Slumlord Gets Slammed in Tax Court

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By Steven D. Henry, MAI  

Pluris Valuation Advisors, Newport Beach, CA

In Ali v. Commissioner, T.C. Memo 2014-15, the
petitioners, Dr. Ben Alli and Shaki Alli, made a charitable
donation of an apartment building to Volunteers of America in
September 2008. At the time of the donation, the property was owned
by BSA Corp., an S corporation in which Dr. Alli was the sole
shareholder. The property, a 34-unit building located at 2987
Gladstone in Detroit (Gladstone), was in such poor condition at the
time that it did not meet minimum standards for decent, safe and
sanitary conditions.  The owner had a track record dating back
to the early 1990s of failing to adequately maintain the property
and make necessary repairs. In fact, the property was in such
disrepair that HUD severed their relationship with the petitioners
in 2000 after nearly a decade of issuing citations for deficiencies
in the property. At the time of donation, only six of the units in
the Gladstone Property were occupied.

The petitioners originally purchased the property in 1983 along
with another apartment property located at 2211 Pingree in Detroit
(Pingree) for a total purchase price of $353,000. The petitioners
claimed that the amount of the charitable donation for Gladstone
alone was $499,000 and that the cost basis in the properties at the
time of the donation was $1,200,000.

There were two appraisals performed on the properties during
BSA's ownership. The first was a market rental survey completed by
Anthony Sanna, MAI (Sanna Appraisal) in 1999. The purpose of that
appraisal was for HUD's Section 8 housing program, and the
appraisal did not include an opinion of fair market value.

A second appraisal of the properties was completed by Darvin
Jones in April 2008, about five months prior to the donation of the
Gladstone property (Jones Appraisal). The Jones appraisal was
referred to as an update to the Sanna Appraisal. The value
concluded by Jones for both properties was $1,562,500; the
estimated value of Gladstone was $664,062. The purpose of the
appraisal was to establish the value of the properties "after the
renovation and remodeled [sic] condition." The condition of the
properties per the purpose of the appraisal was assumed to be
"good" and the appraisal assumed that the all necessary repairs had
been made to the property to restore it to a safe and sanitary
condition. Furthermore, the definition of market value used in the
Jones Appraisal was "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 key issues of this case are:

1. Whether the property donated was actually held by the
petitioners;

2. Whether the petitioners were entitled to claim a deduction
for the property as it was held by an S corporation;

3. Whether the requirements for a qualified appraisal were met
by either of the two appraisals that were completed for the
properties; and

4. Whether the lack of compliance should be excused under the
doctrine of substantial compliance.

Ownership and Deduction  

The first two issues before the court in this case were whether
the petitioners actually owned the property, and whether they were
entitled to take a deduction on a contribution of a property held
by an S corporation. The court found that the petitioners failed to
provide sufficient documentation that the Gladstone property was
held individually. Rather, the court found that records were clear
that the property was owned by BSA Corp., an S
corporation. 

On the issue of whether the petitioners were entitled to a
deduction for the contribution in light of the ownership of the
property, the court found that they may be entitled to a
deduction.  S corporations are not generally taxed at the
corporate level. Instead, the corporation's income or loss passes
through to the shareholders and is taxed at the individual level.
The only shareholder in BSA was Dr. Alli. As a result, the court
found that Dr. Alli could be entitled to a charitable donation
deduction assuming all of the requirements for that deduction were
met.

Qualified Appraisals and Appraisers  

The key valuation issue in this case is whether the appraisals
were qualified to serve as a valuation basis for the charitable
donation. According to tax regulations, each report submitted as
support for a charitable donation must meet the requirements for a
qualified appraisal. Both of the reports submitted failed to meet
the criteria for a qualified appraisal.

