In a recently issued Tax Court Memorandum decision written by Judge Holmes the taxpayers were denied charitable deductions for millions of dollars in value of real property which they contributed by donation in 2003 and 2004 for the benefit of three charities as remaindermen of a charitable remainder unitrust. The taxpayers were denied any deduction on the basis that they failed to meet the substantiation and qualified appraiser requirements under the regulations to §170(a) with respect to each contribution of property made during such years. 

Charitable Contribution Deductions for Transfers of Property to Charitable Trusts

Section 170 allows an individual or other taxpayer to claim a charitable contribution deduction for a contribution or gift made “to or for the use of” a charitable or educational organization for the fair market value of the property gifted subject to applicable limitations.  For donations to a qualifying charitable remainder unitrust or CRUT. See §§ 170(f)(2)(A), 2055(e)(2), 2522(c)(2).  

For federal income tax purposes,  a taxpayer can claim an immediate deduction for a portion of the value of property settled in a split-interest trust, with respect to the value of the portion irrevocably contributed to the trust for the charity's benefit. Under a charitable remainder annuity trust or CRAT, the annual distribution must be a sum certain that is not less than 5% or more than 50%of the initial net fair market value of the property placed in trust. § 664(d)(2)(A). Under a charitable remainder unitrust or CRUT, the required distribution must be a fixed percentage, not less than 5% or more than 50%t, of the net fair market value of the trust assets, valued annually. A second type of CRUT, an “income only” unitrust,  limits the annual payout to the trust's income for the year but may provide for a shortfall for any year to be made up from excess income in later years. §664(d)(3). For donations to a qualifying CRUT, a taxpayer can claim an immediate deduction for a portion of the value of property settled in a trust, the income of which goes to the donor for life or for a term not to exceed 20 years with the remainder to charity.

Substantiation Requirements; Qualified Apraiser Rules

In 2003 and 2004, when the donations at issue were made, the regulations imposed strict requirements for substantiating charitable deductions greater than $5,000. Under Treas. Reg. § 1.170A-13(c)(2), the donor had to: (i) obtain a qualified appraisal (see below) for the property contributed; (ii) attach a fully completed appraisal summary to the tax return on which the deduction was claimed; and (iii) maintain records relating to the claimed deduction. The qualified appraisal had to be made no more than 60 days before the date of the transfer by gift and no later than the due date of the return, had to be signed by a qualified appraiser, had to include specific information (e.g., description of the property), and couldn't involve a prohibited fee. The appraiser couldn't be the donor, the taxpayer claiming the deduction, or the donee of the property. Treas. Reg. § 1.170A-13(c)(5)(iv). (emphasis added)

The Mohamed’s Charitable Donations of Real Property to a CRUT

Mr. Mohamed, the Petitioner,  is a real-estate broker and appraiser who lives in Sacramento, California. In 1998, he and his wife formed a charitable remainder unitrust or CRUT, which allowed the taxpayers to claim an immediate deduction under §170 for a portion of the value of the property transferred to the CRUT for the value of the remainder interest passing to charity. The donors reserved an unitrust payout (fraction of FMV) to be made each year for up to 20 years. The charitable remaindermen were the Shriners Hospitals for Children, the Sacramento Food Bank & Family Services, and the Pacific Legal Foundation.

Five years later in 2003 (and 2004) the couple donated five properties worth millions of dollars to the CRUT which were in the Sacramento area. Mr. Mohamed  filled out the 2003 tax return himself, including the Form 8283, Noncash Charitable Contributions. At trial, he admitted he did not read the instructions before completing the form which requires specific information about the donated property a in this instance, copy of a complete and signed appraisal.The instruction form related to contributions of art and not real estate.

The taxpayer, reporting the donations of the 5 parcels used his own appraisal for the properties which he claimed had an aggregate value of $14,873,921. He didn't report his basis, but stated that he had bought all the properties in the 1970s and 1980s. The contribution deductions claimed on the 2003 return for the real property was approximately $3.67M. He left blank the Declaration of Appraiser because it stated, “I declare that I am not the donor, the donee, a party to the transaction,” and Joseph recognized that he was the donor (and the donee, since he was trustee of the Trust). But he did sign the Donee Acknowledgment saying that the Trust was a qualified organization under section 170(c) (governing which organizations qualify as charities) and that the Trust had actually received the claimed donations.  He provided the addresses of the properties transferred and detailed descriptions of their value. Mr. Mohammed signed the return schedule indicating that he was the “Real Estate Broker/Appriaser”. He was conscious of not overvaluing the property donated.

In 2004 the Mohameds donated a shopping center near Sacramento to the CRUT and Joseph Mohammed again  filled out the 2004 return and once more acknowledge he did not read the instructions to Form 8283 (charitable donations). On his 2004 Form 8283, Joseph wrote the address of the shopping mall and valued it at $2 million. He wrote “statement attached” in the boxes marked “Date acquired by donor” and “How acquired by donor,” but left blank the box where he should have written his basis. He claimed a $488,040 deduction for 2004. He again didn't sign the declaration, but did sign the donee acknowledgment on behalf of the Trust. Other information was provided but the taxpayer’s statement gave no specific appraisal information, and he did not sign it.

Mr. Mohamed prepared another statement for the shopping center that looked much like the one he attached to his 2003 return. This one listed the income and expenses from the shopping center and used a 6.5% “cap rate” to compute a market value of $2,642,190.62. Joseph signed this statement, but listed his job title as “Owner and Licensed Real Estate Broker.” Joseph says he attached this to his 2004 tax return, but the Commissioner says he didn't get it until sometime in 2006 after the audit.

