Burnt Offering Rejected

The Tax Court denied a deduction for a house donated to a fire department for burning in a training exercise, saying its value was decreased by restrictions on its disposition to less than the benefit to the owner from its demolition.

Theodore Rolfs and his wife, Julia Gallagher, purchased lakefront property in Wisconsin. Access was by a private road. The property contained a house built around 1900. Rolfs decided to build a new house on the site rather than remodel the existing one. Rather than paying an estimated $10,000 to $15,000 to have the house demolished, he donated it to the local fire department to be used for a training exercise that involved burning the house to the ground. The couple included in their itemized deductions on their 1998 joint income tax return a $76,000 charitable contribution for the donated house. They listed the house’s adjusted basis as $100,000 and attached an appraiser’s statement of $76,000 as its fair market value, along with a letter from the fire department acknowledging the donation. The IRS disallowed the deduction.

A charitable contribution is a gift made to a charity without the expectation of receiving a substantial payment or benefit in return. But if the taxpayer receives some payment or benefit, it may still be possible to claim a charitable contribution deduction if the transaction can be bifurcated into part sale, part contribution. Initially, the test for the existence of a partial contribution (although not necessarily its amount) was enunciated in Scharf v. Commissioner, TC Memo 1973-265 (which also involved a building donated to a fire department for burning), as whether the value of the public benefit of the donation exceeded the value of the benefit received by the donor. The Supreme Court, in U.S. v. American Bar Endowment, 477 U.S. 105 (1986), revised the test to be whether the fair market value of the contributed property exceeded the fair market value of the benefit received by the donor. The test was subsequently incorporated into Treas. Reg. § 1.170A-1(h).

The taxpayers argued that the value of the land with the house minus the value of the land without the house ($76,000) was the contribution, since the actual benefit from the destruction of the house had a de minimis value. The government argued that the value of the house should be calculated by taking into account the restrictions on the contribution, that is, the land was to be returned to the taxpayer, the house was to be destroyed, and the house was not available as a residence. Given these restrictions, the government determined that the value of the house was less than the $10,000 minimum estimated cost of demolition, and therefore the taxpayers were not entitled to a charitable contribution deduction. The government’s appraisers determined the actual value of the house by estimating what a person would pay for it, given that the purchaser would have to remove the house from the land and place it on other property. Given the age of the house and the limited access, the appraisers concluded the value was close to zero.

The Tax Court accepted the government’s argument. The court rejected the taxpayers’ “before-and-after” approach to valuation, saying it was limited to cases such as those involving the measure of the value of a donated easement, where the taxpayer owned the same property before and after the donation. According to the court, this method of valuation could not be used to value a donation of a house severed from underlying real property with conditions and restrictions on its use, because the method does not take into account these conditions and restrictions.

However, the court rejected the imposition of the accuracy penalty. Because the taxpayers complied with all reporting requirements, kept the necessary records and fully disclosed the deduction on their return, and because the legal issues raised by their deduction claim were not settled, the court held that they had acted with reasonable cause and good faith and were therefore excepted from the penalty.

  Theodore R. Rolfs v. Commissioner, 135 TC no. 24

By Edward J. Schnee, CPA, Ph.D., Hugh Culverhouse Professor of Accounting and director, MTA Program, Culverhouse School of Accounting, University of Alabama, Tuscaloosa.

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