The Fourth Circuit denied a couple's deduction for a charitable donation of salvaged materials from their home's demolition due to the couple's retained recorded ownership of the property. A transfer agreement with the charity receiving the items was ruled insufficient to support a transfer of interest.
Facts: Linda and Lawrence Mann purchased a house and the accompanying land in Maryland. After deciding to tear down the house and construct a new one on the property, the Manns entered into an agreement by which they would retain ownership of the land and donate the house to Second Chance, a charitable organization that provided job-training services to disadvantaged local residents. Second Chance would perform a deconstruction of the house to salvage any useful or profitable components, which it would then sell to fund its job training programs. Demolition of any remaining portion of the house after the deconstruction would be the Manns' responsibility. The Manns claimed a charitable deduction of $675,000 on their income tax return, the appraised value of the house, assuming it had remained intact.
Issues: Upon audit, the IRS disallowed the entire charitable deduction. The IRS argued that the Manns had not met the requirement that they donate an undivided interest in the relevant property, which was the land and the improvements affixed to it (in this case, the house). To transfer the house separately, the Manns were required to sever the property from the land by recording the transfer of the house with the county (Sec. 170(f)(3)). The Manns did not record the transfer of the house, so the house was not severed from the land, and the Manns had not transferred an undivided interest in the property they owned, the IRS argued.
Second, the IRS argued that, even if the house had been properly transferred, the value of the deduction the Manns claimed was incorrect. Prior to the deconstruction of the house, the Manns had acquired an appraisal that valued the house at $675,000, based on its "highest and best use," which would be to move the house to another lot. Thus, the IRS contended that the Manns' initial deduction was overstated because they had not donated the entire house; rather, they had only donated the components of the house that Second Chance removed for resale.
The Manns filed an amended tax return for the tax year and reduced the claimed deduction to $313,353, based on an alternative appraisal, which based the house's fair market value on secondhand market valuations of its components. For items without a secondhand market, the appraisal used the cost of the components as new and depreciated them to estimate their current value. The IRS again disallowed the deduction, as this alternative appraisal included all components of the house rather than only the components removed by Second Chance for resale.
The Manns paid the contested taxes and sued for a refund in federal district court. The court, agreeing with the IRS's arguments, granted summary judgment to the government on these issues. The taxpayers appealed the decision to the Fourth Circuit.
Holding: The Fourth Circuit affirmed the district court, finding that the Manns, who had not recorded the house's transfer, still retained record ownership of the house and were still liable for paying property taxes on it under Maryland law. Therefore, the Manns had not conveyed their entire interest in the property. The Manns argued that recordation was not necessary, and the agreement between the parties to donate the house constructively severed the house from the land and transferred contractual ownership of the entire house to Second Chance.
The Fourth Circuit disagreed, determining that even if the donation agreement both constructively severed the house from the land and conveyed contractual ownership of the house to Second Chance, the Manns still remained the record owners of the house responsible for real estate taxes.
The court further found that, regardless of its form, the substance of the transaction was that the Manns donated some components of the house for salvage and resale, and some of the house's components were destroyed on-site, either as part of Second Chance's workforce training program or as necessary to remove salvageable components. However, the Manns maintained the benefits and burdens of ownership of the remaining components, which they ultimately paid a contractor to demolish. Thus, in substance, the Manns did not donate, as personal property, the entire interest in the house, making their attempt to claim the value of the entire house as a charitable deduction improper.
Finally, the $313,353 alternate appraisal value failed to isolate and value the contributed property separate from the property that was left behind and/or destroyed by Second Chance.
- Mann, No. 19-1793 (4th Cir. 1/6/21), aff'g 364 F. Supp. 3d 553 (D. Md. 2019)
— By Shannon Veyon Jemiolo, CPA, Ph.D., assistant professor of accounting, Canisius College, Buffalo, N.Y.