Valuation Methods

As this case demonstrates, however, knowing that one must account for a condition in a valuation opens up a second tier of questions about exactly how to do so. The Tax Court weighed conflicting evidence on valuation and rejected the taxpayers’ evidence claiming that the donated house had a value of $76,000. The Tax Court found instead that the condition requiring destruction of the house meant that the donated property had essentially no value. 135 T.C. at 494. The Tax Court did not err.

In this case there is no evidence of an actual market for, and thus no real or hypothetical willing buyers of, doomed houses as firefighter training sites. ... Sometimes fire departments ... conduct exercises using donated or abandoned property, but there is also no record evidence of any fire departments paying for such property. Without comparators from any established markets, the parties presented competing experts who advocated different valuation methods. The taxpayers relied on the conventional real estate market, as if they had given the fire department fee ownership of the house. The IRS relied on the salvage market and the market for relocated houses, attempting to account for the conditions proposed in the gift.

The taxpayers’ expert witness is a residential appraiser. ... The taxpayers argued that the “before-and-after” method should be applied. Their appraiser started with an estimated value of $675,000 for the land and house together, based on comparisons to recent sales of similar properties in the area. Using the same method, he estimated a value of $599,000 for the land alone, without any house on it. He subtracted the latter from the former to estimate $76,000 as the value of the house alone.

The before-and-after approach is used most often to value conservation easements, where it is hard to put a value on the donated conservation use. Experts can estimate both the value of land without the encumbrance and the value of the land if sold with the specified use limitations, using the difference to estimate the value of the limitations imposed by the donor. As we explain below, there are significant differences between the Rolfs’ donation and a conservation easement. While this approach might superficially seem like a reasonable way to back into an answer for the house’s value apart from the underlying land, the before-and-after method cannot properly account for the conditions placed on the recipient with a gift of this type. The Tax Court properly rejected use of the before-and-after method for valuing a donation of property on the condition that the property be destroyed.

... The IRS asserted that a comparable market could be sales of houses, perhaps historically or architecturally important structures, where the buyer intends to have the house moved to her own land. Witness Robert George is a professional house mover who has experience throughout Wisconsin lifting houses from their foundations and transporting them to new locations. He concluded that it would cost at least $100,000 to move the Rolfs’ house off of their property. Even more important, he opined that no one would have paid the owners more than nominal consideration to have moved this house. In his expert opinion, the land in the surrounding area was too valuable to warrant moving such a modest house to a lot in the neighborhood. George also opined that the salvage value of the component materials of the house was minimal and would be offset by the labor cost of hauling them away. ... Based on this testimony, the IRS argued that since the house would have had negligible value if sold under the condition that it be separated from the land and moved away, the house must also have had negligible value if sold under the condition that it be burned down.

The Tax Court found that the parties to the donation understood that the house must be promptly burned down, and the court credited testimony by the fire chief that he knew the house could be put to no other use by the department. The court rejected the taxpayers’ before-and-after method as an inaccurate measure of the value of the house “as donated” to the department. The taxpayers’ method measured the value of a house that remained a house, on the land, and available for residential use. The conditions of the donation, however, required that the house be severed from the land and destroyed. The Tax Court, accepting the testimony of the IRS experts, concluded that a house severed from the land had no substantial value, either for moving off-site or for salvage. Moving and salvage were analogous situations that the court found to be reasonable approximations of the actual scenario. We agree with these conclusions, which follow the Cooley principle by taking into account the economic effect of the main condition that the taxpayers put on their donation. The Tax Court correctly required, as a matter of law, that the valuation must incorporate any reduction in market value resulting from a restriction on the gift. We review the Tax Court’s findings of fact for clear error and its conclusions of law de novo. Freda v. Comm’r of Internal Revenue, 656 F.3d 570, 573 (7th Cir. 2011). We find no clear error in the factual findings and conclude further that it would have been an error of law to ascribe any weight to the taxpayers’ before-and-after valuation evidence.

....

