It may sound suspicious, but many CPAs and attorneys argue that it’s a legitimate tax strategy. Five years ago, ESPN commentator Kirk Herbstreit and his wife Allison allowed their home to be burned to the ground. Then they deducted the appraised value -$330,000 - on their income tax return for 2004 as a charitable deduction. After the house was burned and the debris cleaned up, the couple built a new home on the same land. Later the IRS rejected the deduction and set the Herbstreits a bill for $134,606 in back taxes and interest. For the past three years, the legitimacy of their deduction has been debated on taxalmanac.org with CPAs lining up on both sides.
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Here are the details.
Kirk and Allison Herbstreit donated their home at 2321 Onandaga Drive in Upper Arlington, Ohio to the Upper Arlington Fire Department to be used for training purposes. While this may not be a common practice all over the country, it is where the Herbstreits live in Central Ohio. Since 1988, thirty-one homes have been donated and 28 have been burned to the ground. Minnesota and Wisconsin have also seen many homes donated, and the value of the homes has been deducted on the tax returns of the donors.
Upper Arlington Fire Chief Mitch Ross told reporters that the donations are greatly appreciated, since they have no other way to practice in structures that are realistic to the actual fires they fight. Trainees are able to learn new techniques, perform search and rescue drills, and carry out arson detection procedures. Police also use the donated structures to practice hostage rescue.
Before training begins, the donors must remove the roof shingles and any asbestos that is present. And, after the demolition, the homeowners are responsible for the cleanup. With all of this done, the custom has been that the donors can then deduct the fair market value of the home on their tax returns.
Unfortunately for the Herbstreits, in 2004, which was the year of their donation, the IRS began taking a different view of these donations. The tax agency rejected the deduction on the theory that the Herbstreits did not relinquish their entire interest in the donated property to the fire department, therefore, there is no deduction available. IRS spokesman Eric Erickson refused to comment on the particular case, adding, “When you’re talking about charitable-donation deductions, it’s always case by case. Every case is different.”
Earlier the same year, another couple from Upper Arlington - James and Lori Hendrix - also entered into a similar battle with the IRS. In 2004, they donated a home worth $287,400 and claimed a charitable donation deduction. The IRS later rejected their claim, and charged the couple $125,053. Both couples paid the tax bills, and then filed suit against the IRS to get the money back, with the help of Columbus attorney, Terry Grady.
Grady argues that the charitable donation deductions are legitimate because in each case, the amount deducted as a charitable contribution was the entire interest in the house. Both couples used the fair market value of their houses to calculate the deductions, and did not include the value of the land. Grady adds that the contributions of houses like these two serve an important purpose for the government by making possible critical training that otherwise would not be available. And, he says, that purpose is frustrated by a misinterpretation of tax law.
The Hendrixes and the Herbstreits have each built a new home worth in excess of one million dollars, on their respective properties. Grady has filed a motion to dismiss the Herbstreit case because of its similarity to the Hendrix case. If the Hendrixes prevail, he says, that verdict will affect the Herbstreit’s case with the IRS.
Meanwhile, the debate among CPAS goes on. What do you think?