The tax law imposes stringent requirements for deducting charitable gifts of property. The rules are especially tough when donating appreciated property. If you don’t observe all of them, your tax deduction might be reduced or even eliminated.
The U.S. Tax Court case Mohamed v. Commissioner 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’d failed to obtain an independent appraisal.
When you donate property that would have qualified for long-term capital gains treatment if you’d sold it rather than donating it — in other words, you’ve owned the property for more than one year — you’re generally 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 tax planning opportunity for some taxpayers. Notably, you can contribute property that has significantly appreciated in value, such as real estate or securities, 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% of your adjusted gross income (AGI). There is an overall limit of 50% of AGI for all charitable deductions. Any remainder above these limits may be carried forward for up to five years.
However, the tax law imposes several other requirements when you give property to charity. For instance, if you donate tangible personal property that isn’t 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 ($10,000 for closely held stock), you must obtain an independent written appraisal. That was the taxpayer’s undoing in Mohamed.
The taxpayer was a real estate broker, certified real estate appraiser and entrepreneur. He and his wife 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.
The taxpayer 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’d never read the accompanying instructions to the form. Due to this oversight, he thought a self-appraisal would suffice.
Besides failing to obtain an independent appraisal, the taxpayer 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 an FMV of $14.8 million for the fifth property, which he said he undervalued because he didn’t want to risk an inflated deduction. For the shopping center, he used an FMV of $2 million. The taxpayer also left the “Declaration of Appraiser” section on Form 8283 blank.
After the IRS audited the taxpayer and questioned the self-appraisals, he hired independent appraisers to value the properties. Their appraisals resulted in FMVs similar to the ones the taxpayer had claimed. Furthermore, subsequent sales by the CRT provided prices close to the values he’d used. But the IRS continued to object that the values were excessive, so the taxpayer appealed the case to the Tax Court.
The Tax Court spoke sympathetically about the situation and even opined that the taxpayer had probably undervalued the donations. What’s more, it acknowledged that Form 8283 could be misleading. But the Tax Court still disallowed any deduction because the rules are the rules and the taxpayer failed to follow them: He didn’t obtain any written independent appraisals (those he obtained while being audited were too late) and he omitted other required information from Form 8283.
When you donate property to charity, the stakes 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.
When it comes to charitable gifts of property, it can be cumbersome to follow the stringent rules to claim deductions. Contact our Individual Tax Planning experts for assistance with maximizing your deductions without running into trouble with the IRS.
