Introductions
Jessica I. Marschall, CPA, ISA AM—practicing CPA for 20 years. Accredited member of the International Society of Appraisers, graduation from the American Association of Appraisers CASP education program in personal property and an Associate Member of American Society of Appraisers. Completion of 350 continuing education hours in 2020- 2021 including attendance at numerous events including presentations by IRS Counsel Theresa Melchoire with discussions specific to Internal Revenue Code procedure and recent tax court cases pertaining to deconstruction appraisals.
Mayur Dankhara, LEED AP, ISA AM- Accredited member of the International Society of Appraisers and has a Masters in Construction Management from Texas A&M and an undergraduate from University of Mumbai. Worked within the construction industry and deconstruction/personal property donation industry for 10 years. Currently working with many deconstruction firms and non-profits throughout USA for achieving best practices and guidance to the clients for deconstruction projects and personal property appraisals.
The Finances of Deconstruction
By necessity, deconstruction typically costs more than demolition due to the additional time needed to carefully take apart a structure with the aim of preserving the salvaged elements—opposed to the break-and-dump processes of demolition. However, these costs can be offset through tax deductions.
Individuals, pass-through entities, and corporations may be able to deduct the Fair Market Value of the materials and property on their tax returns.
For individuals and pass-through entities, these deductions are taken on the Individual 1040, Schedule A: Itemized Deductions:
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This deduction is limited to 50% of Adjusted Gross Income with a 5-year carry-forward. Corporations may take the deduction on their corporate income tax return, Form 1120:
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This deduction is limited to 10% of net income with the inclusion of specific add-backs, also with a 5-year carry-forward.
Appraisals
The IRS requires an appraisal for a donation of property with a Fair Market Value in excess of $5,000. Ensuring these appraisals are produced accurately and in line with Internal Revenue Code, relevant case law, personal property organization valuation principles as well as USPAP (the Uniform Standards of Professional Appraisal Practice) is critical to ensure client’s deductions can be substantiated and are not disallowed by the IRS.
Appraisal steps include:
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1.Determining the scope of the donation with the client and providing an initial estimated value range. We provide this at no cost.
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2.The client then ensures they qualify to take the tax deduction by consulting their CPA or tax professional.
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3.The client then chooses both a deconstruction team and a nonprofit or governmental entity to be the recipient of the donation.
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4.Once completed, the recipient organization provides a detailed receipt of all property received and accepted.
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5.An appraisal is produced based upon that final inventory list.
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6.Appraisals should include the following elements:
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a.Complete description of the property with corresponding photographs.
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b.Analysis and selection of comparable market sales at the correct market level, which is typically secondary retail sales at auction or firm offers of sale by retailers of pre-owned materials, furnishings, and other property.
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c.An appraisal report following IRS, personal property organizations and USPAP guidelines.
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d.Inclusion of both a macro and micro economic analysis of the current market for the materials.
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e.All corroborating data upon which our values were concluded.
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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:
Sales Comparison Approach (Market-based Approach)
Cost Approach
Income 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 used for financial planning and valuation purposes.
The Sales Comparison Approach is used for the vast majority of appraisals for charitable contributions as taught by the three organizations.
The International Society of Appraisers introductory textbook provides the following table:
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From the American Society of Appraisers, they state that the Sales Comparison Approach is used in most assignments:
Sales Comparison Approach is used when:
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a.The property is a non-income-producing property
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b.When a new or reproduced item would not have the same value or utility
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c.When the type of value and intended use of the appraisal dictate that the property be valued in its current (used) condition. 4
From the Appraisers Association of America:
The “comparative market data” (“sales comparison,” “market data,” or “market comparison”) approach is the most common method appraisers use when ascertaining values. The market comparison allows appraisers to analyze recent sales or offerings of comparable articles in appropriate markets where the article in question would normally be traded. Adjustments are made for each article based on age, condition, rarity, artistic merit, technical workmanship, current trends, and availability of the article as compared to those recent sales.5
Appraisers must ensure they are qualified appraisers, use correct methodology, produce a comprehensive appraisal, and use correct valuation methodology to protect the taxpayer from having their deduction disallowed.
By the Numbers
As an example, assume a taxpayer has an effective (average) federal tax rate of 20% and a state tax rate of 5% for a combined rate of 25%. This also assumes that the state permits deductions for charitable contributions. Please refer to the site in footnotes for a complete listing.6
Donation: Kitchen cabinetry, high-end appliances, granite countertops, light fixtures.
