Failure to Properly Substantiate Charitable Contributions

Most taxpayers are familiar with the benefit of charitable contribution deductions.

When a donation is made to a qualified charity, the gift can be claimed as a tax deduction, as governed by Section 170 of the Internal Revenue Code (and related Regulations) and, thereby, can reduce overall taxable income. However, recent tax rulings have suggested that although taxpayers recognize the significant savings that deductions can offer, they may not be aware of the specific steps that need to be taken in order to comply with Internal Revenue Service (IRS) substantiation requirements and qualify for a deduction on their non-cash contributions.

Recent Tax Rulings

In Mohamed v. Commissioner, a California couple was penalized and denied an $18.5 million deduction for their real estate donations simply because they did not have the appropriate paperwork when they filed their return. IRS denied the deduction because the Mohameds did not have their contribution independently valued by a qualified appraiser, as required by tax law for non-cash property contributions of more than $5,000. Instead, the taxpayers prepared and filed their own tax return, including Form 8283, the form used to report non-cash contributions to charity. Despite the Mohameds' good faith, the Tax Court agreed that the Mohameds failed to meet the Section 170 requirements, upholding IRS’ denial of the deduction. In other words, the Mohameds were denied their $18.5 million deduction for not reading the fine print and appropriately following instructions.

In Rothman et al. v. Commissioner, the Tax Court faced another non-cash donation involving a historic façade easement. There was no question that the easement was placed on the property and then donated to a qualified charity. Why, then, did IRS deny the deduction? The appraisal did not meet the technical requirements of a qualified appraisal. In its detailed opinion, the Tax Court agreed with IRS that this appraisal failed on a number of the detailed qualified appraisal provisions of the regulations.

Do It Right

These recent cases can serve as a reminder that when making non-cash charitable contributions in an amount greater than $5,000, it is vital to obtain a qualified appraisal to meet the requirements to claim a tax deduction and submit the appraisal as part of the tax return. A qualified appraisal, as defined in the regulations, must include certain information including a legal description of the property, the property’s physical condition, the date of the contribution and a statement that the appraisal was prepared for income tax purposes. The document must also describe the method(s) of valuation used to develop the value and the market data considered, among other items. The qualified appraisal must also be prepared by a qualified appraiser.

What is a qualified appraiser? A qualified appraiser, also defined in the regulations, is an individual who has earned an appraisal designation from a recognized professional appraisal organization, or has met the minimum education and experience in valuing the type of property being valued as outlined by IRS.

As evidenced by the two cases above and numerous others, it is critical to get a qualified appraisal from a qualified appraiser to properly support a charitable deduction. Although the taxpayers in the aforementioned cases argued that their compliance with the rules was close enough, IRS and the Tax Court disagreed. The lesson seems clear: the tax law is complex. If the regulations list requirements one must follow to get a deduction, it is much easier to follow the steps from the start than try to challenge the validity of a regulation later.