Any tax adviser who has ever been saddled with the unenviable task of reporting a client’s charitable contribution of real estate knows that it’s a colossal pain in the ass. The rules of I.R.C. § 170 and the related regulations contain numerous substantiation requirements for contributions of property with value in excess of $5,000, including the need for a qualified appraisal that must be attached to the return containing the contribution. The “qualified appraisal,” in turn, comes with its own lengthy set of requirements, ranging from who can be considered a “qualified appraiser” to a laundry list of information that must be contained within the report. These onerous substantiation requirements have left some tax advisers pondering whether the IRS is actually trying to discourage charitable giving.
Expect that sentiment to reach well beyond the tax world when word leaks out about the Tax Court’s decision today in Mohamed v. Commissioner, T.C. Memo 2012-152. In Mohamed, a prominent California entrepreneur and philanthropist who everyone seems to concede contributed over $18,000,000 in real estate to qualified charities, received zero charitable contribution deduction because of his failure to comply with the substantiation requirements of Treas. Reg. §1.170-13.
Joseph Mohamed made his millions in real estate; as a broker and certified appraiser, he amassed a fortune in real property. Mohamed and his wife wanted to share their considerable wealth, so they established a charitable remainder unitrust — or CRUT — to facilitate the transfer of some of their properties to charitable organizations.
During 2003 and 2004, Mohamed donated six properties to his CRUT, claiming $4.2 million in charitable contribution deductions, with another $15 million limited by AGI and carried forward to future years.
Mohamed is a bright guy with one fatal flaw: he ventured to prepare his own tax return. In doing so, he filled out Form 8283 — Noncash Charitable Contributions — without reading the instructions, because it “seemed so clear that he didn’t think he needed to.” This would prove to be a costly mistake.
Before we go any further, a quick primer on the specific substantiation requirements for property contributions in excess of $5,000 is in order. These requirements are found in Treas. Reg. §1.170-13.
- A qualified appraisal must be made not more than 60 days before the gift and no later than the due date of the return;
- It must be signed by a qualified appraiser, who cannot be the donor or taxpayer claiming the deduction or the donee of the property.
- The qualified appraisal must contain scores of information required by the regulations, including a description of the property, the basis of the property, and the appraised FMV of the property.
Having read neither the regulations nor the form instructions, Mohammed knew not of these requirements. Instead, he took a rational approach when completing Form 8283: he was a real estate appraiser, he knew the value of the contributed properties, so he filled out the form with the information as he saw it. As a result, Mohamed failed to comply with the regulations in the following ways:
- He didn’t obtain an independent appraisal. Instead, he appraised the properties himself, a direct violation of the regulations;
- He did not sign the Declaration of Appraiser (because Form 8283 indicated he could not since he was the donor, which should have tipped him off to larger problems);
- He attached statements to the return that failed to contain much of the required information concerning the properties, including basis of the contributed properties and their manner of acquisition.
The IRS began auditing Mohamed in 2005, and sought to strike down the full amount of his charitable contribution deductions . To combat the IRS scrutiny, Mohamed obtained an independent appraisal in 2005, which verified that the values actually exceeded the amounts claimed on the return. Undeterred, the IRS then shifted its attack to the substantiation requirements, arguing that since Mohamed failed to satisfy the rules of Treas. Reg. §1.170-13, the deductions must be denied in full.
In his defense, Mohamed posed three argument:
1. That the I.R.C. § 170 regulations were invalid,
2. That he substantially complied with the substantiation requirements, or
3. That Form 8283 was not adequate in advising taxpayers of the substantiation requirements.
The Tax Court quickly dismissed arguments 1 and 3, holding that the regulations were indeed valid, and that while Form 8823 may be confusing, the ultimate sources of law are the statute, regulations, and judicial decisions and not the form instructions.
As a result, the Tax Court was left to decide whether Mohamed substantially complied with the substantiation regulations; in other words, did he do enough to justify a deduction even in the absence of meeting the formal requirements of Treas. Reg. §1.170-13?
Ultimately, while conceding that the ruling was extremely harsh, the Tax Court disallowed all of Mohamed’s charitable contribution deductions, holding that he failed to substantially comply with the regulations, as he made the following fatal mistakes:
- He failed to comply with the “essential requirement” of obtaining a qualified appraisal,
- He failed to qualify as a qualified appraiser, since he was both the donor and donee;
- His attachments to Form 8283 lacked detailed information to put the IRS on notice of the nature of the donation;
- He didn’t sign his statements or indicate the method for computing the valuations;
- The appraisals by the independent appraiser were performed more than a year and a half after the required due dates, and thus could not be “qualified appraisals.”
There are two lessons of note here: First and foremost, this is a cruel reminder that good intentions do not guarantee tax deductions. You must comply with any substantiation requirements, onerous and unnecessary as they may seem. The IRS and Tax Court both conceded that Mohamed made a deduction of eligible property to a qualified organization, and in fact may have understated the properties’ values, but failure to follow the substantiation rules doomed his entire deduction.
Secondly, no matter how smart you fancy yourself, hire a tax preparer. I’ve met some bad preparers in my day, but there’s nary a one who would claim a $19 million charitable deduction without making sure the required i’s were dotted and t’s crossed. The tax rules are too complicated for those outside the industry to fully grasp; do yourself a favor and get some professional help.