Fair Market Value: $20,000
Net tax benefit: $5,000
An accurate and compliant appraisal will include the following information:
Step One : Literal Description—The first step to be taken is for an appraiser to give a literal description of the donated property. Let’s take the example of a donated door. A literal description of the door would be:
Six-panel door, manufactured of pine and painted white, having a solid core with six beveled frames, devoid of hardware and without inclusion of the door jamb. Dimensions: 80”H x 36”W. The door is in overall good condition with noted signs of chipped paint along the bottom.
Step Two : Comparable Sales—The appraiser should present comparable sales to substantiate their concluded value. In this case, a comparable sale could be included with the following description:
Comparable 1: This is a sale of a similar six-panel door, also in pine but having an unfinished rather than painted exterior. The door has the same dimensions and is in used good condition, with similar wear evident along the interior edges. The sale occurred at Sample Retail on 12/31/20 for $105. The sale included antique style brass hardware including a knob and hinges as well as the door jamb.
Step Three : Adjustments to Value—The appraiser then makes adjustment to the comparable sale to conclude final value.
In concluding value, I considered this sale as relevant due to the following factors: The door is of similar dimensions and the lack of paint does not appear to affect value after a review of other comparable sales. The door is in similar condition to the appraised but requires adjustments downward due to the inclusion of hardware, hinges, and a door jamb. The sale occurred within close proximity to the effective valuation date. The appraised value is adjusted downward to $85.
Then, a copy of the comparable sale should be included within the appraisal.
This is a simple example. Some properties require the review of many comparable sales to conclude value with lengthy descriptions and detailing of comparable property characteristics. However, the valuation methodology, which requires researching consummated sales on the open market and making adjustments to value, is the same whether appraising this door or a Louis XVI fauteuil.
Additionally, current market conditions need to be researched and documented. This is especially pertinent in the economically volatile times in which we currently find ourselves. Modern art prices have proven to be inelastic on the auction market but furniture from the French Empire style has taken a dive. It is a great time to procure a Napoleonic Egyptian style bureau plat!
How does the tax deduction work?
As briefly presented above, taxpayers can deduct the IRS defined Fair Market Value of the donated materials as an Itemized Deduction on their Schedule A or as a Charitable Contribution on their 1120 if they are a corporation. Pass-through entities take the deduction at the personal income tax level.
Important Tax Considerations
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1.To take the deduction for Non-Cash Charitable Contributions a taxpayer must itemize deductions (1040 Schedule A) as opposed to taking the standard deduction. With the Tax Cuts and Jobs Act (TCJA) the standard deduction was significantly raised. For 2021 the standard deduction will be $12,550 for single taxpayers, $25,100 married joint and $18,000 head of household. The taxpayer needs to ensure that they are above the standard deduction before including the value of the charitable contribution. For example, if your itemized deductions come in at only $14,000 before taking the charitable contribution, the net tax value of the donation will be less than if you had already exceeded the standard deduction threshold. Keep in mind the following categories that comprise the Schedule A, Itemized Deductions:
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a.Medical Expenses—Only included when they exceed 7.5% of Adjusted Gross Income (Congress recently acted to reduce this from 10% to 7.5%.) This is rarely taken by taxpayers as it is a significant AGI hurdle to cross and typically only taken by taxpayers with high deductible insurance and/or significant medical expenses.
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b.State and Local Taxes (SALT)—Now capped at $10,000. This includes state income taxes paid and local property taxes including real estate and personal property. For a taxpayer who paid $23,000 in SALT, they lose $13,000 of the deduction and are capped at $10k.
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c.Mortgage Interest—Capped at interest on a mortgage loan less than $750k post 2018, $1M pre-2018.
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d.Charitable Contributions—Cash contributions are permitted up to 60% of AGI with a five-year carry-forward and Non-Cash up to 50%, with the same carry-forward. Please note that 2020 cash contributions had the floor raised to 100% of AGI as part of the CARES Act.
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2.What is the value of the Non-Cash Charitable Contribution? If the donation is being lopped on top of the starting point for the standard deduction, it is worth the taxpayer’s Effective Tax Rate. This is the same as the average tax rate. Please note it is not the Marginal Tax Rate, which is the highest income tax bracket hit. Also, please note that most states allow an itemized deduction for charitable contributions, but a few do not including any state with a 0% state income tax rate and the following states: Connecticut, Illinois, Indiana, Massachusetts, Michigan, New Jersey, Ohio, Pennsylvania, Rhode Island, Tennessee, and West Virginia. If 8 you live in Virginia and have a federal effective tax rate of 20% and a state tax rate of 5%, each dollar of contribution will reduce your taxes by $.25.
