In light of Covid-19, a global pandemic, our economy is in a potential freefall and entering unchartered waters. Our country’s climate emergency continues to be of utmost importance despite the fact that all attention is currently on the pandemic—rightfully so. As waste diversion industry members, we must provide cohesive leadership to ensure the large gains in construction and demolition waste diversion continue throughout the pandemic at perhaps a smaller capacity and are ready to reignite with the larger construction economy after weathering this terrifying storm. First, we must examine history to determine what the tax code will most likely resemble post-emergency.
Look to History for Insight into Future Tax Rates
The Covid-19 stimulus checks coupled with forgivable small business loans as well as increased unemployment benefits are critically needed—but they will increase the federal deficit with no clear pathway towards repayment for many years.
Estimates on the cost of the global pandemic have put the bill around $4.1 trillion globally. This pandemic has been compared to war-time economic conditions. A recent study by McKinsey & Company projects that an economic recovery may not happen until 2023. The US impact could be worse than after World War II. 1 Before the first World War, Congress passed the 1916 Revenue Act followed by the War Revenue Act raising the highest income tax rate from 15% in 1916 to 67% in 1917 to 77% in 1918. What followed was a brief respite dropping to 25% from 1925-1931. The Great Depression showed rates rising from 25% up to 63%. In 1944, World War II resulted in a top income tax rate of 94% and in the three decades that followed the rate never fell below 70%. 2 The IRS provides a detailed table of historical tax rates from the inception of the income tax in 1913 to the present. 3 It should be a foregone conclusion that we will be looking at higher tax rates in the years to come.
Even before the Covid-19 undertook record spending of close to $2.3 trillion, the US budget deficit was at the highest rate since 2012. Conservative estimates suggest an additional $2 trillion will need to be spent to ensure our economy and residents stay afloat. With businesses and the economy suddenly contracting, tax revenues will shrink proportionally. 5
Why get into the weeds on tax issues with regard to the ongoing viability of deconstruction? Subjective and objective research demonstrates that deconstruction projects are often completed based solely on the availability of tax deductions to offset the costs of deconstruction and to make the slightly longer work timeline more palatable. Our other writings detail the availability and specifics of the tax deduction for taxpayers.
Reuse yards run on donations. As stated above, donations from deconstruction projects are motivated by the availability of tax deductions for individuals, pass-through entities and corporations. Those donations are worth more when effective tax rates are higher. The Tax Cuts and Job Act reduced effective tax rates and also increased the standard deduction making deductions for charitable donations nonexistent if the taxpayer could not overcome the standard deduction and worth a lot less with lower effective tax rates. If a taxpayer has a federal effective tax rate of 18% and a state tax rate of 5%, the deduction was valued at only 23-cents of every dollar. This landscape will look much different if effective tax rates become closer to 40% federally and state tax rates rise to 10% in states where current tax rates are between 4-6%, for example. As of this writing, state and local governments have been left out of the diffusion of stimulus funds, to a large degree, with some politicians suggesting they declare bankruptcy. We would expect state tax rates to rise along with federal. These higher effective tax rates could potentially drive more taxpayers to make charitable contributions hoping to reduce heavier tax burdens.
While taxpayers seek to aggressively reduce their taxable income, federal and state revenue agencies will be just as motivated to stop illegal tax shelters.
Deconstruction Appraisals Circa 2000-2020
We have authored numerous articles detailing the alleged and actual irregular (or what some might call fraudulent) production of deconstruction appraisals. Please reference our other writings for detailed research on the deconstruction appraisal market over the past few decades. It might not be hyperbole to posit that the IRS is flooded with potentially “unqualified” appraisals. This has been accomplished by an amazing feat of flying under the radar and keeping the nationwide group of deconstruction appraisers to a group of less than 20. Since entering this market over the past year, we have delved into reading, as of today—4,600 pages of appraisal research recommended by the three major personal property appraisal organizations: American Society of Appraisers, International Society of Appraisers and Appraisers Association of America. The most recent publication of the Uniform Standards of Professional Appraisal Practice (USPAP) and the accompanying Advisory Opinions and Frequently Asked Questions as well as IRS codifications, Generally Accepted Accounting Principles, Financial Accounting Standards, applicable tax court case law and legal and tax professional analysis of relevant appraisal topics.
The Three Important Questions to Ask a Deconstruction Appraiser
- 1.Do you primarily use the Sales Comparison Approach? If not, what approach do you primarily use and why?
- 2.What is your level of education including college and graduate studies?
- 3.To what personal property appraisal organization are you an accredited member?
In all personal property appraisal work, not just deconstruction appraisals, the Sales Comparison Approach is the predominant approach to be used per appraisal organization standards. Reviewing public case law as well as speaking with industry members, we posit the majority of current deconstruction appraisers use the Cost Approach to value. Additionally, we believe the majority of appraisers use construction estimating cost software like RS Means or Marshall & Swift to plug deconstructed materials into the database, assign some depreciation and take the output as appraised value. We have not received feedback from current appraisers defending their use of the Cost Approach to the exclusion of the Sales Comparison Approach. Even if an appraiser arrives at an appraised value using the Cost Method that is the same or less than what would be arrived at using the correct methodology (Sales Comparison) the IRS could potentially disallow the deduction based on the appraisal methodology being inappropriate.
