The petitioners in this case, Dr. Ben Alli and Shaki Alli, made a charitable donation of an apartment building to Volunteers of America in September 2008. At the time of the donation, the property was owned by BSA Corp., an S-Corporation in which Dr. Alli was the sole shareholder. The property, a 34-unit building located at 2987 Gladstone in Detroit (Gladstone), was in such poor condition at the time that it did not meet minimum standards for decent, safe and sanitary conditions. The owner had a track record dating back to the early 1990’s of failing to adequately maintain the property and make necessary repairs. In fact, the property was in such disrepair that HUD severed their relationship with the petitioners in 2000 after nearly a decade of issuing citations for deficiencies in the property. At the time of donation, only 6 of the units in the Gladstone Property were occupied.
The property was originally purchased by the petitioners in 1983 along with another apartment property located at 2211 Pingree in Detroit (Pingree) for a total purchase price of $353,000. The petitioners claimed that the amount of the charitable donation for Gladstone was alone $499,000 and that the cost basis in the property at the time of the donation was $1,200,000.
There were two appraisals performed on the properties during BSA’s ownership. The first was a market rental survey completed by Anthony Sanna, MAI (Sanna Appraisal) in 1999. The purpose of that appraisal was for HUD’s Section 8 housing program, and the appraisal did not include an opinion of fair market value.
A second appraisal of the properties was completed by Darvin Jones in April 2008, about 5 months prior to the donation of the Gladstone property (Jones Appraisal). The Jones appraisal was referred to as an update to the Sanna Appraisal. The value concluded by Jones for both properties was $1,562,500; the estimated value of Gladstone was $664,062. The purpose of the appraisal was to establish the value of the properties “after the renovation and remodeled [sic] condition.” The condition of the properties per the purpose of the appraisal was assumed to be “good” and the appraisal assumed that the all necessary repairs had been made to the property to restore it to a safe and sanitary condition. Furthermore, the definition of market value used in the Jones Appraisal was “the highest price estimate in terms of money which a property Will [sic] bring, if exposed for sale in the open market, allowing a reasonable time of [sic] Find [sic] a purchaser who buys with knowledge of all uses of which it is adapted, and for which it was capable of being used.”
The key issues of this case are:
- Whether the property donated was actually held by the petitioners;
- Whether the petitioners were entitled to claim a deduction for the property as it was held by an S-Corporation;
- Whether the requirements for a qualified appraisal were met by either of the two appraisals that were completed for the properties; and
- Whether the lack of compliance should be excused under the doctrine of substantial compliance.
Ownership and Deduction
The first two issues before the Court in this case were whether the petitioners actually owned the property, and whether they were entitled to take a deduction on a contribution of a property held by an S-Corporation. The Court found that the petitioners failed to provide sufficient documentation that the Gladstone property was held individually. Rather, the court found that records were clear that the property was owned by BSA Corp., an S-Corporation.
On the issue of whether the petitioners were entitled to a deduction for the contribution in light of the ownership of the property, the Court found that they may be entitled to a deduction. S-Corporations are not generally taxed at the corporate level. Instead, the corporation’s income or loss passes through to the shareholders and is taxed at the individual level. The only shareholder in BSA was Dr. Alli. As a result, the court found that Dr. Alli could be entitled to a charitable donation deduction assuming all of the requirements for that deduction were met.
Qualified Appraisals and Appraisers
The key valuation issue in this case is whether the appraisals were qualified to serve as a valuation basis for the charitable donation. According to tax regulations, each report submitted as support for a charitable donation must meet the requirements for a qualified appraisal. Both of the reports submitted failed to meet the criteria for a qualified appraisal.
The Sanna Appraisal was completed nearly 10 years prior to the date of donation, which is far outside the acceptable time frame cited in the tax regulations. Tax regulations state that an appraisal used as support be completed no earlier than 60 days prior to the donation and no later than the extended due date of the tax return on which the donation is claimed. The second issue with the Sanna Appraisal is that it failed to report the expected date of the contribution.
Items missing from the Sanna Appraisal included the terms of the agreement for the donation and a statement that it was prepared for income tax purposes. Furthermore, the Sanna Appraisal did not estimate the fair market value of the Gladstone property. Rather, it was a market rental study that did not even include an opinion of value for the subject property. As a result of the deficiencies in the Sanna Appraisal, the Court found that it was not a qualified appraisal.
One of the most glaring deficiencies of the Jones appraisal is that it was not an appraisal of the donated property. As previously noted, the Jones Appraisal included hypothetical condition that the Gladstone property was renovated, repaired and in good, rentable condition. The reality is that fewer than 20 percent of the units in that property were even suitable for occupancy, let alone in good condition. As a result, the Court found that the property appraised in the Jones Appraisal was not the property donated. This also relates to the second deficiency of the Jones Appraisal, which is that it failed to adequately describe the condition of the property “as-contributed.” Also, as previously noted, the Jones Appraisal cited an improper definition of market value.
The Jones Appraisal failed to include the qualifications of the appraiser and the identifying number of the appraiser as required for a qualified appraisal. Other deficiencies in the Jones Appraisal included failure to disclose the anticipated donation date, the terms of the donation agreement, and a statement that the purpose of the appraisal was for income tax purposes. Finally, the Jones Appraisal was completed about 5 months prior to the donation, which is outside the time period allowed by tax regulations.
The final issue considered in this case was whether the appraisals provided constituted substantial compliance with tax regulations. In some cases, the Court will overlook minor omissions by appraisers and tax preparers if the omission is unintentional or there is good reason for it. In this case, the Court found that not only did the petitioners omit information necessary to property evaluate the validity of the donation, they falsified information, including the value of the Gladstone property and the cost basis of the property.
The fact that neither appraisal performed on the property met the criteria for a qualified appraisal, and the fact that the petitioners omitted entire categories of required information led the Court to conclude that the petitioners failed to provide substantial compliance for the donation of the Gladstone property.
Neither appraisal came close to providing adequate support for the value claimed on the charitable donation. The Sanna Appraisal was grossly outdated and did not even provide an opinion of value. The hypothetical condition noted in the Jones appraisal paints an inaccurate and misleading picture of what the property was at the time of the donation, rendering a value conclusion far higher than the actual property value. There wasn’t necessarily anything wrong with either appraisal for the purposes for which they were originally written (the Sanna Appraisal was for HUD Section 8, and the Jones Appraisal specified that the purpose was to value the property as-renovated).
The problem in this case lies with the taxpayer trying to rely on reports completed for purposes other than income tax valuation. As a result, both reports were missing substantial information required by tax regulations, and neither report was accepted by the Court as a qualified appraisal. Furthermore, the taxpayer blatantly misrepresented the condition of the property, the estimated value of the donation and the cost basis of the property.
In the end, the Court ruled in favor of the IRS (respondent). This case highlights a number of issues relating to both the valuation and reporting of a charitable donation. Aside from the obvious importance of clearly, accurately and truthfully reporting all relevant information when claiming a charitable donation, this case reinforces the importance of obtaining a qualified appraisal, performed specifically for income tax purposes and prepared by qualified appraisers when making charitable donations.
Steven D. Henry, MAI, is Vice President and National Head of Real Estate Appraisal Services at Pluris Valuation Advisors LLC. Mr. Henry resides in our Newport Beach office and can be reached at 949.798.5559. Comments or questions are welcome at firstname.lastname@example.org.