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3.What tax forms are required for taking the deduction? If the donation of materials is in excess of $5,000 then the IRS requires an IRS defined Qualified Appraisal by an IRS defined Qualified Appraiser. The taxpayer must remit IRS Form 8283, which must be filled out by the client in its entirety and signed by both the nonprofit and the appraiser. Please note case Loube v. Commissioner, the deduction was disallowed when the taxpayer did not properly full out the form and the appraiser forgot to sign.
Here are the portions of the form the taxpayer must ensure are filled out correctly:
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4.What is IRS defined Fair Market Value? Like all IRS definitions, this must be followed with exactness. Fair Market Value is defined in Treasury Regulation §1.170A-1(c)(2) as,
The price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts. If the contribution is made in a property of a type which the taxpayer sells in the course of his business, the Fair Market Value is the price which the taxpayer would have received if he had sold the contributed property in the usual market in which he commonly sells, at the time and place of the contribution and, in the case of a contribution of goods in quantity, in the quantity contributed. The usual market of a manufacturer or other producer consists of the wholesalers or other distributors to or through whom he customarily sells, but if he sells only at retail the usual market consists of his retail customers. If the donor makes a charitable contribution of property, such as stock in trade, at a time when he could not reasonably have been expected to realize its usual selling price, the value of the gift is not the usual selling price but is the amount for which the quantity of property contributed would have been sold by the donor at the time of its contribution.
This definition requires the appraiser to determine the value based upon actual market data procured from secondary retail sales and offers of sale. Personal property appraisal organizations call this approach the Sales Comparison Approach.
The values must be tethered to these comparable sales to accurately value the materials.
Potential Tax Law Changes
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1.Restoration of the 39.6% top. Higher effective (average) tax rates make every dollar’s worth of non-cash donation worth more.
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2.Long-term Capital Gains tax rate of 39.6% potentially for households with >$1M in income. This comes into play with donating appreciated property like art, antiques and collectibles rather than selling. The Fair Market Value deduction at a higher effective tax rate may net a higher return than selling and paying taxes on the increase over basis.
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3.Extend the higher Child Tax Credit and make it permanently refundable. Taxpayers with children will, consequently, have lower effective tax rates and donations will be worth less in after-tax benefits.
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4.Repealing the State and Local Tax (SALT) cap of $10,000, opening up higher total Schedule A “Itemized” deductions.
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5.Potentially cap Itemized Deductions at 28%. Higher earners would have their non cash donations capped. For example, if a taxpayer had an effective tax rate of 35%, they would lose 7% of their itemized deductions.
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6.There have, so far, been no changes regarding the 50% Adjusted Gross Income limitation and 5-year carryforward for non-cash charitable contributions, or any other line-item dealing with donations to charity.
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7.Changes could potentially be retroactive.
What makes an appraiser qualified?
The IRS provides educational and experience qualifications outlined to ensure competency. However, there is no licensure, either state or federal, for personal property appraisers. There are reputable personal property appraisal organizations who sponsor the congressionally organized Appraisal Foundation, a nonprofit helping to heighten appraiser education and standards. They also promulgate USPAP, the Uniform Standards of Professional Appraisal Practice. At a minimum expect and demand the following standards from your appraiser:
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1.Review the appraiser’s CV to ensure they have undergraduate and preferably graduate education credentials in a field in which valuation theory and processes are firmly understood. All members of the appraisal team, both owners and staff appraisers should have sufficient college and relevant course-related education completed and up to date.
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2.Ensure your appraiser is an accredited member of one of the three personal property organizations:
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a.American Society of Appraisers (ASA)
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b.Appraisers Association of America (AAA)
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c.AInternational Society of Appraisers (ISA)
These organizations are a wealth of knowledge in appraisal methodology and valuation theory. Personal property, be it fine art, antique furnishings, or a salvaged four-panel door are valued based upon the examination of the current market for that property. If a market exists for the property, the value must be anchored to a study within the market. This includes excruciatingly detailed analyses of comparable properties that is currently or has been available on the market, analysis of this data, and a final conclusion of value adjusting from these market values. This primary valuation methodology used in personal property appraisals is not up for debate. It is presented as fact within all three organizations.
