In Evenchik v. Commissioner, T.C. Memo. 2013-34 (Feb. 4, 2013), the taxpayers donated approximately 72 percent of their shares in a corporation called Chateau Apartments, Inc., to a non-profit housing organization. Chateau’s sole assets were two apartment buildings located in Arizona. The taxpayers obtained appraisals of Chateau’s underlying assets and, based on these appraisals, claimed a charitable deduction under Internal Revenue Code Section 170 in 2004. They were unable to claim the entire amount of this deduction in 2004, so they claimed a portion of the deduction as a carryforward in 2006. The issue addressed in the case was whether the taxpayers submitted a qualified appraisal for the charitable deduction carryforward claimed on their 2006 return.
Valuation of Incorrect Assets
The Tax Court held that the taxpayers didn’t submit a qualified appraisal in accordance with IRC Section 170 and the underlying Treasury regulations. Importantly, the appraisals provided by the taxpayers didn’t evaluate the proper assets. The taxpayers obtained appraisals of Chateau’s underlying assets, which provided that these apartment buildings were worth approximately $1 million. The taxpayers used these appraisals to calculate their charitable deduction. However, this was a serious error, as neither appraisal examined the fair market value (FMV) of Chateau’s common shares, much less the value of the taxpayers’ partial interest in the company. The Tax Court found that this was quite problematic, as it prevented the Commissioner from determining whether the contributed property was overvalued. (Interestingly, the taxpayers stipulated in the case that the donated property was overvalued by 35 percent.) The Tax Court noted that the difficulties and inconsistencies arising from property valuations led Congress to establish strict substantiation requirements, which donors must satisfy to obtain charitable deductions.
Treas. Regs. Section 1.170A-13(c)(3)(ii) requires that a qualified appraisal include, among other things: (1) “a description of the property in sufficient detail for a person who is not generally familiar with the type of property to ascertain that the property that was appraised is the property that was contributed,” (2) the date of the contribution, (3) the name and qualifications of the appraiser, (4) the appraised FMV as of the date of contribution, and (5) the method of valuation.
There have been a number of cases in which the Tax Court found that the taxpayers substantially complied with these substantiation requirements. For instance, in Bond v. Comm’r, 100 T.C. 32 (1993), the Tax Court allowed a charitable deduction because the appraisal included all of the required information, except for a statement of the appraiser’s qualifications. The Court determined that the exclusion of this statement was minor, given that all the other substantiation requirements were satisfied. On the other hand, in Smith v. Comm’r, 2007 WL 4410771, the taxpayers donated stock in a family limited partnership (FLP), whose sole asset was stock in a closely held corporation. The taxpayers in Smith obtained an appraisal of the underlying assets of the FLP, rather than the value of the FLP interests. The Tax Court held that these taxpayers didn’t substantially comply with the qualified appraisal requirement, due to their failure to appraise the correct assets and comply with many of the other substantiation requirements provided in the regulations. In recognition of this precedent, the Tax Court noted in Evenchik that “a taxpayer can’t substantially comply with the qualified-appraisal requirements if the appraisal he submits fails to meet the ‘essential requirements of the governing statute.’” (citation omitted).
The taxpayers in Evenchik argued that, while the appraisals valued the incorrect asset, they nonetheless substantially complied with the qualified appraisal requirement provided in the regulations and, therefore, that the charitable deduction should be allowed. The Tax Court disagreed; the valuation of the wrong asset was a serious error, as discussed above. In addition, the appraisals excluded a number of other details that the regulations require. Specifically, these appraisals didn’t give a detailed description of the property, state the date of contribution or provide the appraised FMV on the date of contribution. Based on these errors, the Tax Court held that the taxpayers failed to adhere to the qualified appraisal requirement and denied the charitable deduction.
When donating shares of a company to a charitable organization, it’s important to obtain an appraisal of the contributed shares, rather than the value of the underlying assets of the company. Further, it’s especially important for both practitioners and taxpayers to follow all of the substantiation requirements provided in the qualified appraisal regulations. As demonstrated in Evenchik, the failure to obtain appraisals that substantially comply with these substantiation requirements may result in a disallowance of the charitable deduction.