No Deduction for House Donated to Fire Department

Editor: Greg A. Fairbanks, J.D., LL.M.

Charitable Contributions

What is the amount of the charitable deduction for the donation of a house to a fire department that intends to use the house for training exercises—including burning it to the ground? One might logically think that it is the fair market value (FMV) of the home. What if only the home and not the underlying property were donated? One might still think it is the home’s FMV. In Rolfs, 135 T.C. No. 24 (2010), the Tax Court, in a fully reviewed opinion, took up the issue. While agreeing that the amount of the charitable contribution was the value of the house, the Tax Court denied the taxpayers’ charitable deduction because it determined that the taxpayers received a substantial benefit from the donation.

The taxpayers, a married couple, purchased lakefront property in an affluent area in Wisconsin for $600,000. The property contained a lake house, which the taxpayers were initially undecided as to whether to remodel or demolish and rebuild. About a year after purchasing the property, the taxpayers entered into an agreement with the wife’s mother to demolish the structure and build a new home on the property to the mother’s specifications. The couple and the mother would then swap each other’s property. After evaluating the cost of demolition and removal of the lake house, the taxpayers decided to donate the property to the local fire department for use in its training exercises. The parties understood that the house would be used solely for training exercises and that it would be burned down within a relatively short period of time after donation.

At the time of the donation, the lake house was appraised at $76,000, for which the taxpayers claimed a charitable deduction on their income tax return. The IRS denied the deduction, contending that the taxpayers contemplated and received a substantial benefit in exchange for the contribution, namely, demolition services. In the alternative, the IRS argued that (1) a charitable deduction was not allowed because the taxpayers did not donate their entire interest in the lakefront property (i.e., they did not transfer the underlying land) and (2) the lake house as donated to the fire department was worthless.

Under Sec. 170(a), an individual is allowed an income tax charitable deduction for contributions made to an organization described in Sec. 170(c) (a charitable organization generally described in Sec. 501(c)) for the tax year in which the contribution occurred. A charitable contribution for which a deduction is allowed under Sec. 170(a) generally consists of five elements: (1) a transfer (2) of money or property (3) to a permissible donee (4) that is both voluntary and without receipt of economic consideration or benefit and (5) that is in the proper form.

The term “charitable contribution” is defined in Sec. 170(c) as a “contribution or gift” to or for the use of a permissible donee. The term “contribution or gift” is not defined in Sec. 170 but has been judicially developed. The burden is on a taxpayer claiming a charitable contribution deduction to show that all or part of a payment constitutes a contribution or gift. Whether a particular transaction constitutes a gift is based on the facts and circumstances of each transaction. The characterization of a transfer by the parties involved does not determine whether the transfer is a gift under Sec. 170. A charitable contribution must be made voluntarily and not under compulsion; however, the fact that a transfer is not legally or morally required does not, in itself, signify a charitable intent.

After reciting the above requirements to claim a charitable deduction under Sec. 170, the Tax Court focused on the IRS’s quid pro quo argument (that the taxpayers received a substantial benefit from the transfer) as set forth in American Bar Endowment, 477 U.S. 105 (1986), and later incorporated in Regs. Sec. 1.170-1(h)(1). Under Regs. Sec. 1.170A-1(h)(1), no part of a payment that a taxpayer makes to or for the use of a charitable organization that is in consideration for goods or services is a contribution or gift within the meaning of Sec. 170(c) unless the taxpayer:

• Intends to make a payment in an amount that exceeds the FMV of the goods or services; and
• Makes a payment in an amount that exceeds the FMV of the goods or services.

The above requirements are often referred to as the “dual payment rule” or “quid pro quo test.” The quid pro quo test recognizes that a single payment to a charitable organization may be in part a deductible charitable contribution and in part a nondeductible payment for goods or services.

The test takes into account both the receipt of consideration and the intention of the putative donor. The first part of the test focuses on the presence or absence of a benefit derived from the contribution. The amount of the charitable contribution is limited to the amount, if any, by which the payment to charity exceeds the value of goods, services, or other benefits flowing to the transferor. The existence and amount of a benefit can be determined objectively by examining the external features of the transaction. If the benefit received by a transferor equals or exceeds a payment to charity, the transfer is disqualified from treatment as a charitable contribution under Sec. 170, and no further inquiry is necessary.

If the payment to charity exceeds the benefit, the second part of the test looks at the transferor’s intention to make a charitable contribution of the excess. The intent to make a charitable contribution of the excess of the amount transferred over the return benefit received is present if a taxpayer knowingly and intentionally transfers the excess to the permissible donee.

The Tax Court determined that the “external features of the transaction” reflected that the taxpayers anticipated a benefit in exchange for the donation of the house: demolition of the house. Thus, it determined that the application of the quid pro quo test to the donation was the appropriate test to determine if the taxpayers were entitled to a charitable contribution for the donation of the house to the fire department.

Applying the quid pro quo test, the Tax Court considered whether the value of the lake house as donated exceeded the value of the demolition services taxpayers were to receive as a result of the donation. After consideration of both the taxpayer’s and the IRS’s experts, the court determined that the value of the demolition services would be at least $10,000.