Simply paying a yearly membership due without taking the rigorous courses, examinations to become accredited. In addition, accredited members have their appraisals reviewed by the organization and they must pass to receive accreditation.
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3.The appraiser or owners of the firm must not be precluded from preparing appraisals for the IRS as detailed in IRS Circular 230, found here: https://www.irs.gov/pub/irs-pdf/pcir230.pdf. Appraisers prepare documentation “relating to a taxpayer’s rights, privileges, or liabilities under laws or regulations administered by the Internal Revenue Service.” They are held to the same standards as attorneys, CPAs and other enrolled agents presenting documentation to the IRS. It sounds obvious but a quick criminal record check never hurts.
Circular 230 provides the following information:
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4.Request a sample appraisal and look for the following:
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a.Thorough market analysis that is up-to-date and relevant
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b.Adequate descriptions of the property
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c.Inclusion of comparable sales data in the analysis of all valued property
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d.An explanation of how the appraiser came to the concluded value. Simply plugging in a value does not suffice.
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e.Inclusion of photographs of all donated property
An appraisal should be a demonstration of an appraiser’s skills and they should be eager to provide you with a sample. Be wary of an appraiser unwilling to do this.
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5.Watch for warning signs from appraisers claiming to be:
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a.Audit proof
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b.Never had an IRS Audit—Impossible for the appraiser to know since the taxpayer is only notified should the return go to review and the appraisal be deemed unqualified
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c.USPAP Certified—Not a certification
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d.Licensed appraiser—No such license exists
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Ensuring Compliance with the IRS
Recent case law has demonstrated the importance of hiring an IRS defined Qualified Appraiser. In the case of Mann v. US (2019)7, Loube v. Commissioner (2020)8, and the Mann appeal, lost by the taxpayer, taxpayers lost a substantial tax deduction and was required to pay fines and penalties as well as legal costs.
Mann v. United States, 2019 and appeal in 2020
In both the original case and the appeal, the taxpayer lost. The first appraisal was of an intact residential real estate structure. The second appraisal used construction cost estimating software, R.S. Means, to calculate the value of the entire structure without any reference to what was constructively donated to the nonprofit. Many materials that were destroyed on site, were included within the donation value despite never being donated. As the appeal made clear, the appraiser should have been relying upon sales in the open market to conclude Fair Market Value. This approach, the Sales Comparison Approach, is used in the majority of all personal property appraisals. The appraiser claimed to be using the Cost Approach or Cost New less Depreciation method, which the court rejected in the appeal.
From an article in The Tax Advisor:
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From the case text:
Finally, the nonprofit did not appear to have maintained an inventory of what was actually donated.
Loube v. Commissioner, 2020
The same appraiser and nonprofit involved in Mann were involved in this case in which the tax deduction was disallowed. In this write up by IRS Counsel Theresa Melchoire, the taxpayer, nonprofit and appraiser made the disallowance easy due to not filling out Form 8283 in its entirety. Ms. Melchoire provided the following memorandum entry. The valuation methodology, again, used R.S. Means to determine the value of the whole house without respect to what was actually donated and did not base the value on market data. Essentially, the house was valued in the pre-deconstructed state.
Chirelli v. Commissioner, T.C. Memo 2021027 March 3rd, 2021
This is another tax court case in which a taxpayer lost their non-cash charitable contribution due to lack of substantial compliance by the appraiser in producing an IRS Qualified Appraisal. There are important takeaways from this case to help protect taxpayers from losing their deductions and the subsequent paying of fines and interest should their appraisals not meet IRS standards.
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1.Like Loube v. Commissioner, 2020, Form 8283 was not filled out completely and signed by the taxpayer, nonprofit and appraiser.
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2.One of the appraisals grouped items into general categories without specifically describing them. As appraisers, one of our primary functions is to observe and identify what we are appraising. Accurate and detailed descriptions do just that. The case notes that the taxpayer did “not otherwise provide reliable written records credibly identifying the individual items donated, their values or condition, the manner of acquisition, the donation dates, or his bases in the property."
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3.The condition was also not specified, with a general category of “excellent” noted. Again, the appraiser did not back-up their work.
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4 .The Contemporaneous Written Acknowledgement letter (CWA), receipts, and accompanying substantiation were found lacking.
Choosing the wrong appraiser can compromise not just the tax deduction but trigger underpayment fines and penalties. There is an accuracy penalty assessed to the appraiser at times, but the major negative implications hit the taxpayer.
