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Importance of Qualified Appraisals and Other Compliance Rules for Charitable Income Tax Deductions

For noncash charitable gifts with a value of over $5,000 (other than gifts of publicly traded stock), a key requirement for receiving a charitable income tax deduction is obtaining a “qualified appraisal” by a “qualified appraiser.” Recent cases have highlighted the importance of this requirement and demonstrated that successful claims for charitable income tax deductions necessitate careful adherence to these and other technical tax rules.

Qualified Appraisers and Qualified Appraisals 

A “qualified appraiser” is an individual who has both peer recognition as an appraiser of the type of property that is the subject of the gift and sufficient education and other experience in appraising that type of property. A “qualified appraisal” is an appraisal by a qualified appraiser that contains certain information that enables someone who is reviewing the appraisal to determine both the value of the donated property and the qualifications of the appraiser who prepared the appraisal. The Treasury Regulations under the Internal Revenue Code are very specific about the criteria that must be met to be a qualified appraiser and the specific elements that must appear in the qualified appraisal. In addition, certain IRS forms must be filed with income tax returns claiming charitable deductions for noncash gifts; and for large gifts (over $500,000), the qualified appraisal must be attached to the tax return. As recent cases illustrate, the failure to obtain or file a qualified appraisal or to substantially comply with the qualified appraisal requirements can result in denial of the charitable income tax deduction.

Failure to Obtain a Qualified Appraisal

Schweizer v. Commissioner (T.C. Memo. 2022-102)

In Schweizer, a very well-known art dealer who specializes in African art made a charitable gift of a work of African art to a museum, taking a charitable income tax deduction equal to the fair market value of the donated work. The Tax Court upheld the IRS’ disallowance of the deduction because the taxpayer (1) failed to obtain the required qualified appraisal for a donation of tangible personal property valued at more than $5,000 and (2) did not file the requisite IRS forms or include a copy of a qualified appraisal with his tax return. 

Failure to File a Qualified Appraisal

Chrem, et al. v. Commissioner (T.C. Memo. 2018-164)

The Chrem case involved a couple’s gift of non-publicly traded stock (valued at over $500,000) prior to the sale of the stock. While the main issue in the case was whether the taxpayers had made an assignment of income such that they remained responsible for the capital gains tax upon the stock’s sale (an important issue in charitable contribution planning we will discuss in a future Loeb & Loeb alert), the case also discussed the substantiation requirements for a charitable gift of non-publicly traded stock. 

The IRS did not question the status of the taxpayers’ appraiser as a qualified appraiser but argued that the taxpayers should still be denied the deduction because (1) the appraisal report submitted was not a qualified appraisal, as it did not contain all the information required under the applicable tax rules, and (2) even if the report had been a qualified appraisal, the taxpayers still failed to attach the appraisal to their tax return, as required for this type of donation.

The issue raised for the U.S. Tax Court was whether the taxpayers had “substantially complied” with the substantiation requirements. The court set forth the general rule that substantial compliance may excuse minor, technical or procedural defects, but it does not excuse the failure to disclose information that goes to the essential requirements of the statute regarding substantiation. The court looked at the facts and concluded that the appraisal was missing many elements essential to the substantiation requirements because the appraisal (1) did not value the specific property that the taxpayers gave but valued a block of stock, some of which was given by the taxpayers and some of which was not; (2) was not addressed to the taxpayers claiming the deduction but rather to the company that issued the donated stock; and (3) was not attached to the taxpayers’ tax return.

The taxpayers tried to excuse the errors by stating that they relied on an experienced certified public accountant who did not do what she was supposed to do in connection with the filing of the taxpayers’ income tax return. Because this case was decided on procedural grounds, it is not clear whether the taxpayers ultimately would win the substantial compliance argument. It is clear, however, that there were major omissions in the taxpayers’ substantiation of their charitable contribution. Accordingly, this case would probably be one in which a failure to follow the strict substantiation rules would result in the loss of the charitable income tax deduction. 

No Substantial Compliance or Reasonable Cause for Noncompliance With Rules

Estate of Hoensheid v. Commissioner (T.C. Memo. 2023-34)

Estate of Hoensheid was another assignment of income case, in which the U.S. Tax Court ruled that the gift of stock to a charity prior to the stock’s sale was made too late and the taxpayer was required to pay the income tax on the disposition by the charity of the gifted stock. Regardless, the taxpayer normally would be entitled to a charitable contribution deduction if he had complied with the substantiation rules. In fact, the taxpayer had claimed a charitable income tax deduction for the contributed stock and filed an appraisal with his income tax return. As in Chrem, however, the IRS claimed that the appraisal was not a qualified appraisal because it did not contain all the information required by the tax rules. The issue for the court was whether there was substantial compliance with the rules or, if not, whether the taxpayer had “reasonable cause” for noncompliance.

The court found that the appraisal was not a qualified appraisal due to deficiencies in several substantive areas: (1) the appraisal did not include a statement that it was prepared for federal income tax purposes; (2) it had the incorrect date for the charitable contribution; (3) it had an incorrect appraisal date; (4) it did not describe the method for the valuation of stock; (5) it was not signed by the appraiser; (6) it was not prepared by a qualified appraiser, as the appraisal did not sufficiently identify (and the appraiser apparently did not have) the required experience and qualifications to be a qualified appraiser; and (7) it did not describe in sufficient detail the property that was given. With so many elements of a qualified appraisal missing, the court easily concluded that there was not substantial compliance with the qualified appraisal rules.
The taxpayer next tried the “reasonable cause” excuse, which provides that if a taxpayer had reasonable cause for noncompliance, the taxpayer still may be entitled to a charitable deduction. Although the taxpayer here relied on a certified public accountant, the court found that the taxpayer was very involved in the mechanics and reporting of the charitable gift and thus did not have reasonable cause for his reliance on the accountant.

No Shortcuts to Compliance

Although the taxpayers in these three cases were very sophisticated, they still ran afoul of the highly technical substantiation requirements for their charitable income tax deductions. These cases are a reminder that substantiation of charitable deductions is not an area in which to be creative or take shortcuts. Courts are loath to excuse errors when the rules are very clear.