... The taxpayers here gave away only the right to come onto their property and demolish their house, a service for which they otherwise would have paid a substantial sum. ... The demolition condition placed on the donation of the house reduced the fair market value of the house to a negligible amount, well enough approximated by its negligible salvage value.

The authorities the taxpayers cite to support the before-and-after valuation method relate to conservation easements and other restrictive covenants, but the features of this donation are quite different from such an easement. When an easement is granted, part of the landowners’ rights are carved out and transferred to the recipient. For example, the Forest Service might be given the right to manage undeveloped land, or a conservation trust might be given the right to control disposition of property. Because it can be difficult to measure the value of this sort of right in isolation, experts instead estimate the difference in sale price for property with and without similar encumbrances. Here, in contrast, the initial value of the home can be estimated with the before-and-after method, but the donation destroyed that residential value rather than transferred it.

That’s why conservation easements provide a poor model for the situation here, and other possible valuation models suffer from a lack of supporting evidence. The value of the training exercises to the fire department is not in evidence. The fire chief testified in the Tax Court that he could not assign a specific value to the significant public benefit of the training—but in any event, we know from American Bar Endowment that trying to measure the benefit to the charity is not the appropriate approach. ...

The Tax Court also undertook a fair market valuation of the benefit received by the taxpayers. The expert witnesses for the IRS both agreed with Mr. Rolfs’ own testimony (based on his investigation) that the house would cost upwards of $10,000 to demolish. ... We see no error in the Tax Court’s factual determination, based on the available evidence and testimony, that the Rolfs received a benefit worth at least $10,000.

When property is donated to a charity on the condition that it be destroyed, that condition must be taken into account when valuing the gift. In light of that condition, the value of the gift did not exceed the fair market value of the benefit that the donating taxpayers received in return. Accordingly, the judgment of the Tax Court is Affirmed. [footnote omitted]

Notes and Questions:

1. How does the test of American Bar Endowment as the court articulates it differ from the test that the Tax Court (evidently) applied in Scharf?

2. Why should taxpayer be able to claim the fmv of the property as the amount to be deducted when that amount is greater than the adjusted basis of the property?

3. The Supreme Court construed the meaning of the phrase “to or for the use of” in § 170(c) in Davis v. United States, 495 U.S. 472 (1990). Taxpayers’ sons were missionaries for the Church of Jesus Christ of Latter-Day Saints. Taxpayers deposited amounts into the individual accounts of their sons. The Church had requested the payments and set their amounts. The Church issued written guidelines, instructing that the funds be used exclusively for missionary work. In accordance with the guidelines, petitioners’ sons used the money primarily to pay for rent, food, transportation, and personal needs while on their missions. Taxpayers claimed that these amounts were deductible under § 170. The Supreme Court denied the deductibility of such payments and adopted the IRS’s interpretation of the phrase. “[W]e conclude that a gift or contribution is ‘for the use of’ a qualified organization when it is held in a legally enforceable trust for the qualified organization or in a similar legal arrangement.” Id. at 485. “[B]ecause petitioners did not donate the funds in trust for the Church, or in a similarly enforceable legal arrangement for the benefit of the Church, the funds were not donated ‘for the use of’ the Church for purposes of § 170.” Id. at 486. And while “the Service’s interpretation does not require that the qualified organization take actual possession of the contribution, it nevertheless reflects that the beneficiary [(organization)] must have significant legal rights with respect to the disposition of donated funds.” Id. at 483.

4. In 1971, the IRS issued Rev. Rul. 71-447 in which it stated the position that a private school that does not have a racially non-discriminatory policy as to students is not “charitable” within the common-law concepts reflected in §§ 170 and 501(c)(3). The IRS relied on this position to revoke the tax-exempt status of two private schools. The United States Supreme Court upheld this determination:

There can thus be no question that the interpretation of § 170 and § 501(c)(3) announced by the IRS in 1970 was correct. That it may be seen as belated does not undermine its soundness. It would be wholly incompatible with the concepts underlying tax exemption to grant the benefit of tax-exempt status to racially discriminatory educational entities, which “exer[t] a pervasive influence on the entire educational process.” [citation omitted] Whatever may be the rationale for such private schools’ policies, and however sincere the rationale may be, racial discrimination in education is contrary to public policy. Racially discriminatory educational institutions cannot be viewed as conferring a public benefit within the “charitable” concept discussed earlier, or within the Congressional intent underlying § 170 and § 501(c)(3).