IRS Audit and Challenge to the Reported Charitable Contribution Deductions

Commencing an audit for the 2003 return two years later, the Service was critical of the taxpayer’s self-appraisal of valuable real estate for which sizeable charitable contribution deductions were claimed. In response, the taxpayers hired an independent appraiser for valuing the contributed real estate. The Court noted that the independent appraisals were similar, but not identical, in value  to values reported by the taxpayers. 

Regardless of the relative consistency of the appraisals between the independent appraiser and Mr. Mohammed’s “opinions”, the Service believe the Mohameds still overstated the values of the properties. In addition, the Service argued that the taxpayers had made several mistakes in filing their charitable deduction disclosures (Forms 8283) for 2003 and 2004, and amended the answer to the Petition to disallow the Mohameds any charitable deduction and moved for partial summary judgment under T.C. Rule 121(b). See Fla. Country Clubs, Inc. v. Comm’r, 122 T.C. 73, 76 (2004), aff’d, 404 F.3d, 1291 (11th Cir. 2005). 

Tax Court Agrees With Commissioner and Grants Respondent IRS’ Motions For Partial Summary Judgment

In starting, Judge Holmes noted the extensive substantiation requirements for charitable contribution deductions in excess of $5,000 contained in Treas. Reg. §1.170A-13(c). See also §170(a)(1). In Treas. Reg. §1.170A-13(c)(2)(i) there are, in general, three specific substantiation requirements: (a) submission of a “qualified appraisal” for the property contributed; (b) attach an appraisal summary on the tax return on which the deduction for the contribution is first reported or claimed; and (b) maintain required records set forth in Tres. Reg. §1.170A-13(b)(2)(ii).

On the first requirement of a “qualified appraisal”, it must be made no more than 60 days before the gift and no later than the due date of the return, must be signed by a qualified appraiser, must include specific information (such as a description of the property and certain disclosures by the appraiser), and must not involve a prohibited fee. Treas. Reg. §1.170A- 13(c)(3)(i). Quite important to this case is that the donor or taxpayer claiming the deduction or the donee of the property cannot be the “qualified appraiser”. Treas. Reg. §§1.170A-13(c)(5)(iv)(A), (C). It is unequivocally clear in this case that the donor-taxpayer was not eligible to be the qualified appraiser. He was also ineligible as trustee of the CRUT. Moreover, for the same and added reasons,  the information as to the value for the various properties did not meet the requirements of an “appraisal summary”.Treas. Reg. §1.170A-13(c)(4). Thus, material information concerning the contributions, as required by the regulations was lacking. The taxpayer did not follow the regulations, i.e., "[H]is appraisals weren't qualified because he did them himself, his attached statements weren't appraisal summaries, and his untimely independent appraisals came too late to be either qualified appraisals or remedial appraisal summaries. This means the Commissioner has to win unless we hold that the regulations are invalid, or unless we find that Joseph [Mohamed]  has raised a genuine dispute that he substantially complied with the regulations, or we find some legal merit in the peculiar problems that he points to in the appraisal form itself.”

The Court found the substantiation and qualified appraiser rules contained in the regulations where valid. Indeed, under §170(a)(1), “A charitable contribution shall be allowable as a deduction only if verified under regulations prescribed by the Secretary”. See also Deficit Reduction Act of 1984, P.L. 98-369, §155. This express delegation of authority to the Treasury and the Service to create rules by regulation  about how a donation is to be verified is entitled to great deference. See Chevron, U.S.A., Inc. v. Natural Res. Def. Council, 467 U.S. 837, 843-44 (1984); Mayo Found. for Med. Educ. & Research v. United States, 131 S. Ct. 704, 714 (2011). The requirements violated here were found by the Court are not “are arbitrary, capricious, or manifestly contrary to the statute.”

The taxpayers argued further that even if the regulation is valid, and granted they did not strictly comply with the regulation, they should be granted the charitable deductions since they were in substantial compliance” citing Bond v. Comm’r, 100 T.C. 32 (1993). But the Court noted that the “substantial compliance” argument under this regulation had, in more recent cases, been rejected by the Court. Todd v. Comm’r, 118 T.C. 334, 336, 347 (2002); Hewitt, 109 T.C. at 260, 264; Jorgenson v. Comm’r, T.C. Memo. 2000-38; Smith v. Comm’r, T.C. Memo. 2007-368, aff'd, 104 AFTR 2d 2009-7830 (9th Cir. 2009).  The Court ruled that based on §170(a)(1), as amplified by DEFRA §155, as well as the case law, substantial compliance requires a qualified appraisal. The Court then proceeded to look at the reporting of the values for each of the gifted properties and found that each was defective from a compliance standpoint. The Court then ruled that the government’s motions for summary judgment were granted and the charitable contributions disallowed in full for 2003 or 2004. The Court was, should we say, “sympathetically, unsympathetic” as to the taxpayers’ loss when it closed by stating:

“We recognize that this result is harsh—a complete denial of charitable deductions to a couple that did not overvalue, and may well have undervalued ,their contributions—all reported on forms that even to the Court's eyes seemed likely to mislead someone who didn't read the instructions. But the problems of misvalued property are so great that Congress was quite specific about what the charitably inclined have to do to defend their deductions, and we cannot in a single sympathetic case undermine those rules. “