The Charitable Contribution of a Home: A Deduction Up in Smoke?
Cook, John K., Webber, Sarah, The CPA Journal
Some tax advisors have, for many years, advised individuals mat they can take a charitable contribution deduction for the value of a building (typically, a personal residence) donated to a municipality. In most cases, the municipality used the donated residence for police or firefighter training, destroying the residence and removing all debris in the process. The individual ended up with a clear lot on which to build a new residence and often enjoyed a handsome tax deduction as well. An older U.S. Tax Court decision arguably supported this tax planning strategy, and the IRS appears not to have challenged it for many years. But more recent court decisions have rejected this strategy - or, at least, have dramatically limited its value. Moreover, certain statutory and regulatory provisions - as yet unaddressed by courts - might likewise prove fatal to the strategy. It is useful for CPAs advising taxpayers on charitable deductions to remain aware of the strategy's prior judicial support, recent related developments, and a few unanswered questions. There are also several tips mat can help preserve some of the individual's deduction.
Some CPAs might have previously advised taxpayers that a donation of a home to the local government (typically, the fire department) could potentially satisfy the charitable contribution deduction requirements under Internal Revenue Code (IRC) section 170. This advice was particularly pertinent for individuals living in areas with high real estate values. These people often owned lake or beachfront homes, or homes in gentrified areas where older, fairly modest houses were typically located on land with significant value. To maximize the property's overall value, clients often wanted to build new homes on the land, which frequently entailed demolishing the existing house. Rather man incur demolition costs, the client donated the structure to the local fire department for use in a training exercise. Thus, the client not only avoided demolition and debris removal costs, but also created a substantial potential charitable contribution deduction.
Prior Judicial Support
The charitable home contribution strategy was arguably supported by the tax court's decision in Scharf v. Comm'r, 32 TC. Memo (CCH) 1247 (1973). In Scharf, the taxpayers (husband and wife Morris and Frances Scharf) owned a building in New Jersey that had been badly damaged by fire and condemned. Steadily rising land values made the taxpayers' land more valuable without the building, which they did not intend to repair or replace. Instead, the couple donated the building to the local fire department for use in training exercises. They claimed a charitable contribution deduction equal to their estimate of the building's value; however, the IRS denied the deduction on audit, and the taxpayers petitioned the Tax Court for review.
The Tax Court acknowledged that the case presented an "exceedingly close question" but nonetheless held for the taxpayer, allowing the deduction. The court recognized the "quid pro quo" nature of the taxpayer's purported charitable contribution, having "no doubt" that the taxpayer was "somewhat motivated" by a desire to have the building destroyed by the fire department (Scharf 15). The court implicitly acknowledged that any substantial benefit flowing to the taxpayer would preclude the taxpayer's deduction. But the court rejected the IRS's argument that any benefit returned to the taxpayer was sufficient to deny the deduction. Instead, the court held that "where the primary benefit inures to the general public with only lesser and incidental benefits flowing back to the donor, then a charitable deduction will be allowed" (Scharf 20). Applying this test, the court concluded that the "benefit flowing back to [the taxpayer] . . . was far less than the greater benefit flowing to the [fire department and, by extension, to the general public]" (Scharf 20). Thus, the taxpayer "benefited only incidentally" and was entitled to a deduction. …