Assume you and the missus just bought a teardown on a prime piece of real estate in lovely East St. Louis. You could simply hire a construction company to demolish the existing home and carry away the rubble, but that’s gonna’ cost you. Or, with a little ingenuity, you could donate the home to the local fire department for use in their drills. What’s the benefit? The fire department does all the heavy lifting by burning the house to the ground — and cutting your costs significantly — and you get a charitable contribution deduction for the value of the house.
At least, that’s the way it has been since the Tax Court blessed such a deduction in Scharf v. Commissioner,[i] 40 years ago.
Yesterday, the Seventh Circuit may well have sounded the death knell for this tax savings opportunity, however, as it upheld the Tax Court’s 2010 decision in Rolfs v. Commissioner,[ii] denying a taxpayer’s charitable contribution deduction on the grounds that the value of the donated home did not exceed the value of the $10,000 benefit they received by having the home demolished for free.[iii] In doing so, the Seventh Circuit established a methodology for valuing homes donated for the purpose of being destroyed that could effectively quash the Scharf charitable deduction play forever.
Like the Tax Court, the Seventh Circuit did not argue that the contribution of a home to a fire department did not qualify as a charitable contribution; to the contrary, both courts agreed that all of the statutory requirements were in place. The issue, rather, was one of value. Remember, the value of a charitable contribution must exceed the value of any benefit the donor receives in return, in this case the demolition services, which were valued at $10,000.
The taxpayers argued that the home should be valued based on the before-and-after method, maintaining that the land was worth $76,000 less after the home was demolished, thus fixing the value of the home, and the resulting charitable contribution, at that amount. (The taxpayers failed to reduce the value of their contribution by the $10,000 value recieved in return)
The Seventh Circuit disagreed, holding that the value of the home had to take into consideration its imminent demise:
When a gift is made with conditions, the conditions must be taken into account in determining the fair market value of the donated property. As we explain below, proper consideration of the economic effect of the condition that the house be destroyed reduces the fair market value of the gift so much that no net value is ever likely to be available for a deduction, and certainly not here. What is the fair market value of a house, severed from the land, and donated on the condition that it soon be burned down? There is no evidence of a functional market of willing sellers and buyers of houses to burn.
The Seventh Circuit thus required the house to be valued at the higher of two alternatives:
1) What the house would be worth if it were immediately burned down and sold for scrap, or
2) What someone would pay for the house if they were required to uproot it and move it elsewhere.
According to an IRS expert witness, both values were held to be less than the $10,000 benefit derived from the home’s destruction:
Witness Robert George…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.
Could there be a situation where a house would retain significant value to a potential buyer even if that buyer were required to move the house elsewhere? It’s certainly possible, but it’s unlikely any taxpayers will be willing to tempt fate by claiming a corresponding charitable contribution deduction in light of yesterday’s decision.
[i] T.C.M. 1973-265
[iii] The fair market value of any substantial benefit received as a result of the contribution must reduce the fair market value of the donation.