With Gifts of Real Property, Form AND Substance Counts!
Back in May 2012, a
Tax Court memorandum case was decided that reminded us in no uncertain terms that form over substance often prevails in the tax world. On January 27
th, the Tax Court issued another memorandum decision that shows that form AND substance are critical.
Alli v. Commissioner, TC Memo 2014-15, is an example of the old bromide that bulls and bears can make money while pigs generally get slaughtered.Here’s the backstory: Dr. Ben Alli acquired some rough and tumble “HUD Section 8” real estate in Detroit back in 1983 for a total of $353,000. In 1988, the two properties were transferred to BSA Corp., an S-corp. in which Dr. Alli was eventually the sole shareholder. As part of the HUD program, Dr. Alli agreed to keep the properties in a safe, decent and sanitary condition. I guess that wording was overly subjective because there were… issues… between Alli and HUD throughout the 1990’s, causing HUD, in 1999, to classify the properties as “troubled.” (Small things like – severe water damage, sink and shower units separating from the walls, actively leaking plumbing, damage or inoperable appliances, doors and lighting and, surprise, surprise, roach infestation.) In 1999, for HUD purposes, Dr. Alli hired an appraiser to conduct a market rent survey of the properties. In 2008, the legal wranglings between Alli and HUD finally came to a head and I guess Alli decided it was time to exit the slumlord business. On April 24, 2008, Dr. Alli had another appraiser “update” the 1999 report; this appraisal concluded that the fair market value of the two properties was $1,562,500. On September 29, 2008, Alli donated one of the properties, Gladstone, to the Volunteers of America (VOA) and claimed a healthy deduction of $499,000. VOA acknowledged the donation as of October 23th but, apparently, it had no desire to enter the slumlord business because it immediately sold the building for the first and only offer received of $60,000. IRS balked at both Alli’s deduction and the amount. Bottom Line: Tax Court agreed with the IRS.
How did Dr. Alli screw up? Let me count the ways…
- Ownership: Although Dr. Alli claimed the charitable deduction, the apartment building was owned in the corporate name of BSA. The good news here is, since the corporation was an S-corporation and Dr. Alli was the sole shareholder, the Tax Court looked through the deficiency and gave him the benefit of the doubt. That, however, was the last of their benevolence.
- Appraisal Deficiencies: Dr. Alli used an almost 10 year old “appraisal,” updated 5 months before the contribution, to value the property. The law says that you have to use a qualified appraisal, completed within 60 days of the date of contribution. The appraisals fell short in many other ways as well. They were not completed for income tax purposes, they valued the property at the estimated value “after renovations,” the appraisers omitted their qualifications from the report, etc., etc. In other words, Dr. Alli used deficient appraisals that were well past their tax expiration dates.
- Substantial Compliance: Dr. Alli lied, point blank, on Form 8283. (Lying is a “no-no,” but you know that, right?) The basis of the property was listed as $1,200,000; in reality it was $353,000 (or less, given that only one of the two properties was donated). The condition of the property was listed as “good”, which is generally an inadequate description; here, it was flat out wrong, unless you consider, among other things, broken elevators, leaky roofs, “heaved up” floors, missing kitchens and even a burnt out apartment unit as indicia of “good condition.”
So, what is the takeaway here? Be realistic in your approach to all noncash contributions. Follow the letter of the law in documenting such contributions. Make sure your deduction is claimed at the proper entity level (don’t just skip the entity level filing; if your S-corp or LLC owns the property, claim the deduction at that level and then pass it out to the shareholders or members). Don’t scrimp on the qualified appraisal – good appraisers are worth their weight in gold in constructing bulletproof valuations.
I won’t even begin to comment on the irony of a medical doctor with a master’s degree in public health operating as a slumlord…