As to the value of the lake house, the Tax Court noted that the donation of the lake house without the donation of the underlying land created a substantial restriction on the lake house’s marketability; the lake house could not remain indefinitely on the land. The court noted two other restrictions on the lake house: (1) the use of the lake house was restricted to training exercises by the fire department and (2) the lake house would be burned down relatively soon after its transfer to the fire department.

The Tax Court noted that the taxpayer’s appraisal of $76,000 for the lake house was based on a fee simple and unencumbered interest and determined by using the comparable sales method, not taking into consideration the above restrictions. Thus, the court determined that the appraisal was based on the assumption that the lake house would be available for residential use and affixed to the lakefront property indefinitely—facts not present in the case before it. The court then considered the testimony of two house-moving experts who both determined that the likelihood of a buyer purchasing the lake house to move it from the site was zero because the characteristics of the lake house and its site rendered a relocation of the structure infeasible. Applying the willing buyer–willing seller test set forth in Regs. Sec. 1.170A-1(c)(2), the court determined that the house was worthless.

Having determined that the taxpayers derived a benefit of at least $10,000 (representing the savings from not needing to have the lake house demolished) and that the FMV of the lakefront house was zero, the Tax Court determined that the fire department derived no benefit from the donation of the lake house in excess of the goods and services the taxpayers received. Based on this determination, it was not necessary for the court to address whether the taxpayers intended to make a charitable donation. Because the quid pro quo test had not been satisfied, the court ruled that the taxpayers were not entitled to an income tax charitable deduction under Sec. 170.

The Tax Court’s decision in Rolfs is in conflict with its earlier decision in Scharf, T.C. Memo. 1973-265. In Scharf, the taxpayer donated a building that had been partially destroyed by fire to his local fire department to conduct fire drills and test the use of its new fire equipment. During three ensuing fire drills conducted by the fire department, the property was completely burned down. The taxpayer claimed an income tax charitable deduction for the value of the fire-damaged building donated to the fire department.

The IRS denied the deduction in its entirety, alleging that the taxpayer donated the building with the expectation that its demolition would increase the value of the land and make the property easier to convert to a more productive use. Therefore, it argued that where the motivation for the taxpayer’s actions is not from a “detached and disinterested generosity” and the primary motive is to obtain a direct or indirect benefit by enhancing the value of the taxpayer’s remaining property, the charitable deduction should be denied.

The Tax Court noted that where the primary benefit of a donation inures to the general public with only lesser and incidental benefits flowing back to the donor, a charitable deduction will be allowed. The court then stated:

While we are confronted here with an exceedingly close question, we conclude under these particular circumstances that the benefit flowing back to [the taxpayer], consisting of clearer land, was far less than the greater benefit flowing to the volunteer fire department’s training and equipment testing operations. The [building], even after razing, still was not completely cleared from the land. [The taxpayer] needed to remove the debris, demolish the foundation and chimney and cover the land before he could market the property. We think the [taxpayer] benefited only incidentally from the demolition of the building and that the community was primarily benefited in its fire control and prevention operations. Consequently, on balance, we hold that the petitioner is entitled to a charitable contribution deduction. [Scharf, T.C. Memo. 1973-265 at 20]

The taxpayers in Rolfs relied on Scharf, stating that their facts were similar to the taxpayer’s facts in that case. The Tax Court noted, however, that the Supreme Court’s test in American Bar Endowment was different from the test it applied in Scharf. Whereas the court’s focus in Scharf was whether the value of the public benefit of the donation exceeded the value of benefit received by the donor, the Supreme Court’s focus in American Bar Endowment was whether the FMV of the contributed property exceeded the FMV of the benefit received by the donor. The difference, according to the court, was the focus on the property’s value and not the public good.

Did the Tax Court get it right? The author believes it is questionable whether the taxpayers received a significant benefit in the form of reduced demolition costs for the donation of the house. Although the building materials used to construct the house are not specifically set forth in the facts, it seems clear that substantial demolition costs would be incurred by the taxpayers with or without the burning of the house. The court recognized this fact in Scharf but did not address it in Rolfs.

However, it seems hard to argue that the house was not worthless under the Tax Court’s application of the willing buyer–willing seller test. Because the taxpayers did not also donate the land beneath the house, the court determined that a willing buyer would take into consideration the removal costs of the house in determining its value. It is difficult to imagine that this would not be a consideration in determining what a willing buyer would pay for the house. Remember that the test looks at a hypothetical willing buyer and willing seller. Thus, the willing buyer in Rolfs is a fire department that would not take into consideration the costs of the removal of the house. The court is implicitly ruling that in these types of cases, if the house demolition costs do not exceed the costs of removal of the house from the site, no charitable deduction is allowed.

The court did not address the IRS’s alternative argument that the taxpayers were not entitled to a charitable deduction because they did not donate their entire interest in the donated property. Sec. 170(f)(3) generally denies a deduction for donations of partial interests in property. This has been a concern of the author in cases where this type of donation has been made. The author, however, believes that if the structure is removable from the property, the donation of the house without the transfer of the underlying property does not run afoul of Sec. 170(f)(3). The court’s ruling seems to indicate that it is also of this opinion.

EditorNotes

Greg Fairbanks is a tax senior manager with Grant Thornton LLP in Washington, DC.

For additional information about these items, contact Mr. Fairbanks at (202) 521-1503 or greg.fairbanks@gt.com.

Unless otherwise noted, contributors are members of or associated with Grant Thornton LLP.