In the recent Mann v. United States case, the federal court of appeals set important precedent in determining how deconstructed and donated building materials, furnishings, and fixtures should be valued in line with IRS defined Fair Market Value. Along with proper and accurate valuation comes two equally important issues: what does and does not constitute an IRS defined Qualified Appraisal and Qualified Appraiser? We first provide an overview of deconstruction and its tax implications, and then address the impact of the Mann case.
What is deconstruction?
Deconstruction is the process of carefully “unbuilding” structures to extract as much salvageable materials as possible. These materials include wood flooring, doors and jambs, windows, shutters, paver stones, millwork, kitchen cabinetry, appliances, door and drawer hardware, mantels, and numerous other materials that would otherwise be gutted and dumped.
How does this involve tax policy?
Tax policy that aligns with environmental initiatives is a wonderful and rare occurrence within the Internal Revenue Code. When building materials are donated to a 501(c)3 charity or governmental entity, a tax deduction can be taken for the IRS defined Fair Market Value of the materials, fixtures, furnishings, appliances and other property incident to the deconstruction. These materials and property have solid value on the secondary retail “resale” market.
A donor must submit IRS Form 8283 Noncash Charitable Contributions to substantiate the donation. The form was updated in December 2020 and moved critical information found in Section B, Part I to the front page from a tougher-to-notice and sometimes overlooked location on page 2 of the previous form. This section must be filled out by the taxpayer in its entirety.
The tax deduction can bridge the gap between more expensive and labor-intensive deconstruction over the slash-and-burn demolition practices typically costing less. In fact, in our experience, close to 95% of residential homeowners who undertook deconstruction over demolition did so because of the tax deduction. Again, it is fantastic when tax policy aligns with sound environmental practices. However, these tax deductions are fraught with challenges. For example, under-qualified appraisers put taxpayers at risk of losing these deductions in their entirety if the appraisal is not produced correctly.
Are personal property appraisers licensed?
There is no licensure, either state or federal, for personal property appraisers. There are standards set forth by the IRS but the education and experience requirements include exceptions that grandfather in appraisers that have been around for some time that may not meet any of the current standards. Experience producing erroneous appraisals for decades does not an IRS Qualified Appraiser make. To practice as a CPA, I had to obtain a master’s degree and then sit for a two-day, grueling CPA examination, in four sections. I am proud to say I passed all four on the first go-round, mostly because I never wanted to take that test again. Taxpayers have no such standard upon which they can judge an appraiser.
However, there are three personal property appraisal organizations who sponsor the congressionally-authorized Appraisal Foundation, a nonprofit helping to heighten appraiser education and standards. They also promulgate USPAP, the Uniform Standards of Professional Appraisal Practice. To protect yourself you should, at a minimum, ensure your appraiser is an accredited member of one of the following organizations. If they are not, ask them why. Sound valuation methodology reaches across appraisal disciplines and the foundational valuation concepts offered by these organizations cannot be learned without rigorous study and examinations.
- 1American Society of Appraisers (ASA)
- 2Appraisers Association of America (AAA)
- 3International Society of Appraisers (ISA)
What is the proper valuation methodology?
There are three valuation methods to be applied when appraising. Each must be considered in an appraisal with the appraiser determining if one or more applies to the given assignment. These include:
- 1Sales Comparison Approach (Market-based Approach)
- 2Cost Approach
- 3Income Approach
The Sales Comparison Approach is used for the overwhelming majority of all personal property appraisals prepared to substantiate an income tax deduction for a charitable contribution. This method includes the research and documentation of consummated sales and offers of sale for comparable property in a relevant time frame and in the relevant market.
The Cost Approach estimates the replacement cost of property and is used primarily for insurance appraisals.
The Income Approach calculates the present value of future cash flow from income producing property and is typically used for financial planning and business valuation purposes.
The Sales Comparison Approach should be used for the vast majority of appraisals for charitable contributions as taught by the three organizations. Arguing against this would run parallel to a CPA arguing that the definition of accrual accounting does not mean that income must be recognized when earned or expenses when incurred. Using other methods as a shortcut to a faster or inflated appraisal contradicts the decades-long approaches of accredited appraisal organizations and valuation theory. Other approaches also lack common sense, and can lead to disallowed deductions, fines, and later repayment of tax benefits.
