Beware of IRS Scrutiny of Non-Cash Charitable Contributions


By Jon Barooshian and Matt Morris

Taxpayers interested in making non-cash charitable gifts to public charities need to be aware of a recent IRS trend developing in Nantucket. A case set for trial on the February 2018 trial list at the Boston session of the United States Tax Court highlights the need for clarity in the law and regulations surrounding charitable gifts.

Petitioners claimed a deduction for a non-cash charitable gift they made to a local public charity known as Housing Nantucket. In short, Petitioners purchased a home in Nantucket that they planned to raze and rebuild. There was also a carriage house on their property that they wanted to replace with a new structure.

In order to benefit the extremely limited Nantucket housing market, Petitioners chose to donate the carriage house to Housing Nantucket rather than attempt to sell it at a significant profit. As Nantucket gained an international reputation as a tourist and summer destination for wealthy individuals, real estate prices skyrocketed pushing housing costs out of reach of many local and year-round residents. Those working in the service and trade industries as well as local government employees and others necessary for a functioning community could no longer afford to live on Nantucket. Since the island is located approximately 25 miles off the coast of Cape Cod, commuting to Nantucket is not a feasible alternative to living there. Created as a non-profit public charity in 1994 and recognized as a IRC §170 public charity, Housing Nantucket’s mission is to create affordable housing opportunities for those who would otherwise be displaced.

Among the methods Housing Nantucket employs to achieve its mission is to accept donations of relocatable structures that are moved to locations it controls and then leased to those who fit within their mission. Housing Nantucket also occasionally accepts donations of relocatable structures, such as taxpayer’s carriage house, and sells them to local qualifying residents who may have land available to them if relocating those structures to land controlled by Housing Nantucket is not feasible.

Housing Nantucket determined that Petitioners’ carriage house was not suitable for relocation to land it controlled but was ultimately able to find a “buyer” who fit within its charitable mission. So, in essence, there were two separate transactions: 1) the Petitioner’s donation of the carriage house to Housing Nantucket, and 2) Housing Nantucket’s “sale” of the home to the Buyer. It is important to note that Housing Nantucket does not appraise properties, is not a real estate broker, and does not regularly buy and sell relocatable structures in their normal course of business. The “purchase price” therefore was based on a determination of what the buyer (a local tradesperson) was willing to pay rather than some objective determination of value.

When Petitioners filed their return, they claimed a charitable deduction equal in amount to the value determined their appraisal which, coincidentally, was approximately ten times more than Housing Nantucket’s “sale” price of the carriage house to the local tradesperson. Appraisers generally use one of three methods to determine market value: 1) the sales comparison approach; 2) the cost approach; or 3) the income capitalization approach. In this case, the appraiser chose the cost approach to establish value and determined that the other two were not suitable proxies for value.

Although a sales approach is often the preferred method of determining value, the appraiser determined that there was not a sufficient amount of data of similar properties that exchanged hands in arms-length transactions between willing buyers and willing sellers where all relevant facts are disclosed. Without enough data, the sales approach is not a meaningful proxy for value. The appraiser specifically declined to use the sales comparison approach because there “was not a competitive and open market for just improvements.” 

Likewise, the appraiser determined that the income capitalization approach, which is generally described as an investor’s approach to value involving a determination of the net present value of an income stream that would or could be achieved from the property, was also not a suitable proxy for value since that method generally understates the value of residential property.

By process of elimination, the appraiser used the cost approach. In short, he estimated the replacement cost of the carriage house (the structure only—not the land) by multiplying the square footage of the property by an estimated cost per square foot to build the property. From that figure, he subtracted the estimated cost to move the property and factored in depreciation.

In all likelihood, it was the IRS matching program that triggered an audit. IRS computers likely flagged the ten-fold discrepancy in value as reported by Taxpayer on their Form 8283 and Housing Nantucket’s Form 8282 it filed recording the sale of the same property in two contemporaneous transactions.

