qualified appraisal. First, the
Sanna appraisal was performed in 1999, "far outside the 60-day
period before the contribution required by the regulations."
Second, the Sanna appraisal was not a fair market value appraisal
of Gladstone, "a deficiency that goes to the heart of the qualified
appraisal requirements." As a result of these substantive
deficiencies, the Sanna appraisal does not substantially comply
with the regulations.

The Jones appraisal also failed at least two substantive
requirements. First, Mr. Jones, as noted above, failed to establish
his qualifications. "More importantly, however, the Jones appraisal
appraised the wrong asset-i.e., a hypothetical fully renovated
Gladstone, rather than Gladstone as contributed."

No Reasonable Cause  

Even if a taxpayer does not strictly or substantially comply
with the qualified appraisal and other documentation requirements,
a charitable contribution deduction will not be denied if the
failure to meet those requirements is due to "reasonable cause and
not to willful neglect."9 In general,
reasonable cause requires that the taxpayer have exercised ordinary
business care and prudence as to the challenged item, as where the
taxpayer reasonably relies on the advice of a tax professional.

Petitioners argued that they relied on one Mr. Siegal, the paid
preparer for their 2008 return, regarding the charitable
contribution deduction. "However, petitioners … produced no
reliable evidence of Mr. Siegal's qualifications, no reliable
evidence that they provided Mr. Siegal with complete information,
no reliable evidence of the content of Mr. Siegal's advice, and no
reliable evidence that they reasonably relied on that advice." Nor
did they call Mr. Siegal as a witness.

Conclusion  

The Petitioners in Alli v.
Commissioner
 basically did everything wrong in
attempting to support their deduction. Practitioners would be
advised to take from this case the importance of a qualified
appraisal to support a charitable deduction. Of particular note is
the "timeliness" requirement, which the Tax Court deemed critical.
The Jones appraisal, although made within five months of the
contribution was considered to be insufficient to satisfy the
requirements of the regulations. Perhaps, however, if the
Petitioners had complied more fully with all of the other
requirements of the income tax regulations, the court might have
been willing to overlook this defect. The cumulative effect of the
numerous misstatements and omissions, however, made such an outcome
extremely unlikely.

For more information, in the Tax Management Portfolios, see
Kirschten & Freitag, 863 T.M.
, Charitable Contributions:
Income Tax Aspects,  and in Tax Practice Series, see
¶2395, Charitable Contributions: Substantiation
Requirements.

 


 

  1 In its pretrial memorandum, the IRS stated that
it had no record of BSA's filing a corporate tax return for 2008 or
2009, but indicated that it would treat BSA as an S
corporation.  On Apr. 4, 2007, as part of HUD litigation
proceedings, Petitioners and BSA stipulated that BSA currently
owned and operated the Pingree/Gladstone apartments. 

  2 The renovations contemplated by the Jones
appraisal were never made. 

  3 P.L. 98-369 §155(a), 98th Cong., 2d Sess. (July
18, 1984). 

  4 Reg. §1.170A-13. 

  5 P.L. 108-357, §883(a), 118 Stat. at 1631. 

  6 Regs. § 1.170A-13(c)(3)(ii). 

  7 Citing Hewitt v. Commissioner, 109
T.C. 258, 265 (1997), aff'd without published opinion, 166
F.3d 332 (4th Cir. 1998). See also Scheidelman v.
Commissioner
, 682 F.3d 189, 198-199 (2d Cir. 2012). 

  8 Citing Mohamed v. Commissioner, T.C.
Memo 2012-152 ("[T]he problems of misvalued property are so great
that Congress was quite specific about what the charitably inclined
have to do to defend their deductions[.]" 

  9 § 170(f)(11)(A)(ii)(II).