Sanna Appraisal  

The Sanna Appraisal was completed nearly 10 years prior to the
date of donation, which is far outside the acceptable time frame
cited in the tax regulations. Tax regulations state that an
appraisal used as support be completed no earlier than 60 days
prior to the donation and no later than the extended due date of
the tax return on which the donation is claimed. The second issue
with the Sanna Appraisal is that it failed to report the expected
date of the contribution.

Items missing from the Sanna Appraisal included the terms of the
agreement for the donation and a statement that it was prepared for

income tax purposes. Furthermore, the Sanna Appraisal did not
estimate the fair market value of the Gladstone property. 
Rather, it was a market rental study that did not even include an
opinion of value for the subject property. As a result of the
deficiencies in the Sanna Appraisal, the court found that it was
not a qualified appraisal.

Jones Appraisal  

One of the most glaring deficiencies of the Jones appraisal was
that it was not an appraisal of the donated property.  As
previously noted, the Jones Appraisal included hypothetical
condition that the Gladstone property was renovated, repaired and
in good, rentable condition. The reality is that fewer than 20% of
the units in that property were even suitable for occupancy, let
alone in good condition.  As a result, the court found that
the property appraised in the Jones Appraisal was not the property
donated. This also relates to the second deficiency of the Jones
Appraisal, which is that it failed to adequately describe the
condition of the property "as-contributed." Also, as previously
noted, the Jones Appraisal cited an improper definition of market
value.

The Jones Appraisal failed to include the qualifications of the
appraiser and the identifying number of the appraiser as required
for a qualified appraisal. Other deficiencies in the Jones
Appraisal included failure to disclose the anticipated donation
date, the terms of the donation agreement, and a statement that the
purpose of the appraisal was for income tax purposes. Finally, the
Jones Appraisal was completed about five months prior to the
donation, which is outside the time period allowed by tax
regulations.

Substantial Compliance  

The final issue considered in this case was whether the
appraisals provided constituted substantial compliance with tax
regulations. In some cases, the court will overlook minor omissions
by appraisers and tax preparers if the omission is unintentional or
there is good reason for it. In this case, the court found that not
only did the petitioners omit information necessary to properly
evaluate the validity of the donation, they falsified information,
including the value of the Gladstone property and the cost basis of
the property.

The fact that neither appraisal performed on the property met
the criteria for a qualified appraisal, and the fact that the
petitioners omitted entire categories of required information led
the court to conclude that the petitioners failed to provide
substantial compliance for the donation of the Gladstone
property.

Conclusion  

Neither appraisal came close to providing adequate support for
the value claimed on the charitable donation. The Sanna Appraisal
was grossly outdated and did not even provide an opinion of value.
The hypothetical condition noted in the Jones appraisal paints an
inaccurate and misleading picture of what the property was at the
time of the donation, rendering a value conclusion far higher than
the actual property value. There wasn't necessarily anything wrong
with either appraisal for the purposes for which they were
originally written (the Sanna Appraisal was for HUD Section 8, and
the Jones Appraisal specified that the purpose was to value the
property as-renovated).

The problem in this case lies with the taxpayer trying to rely
on reports completed for purposes other than income tax valuation.
As a result, both reports were missing substantial information
required by tax regulations, and neither report was accepted by the
court as a qualified appraisal. Furthermore, the petitioners
blatantly misrepresented the condition of the property, the
estimated value of the donation and the cost basis of the
property.

In the end, the court ruled in favor of the IRS (respondent).
This case highlights a number of issues relating to both the
valuation and reporting of a charitable donation. Aside from the
obvious importance of clearly, accurately and truthfully reporting
all relevant information when claiming a charitable donation, this
case reinforces the importance of obtaining a qualified appraisal,
performed specifically for income tax purposes and prepared by
qualified appraisers when making charitable donations.

For more information, in the Tax Management Portfolios, see
Kirschten and Freitag, 521 T.M.
, Charitable Contributions:
Income Tax Aspects, Kelley, 830 T.M., Valuation: General
and Real Estate,  and in Tax Practice Series, see ¶2395,
Charitable Contributions: Substantiation Requirements.