At the audit, the Revenue Agent denied the charitable deduction in its entirety and assessed additional income in an amount equal to the purchase price by Housing Nantucket’s buyer. The IRS’s position was that Taxpayers were not entitled to a deduction for the donated property because the substance of the transaction was a disguised sale. The Revenue Agent relied on IRC §61, Revenue Ruling 78-197, Revenue Ruling 60-370, and the U.S. Tax Court case Rolfs v. Commissioner, 135 TC 24 (2012) (denying taxpayers a charitable deduction for the value of a house donated to a local volunteer fire department for purposes of burning the house to the ground for training purposes).

The Revenue Agent’s alternative theory was that the Taxpayer’s appraisal was not a qualified appraisal. In particular, the Revenue Agent determined that the appraiser relied on an improper method of valuation using the cost method rather than a sales comparison approach.

Finally, the auditor determined that a 40% IRC §6662(h) penalty was warranted apparently determining that there was no reasonable cause that would justify an understatement.

Petitioners trip to IRS Appeals proved equally fruitless. IRS’s formal position was that Petitioners donation did not meet the definition of a charitable contribution pursuant to IRC §170(c) claiming Petitioners derived a benefit in the form of avoiding what they characterize as a long and difficult demolition approval process.

Alternatively, IRS Appeals determined that if the donation ultimately was to qualify as a charitable contribution, the amount of the donation was not properly reported. IRS Appeals stated position was that the cost approach did not reflect the “restrictions” on the sale, the limited market of potential buyers, the risks of moving the structure, and the relocation costs. Furthermore, IRS also inexplicably concluded that the sale price was in line with sales prices for other homes sold under similar conditions in Nantucket.

For settlement purposes, the Appeals Officer was willing to concede the position that the transaction was nothing more than a disguised sale and allow a charitable deduction in an amount equal to the purchase price the buyer paid to Housing Nantucket. The Appeals officer, however, refused to concede the penalty.

After all of the resistance that they encountered in the audit and Appeals processes, the taxpayers were ready for a long battle with IRS Office of Chief Counsel before the Tax Court. Surprisingly, however, it is the Office of Chief Counsel which first conceded that both parties faced significant risks of litigation. The taxpayers’ most significant weakness was the fact that the only market for these movable structures was the sales transactions between Housing Nantucket and those in need of affordable housing. The Service’s most significant weaknesses were the facts that (1) the taxpayers did not stand to gain anything from the donation other than a Schedule A deduction (as demolishing the carriage house would not have cost anything in addition to the cost of demolishing the main house), (2) the “sales price” between Housing Nantucket and those in need of affordable housing was not based on the fair market value of the structures, but rather on the individuals’ ability to pay, and (3) no U.S. Tax Court judge wants to spend valuable time and government resources adjudicating what is essentially a valuation dispute between two professional appraisers.

In consideration of these risks of litigation, the IRS and the taxpayers agreed to split the difference between them almost exactly down the middle. The final settlement represented just over 50 percent of the originally-claimed value of the carriage house, which was just barely over the threshold required to avoid the non-waivable substantial gross valuation misstatement penalty equal to 40 percent of the additional tax due under Code section 6662(h). Both parties ended up making significant sacrifices in consideration of their mutual understanding that the risks of litigation are not easy to anticipate in what is essentially uncharted territory of federal tax law regarding charitable deductions.

Although practitioners might initially assume that the scope of this case is relatively narrow, this case indicates that the IRS is willing to take a very aggressive stance—from audit, to Appeals, and eventually to the U.S. Tax Court—in order to challenge charitable deductions that might appear at first blush to be overinflated. The takeaway for practitioners is to exercise extreme caution with respect to any charitable deduction that requires a professional appraisal. Does the appraiser’s methodology seem reasonable? Does he or she explain why this particular methodology is preferable to other methodologies? Are there any U.S. Tax Court cases on the same or similar issues in which the IRS has ultimately prevailed? These are all questions that we should ask ourselves before advising our clients to sign a Form 8283: Noncash Charitable Contributions.

Jon Barooshian is a highly-respected trial lawyer and former state prosecutor who defends businesses and individuals throughout New England and the U.S. Contact him at

Mathew Morris is a tax attorney and partner at the Massachusetts law firm Bowditch & Dewey. He represents individuals, fiduciaries, corporations and other business entities before the Internal Revenue Service, the U.S. Tax Court, the Massachusetts Appellate Tax Board, the Massachusetts Department of Revenue and other state revenue authorities in a broad range of tax matters.

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