John D. Russell, J.D. of The American Society of Appraisers offers a great write-up of the case here:
JPeter J. Reilly with Forbes also offers an insightful look at the Chirelli case:
Nonprofits and Contemporaneous Written Acknowledgement
Appraisers must only appraise what has been donated to a nonprofit recipient organization. The IRS substantiates these donations through the Contemporaneous Letter of Acknowledgement (CWA) and must ensure that the nonprofit accepts everything the appraiser appraises. At The Green Mission Inc., we do not begin the research and appraisal writing engagement until we have received this detailed receipt from the nonprofit. The potential for inadvertent or deliberate misstatement of inventories exists without this check in place.
Following the rules closely ensures that the taxpayer will not have the entire donation disallowed at a later date, leading to large fines, attorney’s fees, and interest. This is especially true in a transaction where each party has some incentive to maximize the appraisal value and list of items donated. Nonprofits could be motivated to claim acceptance of an expansive list of inventory, some of which could never reach the nonprofit and could presently reside in the dumpster or landfill. This would allow the taxpayer a greater deduction, the appraiser a higher fee and the nonprofit potentially a higher cash donation or fee-for-service charge.
What is USPAP?
The Uniform Standards of Professional Appraisal Practice are “the generally recognized ethical and performance standards for the appraisal profession in the United States…adopted by Congress in 1989, and contains standards for all types of appraisal services, including real estate, personal property, business and mass appraisal.”10
These standards outline the proper appraisal engagement research and reporting requirements to ensure the public can trust appraisals and appraisers. At a bare minimum, all appraisers should be current on either the 15 hour initial USPAP course or the 7 hour continuing education course.
USPAP includes rules applicable to every appraisal field whether real, personal property or business valuation. The rules include:
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1.Ethics Rule
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2.Record Keeping Rule
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3.Competency Rule
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4.Scope of Work Rule
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5.Jurisdictional Exception Rule
The standards that apply specifically to personal property appraisals are:
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1.Standard 3: Appraisal Review, Development
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2.Standard 4: Appraisal Review, Reporting
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3.Standard 7: Personal Property Appraisal, Development
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4.Standard 8: Personal Property Appraisal Reporting
Ensuring Tax Deductions Remain Viable
Having attended multiple presentations by IRS counsel, appraisal organization representatives, and other industry experts, the guidance going forward is clear. The IRS has not stated that they are actively looking to disallow non-cash charitable contributions for deconstructed property. However, they have been clear on what is required to ensure the deduction is not disallowed.
Ensuring the appraiser is qualified as discussed above, is critical to ensuring taxpayers continue to choose deconstruction over demolition. In our experience, over 90% of clients choose to deconstruction over demolish due to the ability of the tax deduction to bridge the costs between demolition and deconstruction. If these deductions are disallowed due to appraisal and/or appraiser deficiencies, the entire reuse industry suffers.
Common sense about material valuation should prevail when considering detached personal property:
When pieces of a home are detached from the real property, they become personal property. The value of an intact real property structure is almost always of significantly higher value than as detached personal property. For a whole house deconstruction, if an appraiser is promising values of around $150,000 for a 1,500 square foot home, that is a valuation of $100 per square foot. Valuations that high are not based on market data and are grossly inflated. Finally, check the tax assessment records of the property. If a client receives an appraised value of $150,000 and the improvements are valued around the same level, something is terribly wrong with the appraised valuation.
We hope the information presented can help ensure the continued transition from demolition and dumping to deconstruction and reuse.
Reference Links:
1 https://www.irs.gov/pub/irs-pdf/f1040sa.pdf
2 https://www.irs.gov/pub/irs-pdf/f1120.pdf
3 ISA Core Course Lesson 1: Appraisal Theory, Part 1—Introduction
4 ASA Monograph 7 Analysis of Research: Approaches to Value Market Models
5 Gayle M. Skluzacek, AAA, Basic Methodology, Appraising Art—The Definitive Guide to Appraising the Fine and Decorative Arts
6 https://www.uscharitablegifttrust.org/tax-treatment-of-charitable-contributions.php
7 https://law.justia.com/cases/federal/appellate-courts/ca4/19-1793/19-1793-2021-01-06.html
8 https://casetext.com/case/loube-v-commr
9 https://www.thetaxadviser.com/issues/2021/mar/no-deduction-donation-house-deconstruction.html