The Mann case provides several examples of what not to do to obtain a Qualified Appraisal. In Mann, the appraiser did not produce a Qualified Appraisal, with the appeals court providing the following analysis:
Finally, the $313,353 appraisal used to claim the deduction was not a qualified appraisal of the contributed property under 26 U.S.C. § 170(f)(11)(C). See 26 C.F.R. § 1.170A-13(c)(3)(ii)(I). The appraisal assumed that every component of the house would be severed and donated to Second Chance for reuse. Based on that assumption about the property contributed and recognizing that many of those components lacked a resale market, the appraisal used a “cost approach to value.” The appraiser determined the value of new and uninstalled versions of the building's components and depreciated that value by 17%, a value calculated based on the components having “60-years of economic life with an effective age of 10.” The appraiser determined that this represented the components' current value based on the largely unexplained assumption that the 10-year-old materials, now cut to the appropriate size and installed in the house, were worth 83% of their new and uninstalled values. Aggregating the value of each such component — including substantial amounts even for the value of the house's foundation and drywall — the appraisal determined that the value of the entire house was $313,353 and that was the amount that the Manns claimed as a charitable deduction on their amended return.
The district court found this appraisal flawed because not every component was donated to Second Chance, stating that “a valuation of over $300,000 based on the extraction and resale of all building materials does not properly value the donation in light of the conditions placed on the conveyance.” Mann , 364 F. Supp. 3d at 564; cf. Rolfs v. Comm'r, 668 F.3d 888, 895 [109 AFTR 2d 2012-828] (7th Cir. 2012) (disallowing deduction based on taxpayers' donation of a house to a local fire department for the house's destruction in a training exercise where “[n]one of the value of the house, as a house, was actually given away”). The court did note that a “proper way” to value the donation would have been “based on the resale value of the specific building materials and contents” that Second Chance removed from the premises. Mann, 364 F. Supp. 3d at 564. The appraisal never provided the IRS with an estimate of the value of those materials.
There are several important takeaways from this case. First, the appraiser used the cost approach to value claiming there was not a resale market, which is false. Second, the appraiser made the “unexplained assumption” about the life of the materials in their current installed form. Third, the appraiser aggregated the value of each component calculated using software and included amounts for foundation and drywall which were never donated. Finally, the court did not find their valuation method proper because it was not “based on the resale value of the specific building materials and contents.”
What are the larger appraiser and appraisal issues?
Due to the lack of licensure, many deconstruction, reuse and architectural salvage appraisers continue to use the Cost Approach to value by plugging values into construction cost estimating software such as Marshall & Swift and R.S. Means and tossing in some depreciation, sometimes arbitrarily assigned. This was what the appraiser did in Mann—they used the Cost approach, which can save time and provide inflated appraisal values, and combined it with an arbitrary depreciation discount that the courts found inadequate. To justify using the Cost approach, some appraisers claim lack of comparable sales data on the open market to support the proper Sales approach. We vehemently disagree.
We currently have a list of 200+ secondary retail stores, websites, and auctions upon which comparable sales data can be pulled…in abundance.
However, this takes time. It is estimated that the average time to produce a deconstruction appraisal using software shortcuts can take 30-60 minutes. Creating a proper appraisal of a deconstructed home typically includes 150+ components to be researched with multiple comparable sales provided for each component to avoid the cherry picking of only the highest price. Completing the same appraisal using correct methodology takes our research team 2-3 weeks. We provide this appraisal while still keeping our rates in line with the market prices for substandard appraisals that put the taxpayer at risk. Perhaps we are the fools realizing smaller revenue margins while spending weeks properly researching and documenting comparable sales data. Or maybe we know that doing the job correctly takes time and pays off in the long run for both our clients and us through positive feedback and return work within the industry. Appraisals are prepared to substantiate value for the Internal Revenue Service. As such, they are considered some of the most detailed and difficult appraisals to produce when compared with insurance or simple valuation appraisals.
Who Demands These High Standards?
The IRS.
After nineteen years as a practicing CPA, I have insisted that clients document everything and make sure any figure provided to the IRS can be backed up by hard data. The same is true when producing appraisals to substantiate charitable contributions for the IRS.
It is well past time for this industry of deconstruction, reuse, architectural salvage, or whatever other self-declared title, to step up, follow the IRS defined Fair Market Value, and tie these valuations to actual market data with full documentation to back up every single valuation assertion and seek the requisite education to be qualified. The Mann case makes this more clear than ever and removes any excuse appraisers have been using in the past to use the simpler, but incorrect, Cost Approach appraisal methodology for depreciating personal property.
Who lost in this court decision? The taxpayer. As IRS Qualified Appraisers, we must ensure we protect our clients, taxpayers, by providing accurate and valid appraisals.
