Conrad Teitell ()
First an overview; then the Tax Court case. Some commentators have focused on a $33 million charitable deduction being completely disallowed because the donor failed to state the contributed property’s cost on Form 8283. Turns out that the Tax Court found the gift’s value was only $3.5 million, but still no allowable deduction.
Question: If the charitable deduction was fully disallowed, why are page after page of a 69-page opinion devoted to determining the gift property’s fair market value?
Answer: Penalties are imposed for valuation overstatements—depending on how egregious, either 20 percent or 40 percent (on the difference between a claimed charitable deduction and the fair market value determined by the court). More about the penalty rules at the end of this article.
Omission of the gift’s cost on the Form 8283 could have been an oversight. Yet, a cynic might say that the taxpayer’s cost of $2.9 million with a claimed fair market value of $33 million for the charitable deduction would have gotten the IRS wondering. Oh, did I mention that the university receiving the gift sold it two years later for $1.94 million.
Although the amount received on a subsequent sale of gift property shortly after the date of a gift isn’t conclusive of fair market value, it’s darn persuasive.1
The result of all this:
• Donor didn’t get a $33 million charitable deduction that would have saved $13.2 million in taxes.
• Donor was assessed a 40 percent gross overvaluation penalty on $29.5 million (difference between the $33 million claimed value and the $3.5 million FMV determined by the Tax Court).
• Due to IRS $11.8 million ($29.5 million x 40 percent).
The Tax Court Case
What happened: Partnership (Donor) paid $2.95 million in March 2002 for a remainder interest in real property. The agreement creating the remainder interest had covenants intended to preserve the property’s value, but limited the remedy available to the remainder interest’s holder for a breach of those covenants to immediate possession of the property. In no event, however, would the holder of the property’s retained term interest be liable for damages to the holder of the remainder interest.
In August 2003, Donor gave the remainder interest to University. Donor claimed a $33,019,000 charitable deduction. The Form 8283, Noncash Charitable Contributions, that Donor attached to its return gave the date and manner of its acquisition of the contributed remainder interest, but left blank the space for the Donor’s “cost or other adjusted basis.” Donor’s omission of this information didn’t satisfy the substantiation requirement of Reg. §1.170A-13(c)(4)(ii)(E). Because Donor’s disclosure of its cost or other adjusted basis in the contributed property would have alerted the IRS to a potential overvaluation of the gift property, its omission, said the court, prevented the Form 8283 from achieving its intended purpose. The omission thus wasn’t excused on the ground of “substantial” compliance.
Interesting fact: University agreed that it wouldn’t sell the gift property before two years. At the time of the gift, charities were required to notify IRS on Form 8282 of a sale within two years of the gift and the amount it received. Under current law, Form 8282 must be filed for sales within three years of the gift. (I’ve dubbed this the “tattletale rule.”)
Tax Court holding: Donor’s failure to comply, either strictly or substantially, with the requirements of Reg. §1.170A-13(c)(2) results in denial of its claimed charitable deduction.
Although the charitable deduction was disallowed, the value of the remainder interest had to be determined to compute the overvaluation penalty. Because of the limitation on remedies available to the holder of the remainder interest for breaches of protective covenants, the agreement creating that interest didn’t provide adequate protection to its holder. Thus for purposes of Reg. §1.7520-3(b)(2)(iii), the standard actuarial factors under IRC §7520 didn’t apply in valuing the remainder interest. Instead, the value of that interest is its “actual fair market value,” determined without regard to IRC §7520, on the basis of all the facts and circumstances (basically, what a willing buyer would pay a willing seller, etc.).
Tax Court determines property’s fair market value. The remainder interest that Donor gave to University in August 2003 had a $3,462,886 fair market value.
Because the claimed $33,019,000 value of the property contributed to University is more than 400 percent of that interest’s actual fair market value, Donor’s claimed charitable contribution deduction results in a gross valuation misstatement. IRC §6662(e)(1)(A), (h)(2).
