Tax Court Denies Deduction for Household Donation

Can you take a charitable deduction when you donate remnants of a house you are deconstructing? It’s a novel approach, but this technique includes a number of potential pitfalls.

Mar 4th 2021
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In a new Tax Court case, Mann, CA-4, No. 19-1793, 1/6/21, taxpayers are often tripped up by requirements for charitable contributions under state law.

Key facts: A couple purchased a home in Bethesda, Md. that they intended to renovate. However, after discovering water issues in the basement and learning from their architect the high cost of desired changes to the house’s layout, they decided to tear down the existing house and build a new one in its place.

Accordingly, the couple hired a building contractor to demolish the existing house, clear the site and build a new house. Other builders recommended that they work with a nonprofit charitable organization offering deconstruction services. The idea was to generate a charitable deduction for the taxpayers.

To this end, the couple reached an agreement with the organization to donate the existing house in its entirety, but not the underlying land.

On their 2011 tax return, the taxpayers claimed a charitable deduction of $675,000, representing an independent party’s appraised value of the house as if it were moved intact to another lot. The charity disassembled some of the house, salvaged useful components and left the remainder for demolition by the couple’s contractor.

But the IRS disallowed the deduction on the ground that the couple didn’t convey their entire interest in the house, as required by law, and that they failed to provide an accurate appraisal of what was actually donated. The IRS also rejected an effort to amend the claimed deduction to $313,353 for settlement purposes based on an alternative appraisal of the house’s value.

Notably, even though the couple sought to convey an undivided interest to the organization via private contract, they never recorded their transaction in accordance with Maryland law. Moreover, the house wasn't properly severed from underlying property and ownership wasn't transferred to the organization. Thus, the district court characterized this as being more in the nature of license to organization and not a valid transfer of an entire interest in real property.

After the district court sided with the IRS, the couple appealed to the Fourth Circuit Court.

Tax outcome: The Fourth Circuit has now affirmed the lower court’s ruling. It determined that the couple wasn’t entitled to a charitable deduction for the value of the house because they had not donated their entire interest in the property under Maryland law.

In addition, considered practically, the couple didn’t donate all the components of the house itself, since some were destroyed and some were retained for demolition. Finally, the alternative appraisal of $313,353, which valued all of the house’s components, overstated the value of their donation.

Conclusion: Be forewarned that the IRS has dug in its heels on these types of charitable deductions. Count on facing an uphill climb for a similar agreement.

 

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