The tax law imposes stringent requirements for deducting charitable gifts of property. These rules are especially tough when you donate appreciated property. If you do not observe all the rules, your deduction may be reduced, or even eliminated. One recent Tax Court case dramatically illustrates this point. The taxpayer donated property worth tens of millions of dollars — which the IRS readily acknowledged — yet his final deduction was zero because he failed to obtain an independent appraisal!
Basic Rules for Gifts of Property
If you donate property to a qualified charitable organization that would have qualified for long-term capital gain if you had sold it rather than donating it — in other words, you’ve owned the property for more than one year — you’re allowed to deduct an amount equal to the property’s fair market value (FMV). Conversely, if you’ve held the property for a year or less, the deduction is limited to your basis (generally, your original cost of the property).
This provides a unique planning opportunity for some taxpayers. Notably, you can contribute property like real estate or securities that has significantly appreciated in value and then claim a large deduction based on the FMV. The appreciation in value in the property remains untaxed forever.
Generally, your current charitable deduction for appreciated property can reach up to 30 percent of your adjusted gross income (AGI). There is an overall limit of 50 percent of AGI for all charitable deductions. Any remainder above these limits may be carried over for up to five years.
However, the tax law imposes several other special requirements when you give property to charity. For instance, if you donate property that is not used to further the charity’s tax-exempt function, your deduction is limited to your basis in the property. In addition, the IRS requires a written description of property valued at more than $500. And, if you claim a deduction exceeding $5,000 for donated property, you must obtain an independent written appraisal. That was the taxpayer’s undoing in the new case.
Facts of the Case
Joseph Mohamed was a real estate broker and entrepreneur in Sacramento, California. He was also a certified real estate appraiser. Along with his wife, he set up a charitable remainder trust (CRT). Over a two-year period in 2004 and 2005, the couple contributed five properties and a shopping center to the CRT.
Mohamed 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 never read the accompanying instructions to the form. Instead, he thought a self-appraisal would suffice.
Besides failing to obtain an independent appraisal, Mohamed omitted information required on Form 8283, such as the basis of the properties he had donated to the CRT. For four of the five donated real estate properties, he claimed a combined FMV of slightly more than $1 million. He claimed a FMV of $14.8 million for the fifth property, which he said that he undervalued because he didn’t want to risk an inflated deduction. For the shopping center, he used a FMV of $2 million. Mohamed also left the “Declaration of Appraiser” on Form 8283 blank.
Because of the AGI parameters for charitable contributions (see above), the couple’s deduction for 2003 was limited to $3.8 million. They carried over the excess deduction.
After the IRS audited Mohamed and questioned the self-appraisals, he hired independent appraisers to do the job right. Their appraisals resulted in FMVs similar to the ones established by Mohamed. Furthermore, subsequent sales by the CRT provided prices close to the values used by Mohamed. But the IRS continued to object that the values were excessive, so the taxpayer appealed the case to the Tax Court.
This is where the IRS laid down the law. It disallowed any deduction because Mohamed failed to obtain a written independent appraisal and omitted other required information. The Tax Court spoke sympathetically about the situation and even opined that Mohamed had probably undervalued the donations. What’s more, it acknowledged that Form 8283 could be misleading. But the rules are the rules: The independent appraisals obtained by Mohamed while he was being audited came too little, too late. Despite the harsh outcome, the Tax Court sided with the IRS and denied Mohamed any deduction. (Mohamed, TC Memo 2012-83)
Lessons to Be Learned
The stakes in this area 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 appraisal is needed for a gift valued at more than $5,000. We can provide the necessary assistance to ensure that you walk away with top-dollar deductions for your charitable gifts of property.
The IRS conceded that Mohamed donated properties worth millions, yet he could not deduct a single penny. Don’t let this happen to you!