RERI Holdings I, 149 T.C. No. 1
Will this case be appealed? If it is, Donor would likely argue:
• It “substantially” complied with the rules—omission of the property’s cost basis is not relevant to determining fair market value.
• The property is worth more than the $3.5 million determined by the Tax Court. If a charitable deduction is allowable, it should get a charitable deduction for more than the value determined by the Tax Court. Note: Appeals courts don’t hesitate to overturn lower courts on legal issues. But infrequently do so on issues of fact—such as fair market value.
• Whether or not a deduction is allowable, the property is worth more than the amount determined by the Tax Court. An increase in the property’s valuation would reduce the amount subject to the overvaluation penalty. Again, the appellate court would have to overturn a fact determination by the Tax Court.
Antepenultimate comment: Cases like this are harmful to philanthropy. They give strong argument that a fair market value deduction for appreciated property gifts should be allowable only for marketable securities.
Penultimate comment: The IRS-was-not-born-yesterday doctrine trumps the substantial-compliance argument.
Final comments: Not saying that it applies here: In egregious cases, the IRS has another penalty in its arsenal—the taxpayer’s spending time in a federal gated community.
Is there a bombshell in this tax shelter? If a donee-charity is restricted from selling a gift for a period of time, perhaps it isn’t an outright but some other type of gift; a defective split-interest gift not qualifying for the unlimited or any gift tax charitable deduction. So would the $33 million value placed on the gift by the donor be subject to the 40 percent gift tax (plus penalties)? (Ah, shucks Commissioner, the gift subject to the gift tax ain’t worth the $33 million claimed as an income tax charitable deduction). What is my authority for the taxpayer getting a double whammy? It’s the hoist-by-one’s-own petard rule.
Penalties for Overstatements
Accuracy-related penalties are imposed on a taxpayer for substantial or gross valuation misstatements relating to an underpayment of income taxes.
Substantial valuation misstatement. A penalty of 20 percent is imposed. IRC §6662(e). A substantial valuation misstatement occurs when the claimed value of any property is 150 percent or more of the amount determined to be the correct value. IRC §6662(e)(1)(A).
Gross valuation misstatement. A penalty of 40 percent is imposed. IRC §6662(h). A gross valuation misstatement occurs when the claimed value of any property is 200 percent or more of the amount determined to be the correct value. IRC §6662(h)(2)(A).
Regarding charitable deduction property, a reasonable cause exception doesn’t apply to a substantial valuation misstatement unless the claimed value of the property is based on a qualified appraisal made by a qualified appraiser and the taxpayer made a good faith investigation of the value of the contributed property. IRC § 6664(c).
1. The donor in Philip Kaplan, 43 TC 663 (1965) acq. 1965-2 CB 5, gave 57 items of art, used clothing and household furnishings to a hospital and claimed a $5,550 charitable deduction, based on an appraisal. Several months later, the items were sold at auction for $459. The Tax Court—calling the appraisal a sham—found that the fair market value of the auctioned items was $459.
Personal property was donated to the same hospital in Rivkin, TC Memo 1965-99. The property was appraised by donor’s expert at $13,735. The Tax Court allowed a charitable deduction of only $954—based on a subsequent auction sale price.
In McGuire, 44 TC 801 (1965) acq. 1966-1 CB 2, gifts of household furniture and furs were donated over a period of three years—again to the same hospital. The donor claimed charitable deductions of $62,073, the appraised value of the gifts. IRS reduced the deduction to $6,619, the amount actually received at auction sales.
However, the Tax Court allowed a deduction of $15,200. Here, the court (over the objections of four dissenting judges) did not find the subsequent sale price conclusive. Other factors—the value of the property to the donor, an expert’s opinion on the property’s retail sales value and the cost to the donor of replacing the property—were considered in determining the value of the gifts.
See also Royster, TC Memo 1985-258.