Just as the Seventh Circuit did four months ago in Rolfs v. Commissioner, today the Tax Court disallowed the charitable contribution deduction claimed by a taxpayer who donated his home to the local fire department for use in their drills, with the understanding that the home would be burned down to clear way for a new residence.
In Patel v. Commissioner, 138 T.C. 23 (2012), however, the Tax Court reached this conclusion via a different approach then it had in its initial decision in Rolfs; between the two methodologies, there leaves little ground for future taxpayers to support a charitable contribution deduction in this scenario, and the only previous authority to allow such a deduction — Scharf v. Commissioner – is effectively dead.
If you recall, in Rolfs, neither the Tax Court nor the Seventh Circuit argued 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.
The Seventh Circuit held 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.
Based on these restrictions, the value of the home was less than the $10,000 benefit the Rolfs derived from having the fire department do their demolition work for them, and thus the deduction was denied under the “quid pro quo” rules.
To the contrary, in Patel, the IRS and the Tax Court attacked the propriety of the taxpayer’s charitable contribution deduction under I.R.C. § 170. The root of the denial was grounded in I.R.C. § 170(f)(3), which denies a charitable contribution deduction for certain contributions of partial interests of property:
(3) Denial of deduction in case of certain contributions of partial interests in property.–
(A) In general.–In the case of a contribution (not made by a transfer in trust) of an interest in property which consists of less than the taxpayer’s entire interest in such property, a deduction shall be allowed under this section only to the extent that the value of the interest contributed would be allowable as a deduction under this section if such interest had been transferred in trust. For purposes of this subparagraph, a contribution by a taxpayer of the right to use property shall be treated as a contribution of less than the taxpayer’s entire interest in such property.
The purpose of the “partial interest” rule is to prevent a taxpayer from deriving a double benefit: once when using the property, and again in the form of a subsequent contribution deduction. Or perhaps to better illustrate it, imagine a building owner who owns 10 apartments. If he grants the use of one of the ten apartments rent-free to a charitable organization and is permitted a charitable contribution for the foregone rent, he would benefit twice: once in the form of reduced taxable income by foregoing the rent, and again for a charitable contribution for the foregone rent.
To answer the question as to whether the Patels granting of the use of their home to the fire department was the granting of a partial interest in the property, the Tax Court looked to Virginia state law, which provides that the term “land” includes any home or building on the property.
Based on this definition, because the Patels contributed an interest in a building that is part of the underlying land under State law but retained all title to and interest in the remaining land, the Patels donated less than their entire interest in the land. As a result, the Patels would not be allowed a charitable contribution deduction unless the donated interest fell within the following exceptions of section 170(f)(3)(B):
(B) Exceptions.–Subparagraph (A) shall not apply to–
(i) a contribution of a remainder interest in a personal residence or farm,
(ii) a contribution of an undivided portion of the taxpayer’s entire interest in property, and
(iii) a qualified conservation contribution.
The Tax Court made quick work of the first and third exclusions, holding that the contribution of the home was neither the contribution of a remainder interest in a personal residence (because the fire department never had any interest in the house) nor a qualified conservation contribution (because the use by the fire department did not qualify as “conservation.”)
The crux of the decision, however, was whether the contribution of the home was a contribution of an undivided portion of the Patels’ entire interest in the home. The regulations provide the following guidance:
An undivided portion of a donor’s entire interest in property must consist of a fraction or percentage of each and every substantial interest or right owned by the donor in such property and must extend over the entire term of the donor’s interest in such property and in other property into which such property is converted. For example * * * . * * * If a taxpayer owns 100 acres of land and makes a contribution of 50 acres to a charitable organization, the charitable contribution is allowed as a deduction under section 170.[i]
In reaching its conclusion to deny the deduction, the Tax Court held that the transfer of the home was not the transfer of an undivided interest in the property, because upon closer inspection, there was not a transfer of any part of the Patels’ interest in the home, because the benefits and burdens of owning the home were never transfered to the fire department. Instead, the court likened the use of the building by the fire department to a license:
Granting a fire department the right to destroy the building while conducting training exercises on the property is not a conveyance of ownership, title, or possession of the building or any other property interest in the building or the Vienna property. Rather it is a mere license to use the property. Granting a fire department the right to conduct training exercises on one’s property and destroy a building thereon by fire grants the fire department the right “to do an act which without such authority would be illegal, a tort, or a trespass”.
The fire department does not acquire the right to eject the landowner from the building and cannot force the landowner to allow the destruction of the building should he change his mind before the house has been destroyed. The fire department has acquired a mere revocable license that does not vest any property interest in the fire department.
It’s important to note, the Tax Court was not unified in its opinion. Justice Gale dissented, taking umbrage with the majority’s contention that the donation of the home to the fire department was merely a license. Gale argued that in a typical license arrangement, there is an understanding that the property will be returned to the grantor of the license subject to normal wear and tear. By permitting the fire department to destroy the building, the Patels formally transferred their property interests to the fire department. Once the fire department destroyed the home, Gale posited, the Patels retained no substantial interest in the home, and thus would have transferred an undivided interest in the property.
Justice Gales did concede, however, that even if the donation were permitted under statute, there remains the question of value to deal with as established in Rolfs; the Patels would be required to show that the value of the home — using the Rolfs methodology — exceeded the benefit they derived from the demolition.
Even with Justice Gale’s dissent, the Tax Court’s decision in Patel serves to add another round of ammunition to the Service’s attack on this type of charitable contribution deduction. In light of these two Tax Court decisions and the Seventh Circuit’s affirmation in Rolfs, taxpayers would be wise not to tempt fate and pursue this deduction.
[i] Treas. Reg. §1.170A-7(b)(1)(i)