Bob Jones University v. United States, 461 U.S. 574, 595-96 (1983). The schools’ tax-exempt status was lost. Donors could not claim a charitable contribution deduction for contributing money to it.

5. There are limits to the amount of a charitable contribution that a taxpayer may deduct. Section 170's rules are complex.

6. Section 170(c) describes five numbered types of charities.

7. A charitable contribution may take one of several forms:

8. A taxpayer’s allowable contributions are subject to the following limitations:

9. Corporations: A corporation may deduct only 10% of its taxable income as charitable contributions. § 170(b)(2)(A). A corporation may not circumvent this limitation by recharacterizing a contribution or gift that qualifies as a charitable contribution as a business expenditure. § 162(b). A corporation computes its taxable income for purposes of calculating this limit without regard to any dividends-received deduction, NOL carryback, § 199 deduction for domestic production activities, and capital loss carryback. § 170(b)(2)(C). A corporation may carry over an excess contribution to each of the next succeeding five tax years. § 170(d)(2)(A). The carryover cannot operate to increase an NOL in a succeeding year. § 170(d)(2)(B).

10. Taxpayer made a $1000 contribution to WKNO-FM, the local public radio station. WKNO-FM is an “A” organization. Because Taxpayer gave “at the $1000 level,” WKNO-FM presented Taxpayer with a HD radio. WKNO-FM had purchased several such radios for its fund-raising drive at a cost of $163 each. The fmv of the radio was $200. Taxpayer already owned an HD radio so s/he put the new one – still in the box it came in – in the attic. How much may Taxpayer deduct as a charitable contribution?

10a. Playhouse on the Circle will “sell the house” to any organization willing to pay $2500 to see a private showing on a Sunday afternoon of the play it is currently showing. A ticket to see the same play on Saturday night – the immediately preceding night – normally costs $35. Many charities engage Playhouse on the Circle to raise funds for their organization. St. Marlboro, an “A” organization engaged in medical research to determine the consequences of smoking only a few cigarettes a day, has “bought the house” and is selling tickets for $35/each. If Taxpayer purchased four tickets at a total cost of $140, how much should Taxpayer be permitted to deduct as a charitable contribution if Taxpayer throws the tickets away because s/he is not the least bit interested in seeing the play that Playhouse is currently showing?

10b. Taxpayer has $200,000 of adjusted gross income and no NOL carryback. Taxpayer made the following charitable contributions:

What is Taxpayer’s allowable charitable contribution deduction? What charitable contribution carryovers will Taxpayer have?

10c. Taxpayer has $200,000 of adjusted gross income and no NOL carryback. Taxpayer made no charitable contributions except for the following transaction:

What are the tax consequences to Taxpayer?

11. Do the CALI Lesson, Basic Federal Income Taxation: Deductions: Charitable Contribution Deductions: Basic Concepts and Computations.

B. Taxes Paid

Section 164 names some taxes that are deductible, irrespective of the circumstances of the taxpayer. The payments do not have to be connected with a trade or business, or for the production of income. They are deductible simply because taxpayer paid them. Section 275 names certain taxes that are not deductible.

There is of course an involuntary element of paying any of the taxes that § 164 names. However, there is also an element of choice involved in the sense that some taxes are simply the cost of owning property – wherever situated – or making income in one place rather than another. Moreover, the taxes named support governments other than the federal government. Thus the taxpayer’s costs of taxes associated with the choices that taxpayer makes are borne at least in part by the federal government.

Some important points about §§ 164/275 are the following:

Do the CALI Lesson, Basic Federal Income Taxation: Deductions: Deductions for Taxes.