Most personal property appraisers across all disciplines (art, antiques, gems, etc.) have at the very least an undergraduate degree if not a Masters.
Finally, being a member of one of the three major personal property appraisal organizations listed above (ASA, ISA or AAA) require accredited members to follow USPAP. There are numerous deconstruction appraisers who do not belong to one of these organizations.
The Path Forward to Promote Deconstruction and Avoid Lost Deductions
The deconstruction and reuse industry can no longer bury their heads in the sand with regard to the current pool of deconstruction appraisers. It also must be considered that the IRS is flooded with 8283s and accompanying appraisals that are currently being disallowed and many more which will receive the same treatment. The taxpayer will bear the brunt of these disallowances. As word spreads of these audit disallowances, many could choose not to deconstruct not wanting to take the audit risk and reduce deconstruction projects and donations. The best way forward is to have internal regulation of our own processes and ensure transparency and correct information is available to taxpayers, their CPAs, tax attorneys and other interested parties.
The confluence of a global pandemic with the drastic dropping of collected tax revenue coupled with taxpayers looking for savvy tax planning strategies along with deconstruction ordinances in cities like Palo Alto could create the perfect storm of tax audits, disallowance of deductions and a major setback for the deconstruction industry.
Correct Deconstruction Appraisal Methodology
Detailed Inventories Must be Maintained
The Green Mission Inc., provides quotes to potential clients free of charge. We produce these quotes after an in-person inspection or after we receive adequate photographic representation on which we can delineate the potential donated materials. This is in line with appraisal standards per appraisal organizations. We then produce a comprehensive inventory listing and send it to the deconstruction contractor and client for review. They may then remove or add materials or items based on donation plans. From there, we produce a quote using comparable sales data for every line-item, essentially producing a small appraisal. We provide the quoted value range to the client and they conference with their tax professional to determine if they can or will take a tax deduction. We do not plug in estimates based on square footage or use data kept only in our heads. Everything is quantified based upon underlying sales data captured and kept in the client’s work-file.
Appraisers must primarily use the Sales Comparison Approach
Just like our quotes are not based on estimation, our appraisals are produced by primarily applying the Sales Comparison Approach. We research numerous completed sales transactions in the correctly chosen and relevant market accounting for regional differences in value. For high-value items that appear to have varying price elasticity, we collect numerous comparable sales data points, run the mean, range, mode and median, toss out any outliers and use these basic statistical tools to substantiate the value we opine. Our appraisal report includes all comparable sales data within the appendix of the report. Some appraisers may claim the comparable sales data is kept within the work-file but that begs the question as to why it was not included within the audit report. While technically acceptable for an appraiser to keep some comparable sales data in the work-file, we propose that appraisers include it within the appraisal for both the client and IRS’ inspection. We include a narrative for most material and property values, including qualitative ranking of comparable sales data, and justification for our derived value including both inductive and deductive reasoning employed. We also include our statistical analysis for select items within the appendix, as well. Our appraisal report seeks to provide the most transparency for both the client and the IRS in evaluating the appropriateness of our valuations. We encourage our clients and their CPAs to e-file with the appraisal attached as a pdf or to paper file. This ensures the IRS has the complete appraisal on hand to review should they choose to dig deeper into the underlying valuations.
Appraisers who do the short-cut method of the Cost Approach plugging in numbers to construction cost estimating software can plow through an appraisal in about 15-30 minutes. Proper methodology takes a long time. Short cut approaches with hopes of artificially pumping up the deconstruction industry by essentially producing unqualified appraisals by unqualified appraisers is not sound economic theory.
Appraisers Must Become Accredited Members of an Appraisal Organization
The body of educational materials, testing standards, peer review and ongoing research into best-practices provided by these organizations is critical to a deconstruction appraiser’s knowledge base. Some appraisers were able to grandfather-in to these organizations prior to 2018 when college education became requisite. The client must take the time to not only ask the appraiser regarding their education level but ask if they are an accredited member of one of the three major personal property appraisal organizations: ASA, ISA and AAA.
Appraisals Available to the Nonprofit
We have implemented language within our contract allowing the receiving nonprofit or governmental entity to receive a copy of our appraisal. This allows the receiving entity to review the inventory and valuations assigned to the inventory and provides daylight between the three triads of the donation process: client, nonprofit and appraiser. The days of secretly gaining access to an appraiser’s report and then publicly shaming them for having square footage estimates deemed “too high” will be an act of the past. Every single deconstruction appraiser should be readily willing to provide a redacted copy of one of their appraisal reports, provide answers to the three questions we posed and, if not up to producing these appraisals correctly, seek a new revenue stream or career choice.
As stated at the outset, the IRS is already onto the alleged and actual fraud within the deconstruction industry. The time to take action to clean up the questionable dealings of the past few decades is now. Thankfully, personal property appraisal organizations and the vast readings available make a path forward easily identifiable. Ignoring the confluence of factors and hoping “all is well” with deconstruction appraisers could be a nail in the coffin of future deconstruction progress.
