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Last month gave us another building material reuse charitable deduction case. The Fourth Circuit sustained a district court decision that entirely denied any charitable deduction to Lawrence and Linda Mann for material from the tear-down of a Bethesda, Maryland house that went to Second Chance a not-for-profit organization. In January 2020, the Tax Court had denied any deduction to Chad and Dana Loube for the material donated to Second Chance from the tear-down of their Potomac, Maryland home.
Appraisal Standard
Both these decisions remind me a lot of what the IRS is doing with syndicated conservation easements. There are serious valuation problems, but the IRS ends going after the deduction on technical grounds. The Manns had taken the position that they had donated the whole house to Second Chance, which would have required the transaction to be recorded in the county land records. That theory had supported a $675,000 appraisal. They had a fallback appraisal of $313,353 that was based on all the material making up the house regardless of whether it was actually salvaged.
According to the district court decision the correct value would have been based on the resale value of the specific building materials that crossed the threshold of the Second Chance warehouse. Mike Gable of Build Reuse has outlined some best practices in a piece I published on Your Tax Matters Partner. The final step in his outline is a “complete inventory” that encompasses what the nonprofit takes possession of. That is what the basis for the appraisal should be.
Industry Reaction
The other thing that the material reuse industry has in common with the conservation easement is an idealistic element. Reuse takes pressure off landfills and it saves much of the energy embedded in the salvaged material. This leads to participation by earnest people who want to do things right and don’t want the purity of the industry besmirched by bad actors.
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They are similar in that regard to members of the Land Trust Alliance who want to protect the charitable benefit of conservation easement deductions from being compromised by abuse. I heard from members of the National Organization of Reuse Appraisers (NORA) who are pleased that the IRS is finally cracking down on abusive appraisals.
They note that the decision provides case law. They note that it was not a matter or lack of qualification but rather violations of the Uniform Standards of Professional Appraisal Practice (USPAP). They believe that the IRS should take action to disqualify appraisers who repeatedly violate USPAP overvaluing deductions and creating tax underpayments.
Steps that they recommend to avoid large disallowances are making sure that the appraiser will be valuing what actually goes to the not for profit and that the appraiser is properly qualified to perform the appraisal. The recipient not-for profit is responsible for providing the final inventory, but it is good practice for donors to keep their own records and photographs.
If you are donating a “whole house” the house will be relocated off your property. Otherwise you are donating pieces of the house. Material destroyed in the deconstruction is not part of what you get credit for in valuing your deduction.
Jessica Marschall CPA of The Green Mission discusses the importance of the precedent in a social media post here.
Practical Takeaway
Two court decisions are not enough to squash an attractive theory that purports a charitable deduction for much more than the charity actually receives. Taxpayers who take that sort of position, however, would be well advised to make sure that they have a solid inventory, including photographs, of what actually ended up going to the reuse charity to fall back on a reasonable deduction in the event of challenge. That might have eased the pain the Manns are feeling now just a bit.
And those who want to do things right now have clear precedents to support them. I doubt that the IRS is going to devote the sort of resources that have gone into fighting syndicated conservation easements in this area, but a bit more caution might be called for. Remember Reilly’s Eleventh Law of Tax Planning – Pigs get fed. Hogs get slaughtered.
Other Coverage
Joshua Sage has Deconstruction House-Only Charitable Deduction Fails to Be an Entire Interest on ESA Law.
While such may seem unfair, Section 170 and the regulations issued under Section 170 provide some very specific rules for deductibility of donations. Primary among these rules are qualification and substantiation. On both grounds the Manns lost on their appeal.
Theresa Schliep has 4th Circ. Affirms Nixing Couple’s Home Donation Deduction behind the Law360 paywall.
Jeffrey Leon has Partial House Donation Misses Out On Charitable Tax Break on Bloomberg Law.