Thursday, November 16, 2017

This Charitable Contribution Deduction was a Bit Too Much for the IRS to Allow

William Delaney, EA
Westwood, MA
In March 2002, a partnership paid $2.95 million for a remainder interest in real property.  In August 2003, the partnership assigned (gifted) the remainder interest to a university (charitable contribution).  The assigned value of this transfer, i.e. the charitable contribution deduction, was slightly in excess of $33 million.  Quite a jump in value in an ownership period of approx. 17 months!  Naturally, the IRS was more than a bit curious. 
See RERI Holdings I, LLC, et. al. v. Comm., 149 T.C. 1 (7/3/17).

Now to Form 8283, the back-up for non-cash contributions.  The date and manner of acquisition (by purchase) of the donated property was disclosed, but the space for the donor’s cost was left blank.  Gee, why would you omit that?  Perhaps because of the tenfold difference between cost and claimed fair market value (just a guess on the part of your Editor; the case is silent).  And, what happens if you omit this kind of information?  Well, as it turns out, the Courts have looked at the regulations covering substantiation of charitable contributions and determined that the requirements are directory and not mandatory.  See Reg. 1.170A-13(c)(1)(i).  OK, so the taxpayer is off the hook if he has substantially complied (a “little” omission isn’t fatal)?

Well, as it happens, one of the substantiation requirements in the regulations is that the cost basis must be disclosed.  Reg. 1.170A-13(c)(4)(ii)(E).  So, there it is and the Court opined that “…disclosure of its cost or other basis in the contributed property would have alerted R (the IRS) to a potential overvaluation of that property, omission of that information prevented the Form 8283 from achieving its intended purpose [emphasis added], the omission thus cannot be excused on the grounds of substantial compliance.”

As a result, the entire charitable deduction amount was denied (we all know that this is a simple pass or fail test).  But, that was not all…read on.

The Court determined that the fair market value of the transferred interest was $3,463,886.  That triggered the substantial valuation misstatement (if the claimed value is greater than 150% of the actual value) of Sec. 6662(e)(1)(A) and the 40% of assessed tax penalty of Sec. 6662(h)(2).  And, of course, this dumped the taxpayer into the definition of negligence and intentional disregard – see Sec. 6662(c).

The case covers 41 pages of mostly technical reading about how appraisals are determined and how different appraisers arrive at differing results.  The take on this case is quite simple.  If you intent to selectively omit information from an income tax return, be certain that you know what you are doing.  This “little” omission opened the floodgates for significant tax penalties and, essentially, knocked the taxpayer out of the box regarding an appeal of the IRS determination, since the tax return filing was not substantially complete.  The only reason that the Court computed the fair market value of the gift was to see how many penalty provisions would apply and to calculate the amount(s) of the penalties.  The taxpayer’s deduction was NOT reduced to the Court’s determination of fair market value; the taxpayer’s deduction was reduced to zero.

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