The Tax Policy Center: Urban Institute & Brookings Institute postulated that the Tax Cuts and Job Act (TCJA) enacted in 2017 and effectual in 2018 would “discourage charitable giving by reducing the number of taxpayers claiming a deduction for charitable giving and reducing the tax savings for each dollar donated.” 1
As a background, the TCJA enacted a higher standard deduction: $24,000 married filing jointly, $18,000 Head of Household and $12,000 single. Itemized deductions (taken on tax form 1040 Schedule A) now must surpass this level to be applied as a deduction. Itemized deductions are comprised of:
- Medical Expenses—These must be in excess of 7.5% of Adjusted Gross Income.
- State and Local Taxes—These include both state income tax, real estate and personal property taxes and are now capped at $10,000. Any amounts paid over $10k are lost—no carry-forward.
- Mortgage Interest—This is limited to $750,000 of originated mortgage interest 2018 or later. Limited to $1M prior to 2018.
- Charitable Contributions:
- Monetary—A taxpayer may deduct up to 60% of their Adjusted Gross Income with a 5-year carry-forward.
- Non-monetary—A taxpayer may deduct up to 50% of their Adjusted Gross Income, also with the same 5-year carry-forward.
- Miscellaneous Itemized Deductions—These no longer exist under the TCJA
- Casualty Losses—These are limited to areas affected by a federally-declared natural disaster.
The bottom line is it will be more difficult to overcome the standard deduction. Without itemizing, gone is the tax deduction for charitable contributions.
What does this mean for nonprofits dependent upon donations for their continued existence? Let’s first examine who exactly will be able to itemize. From the Tax Policy Center, “TPC estimates that the law will cut the number of those itemizing their charitable contributions by more than half, from 21 percent to about 9 percent of households. The share of middle-income households, defined here as those in the middle quintile of the income distribution, claiming the charitable deduction will fall by two-thirds, from about 17 percent to just 5.5 percent.”2 Furthermore, “The share of households itemizing their charitable contributions will fall even among high-income households. The share of households in the 90th–95th percentile (those making between about $216,800 and $307,900), taking a deduction for charitable gifts will drop from about 78 to 40 percent, and the share itemizing among households in the 95th–99th percentile (those making between about $307,900 and $732,800) will fall from 86 to 57 percent.” 3 Charitable contributions, for the individual taxpayer, will mostly be taken by the very high-income taxpayers.
This has numerous repercussions into which we will not delve within this forum. These include the wealthiest Americans picking the “winners” when it comes to who gets what in donation dollars or property donations. It also means that churches, school districts and other organizations, often supported by the middle-class, may experience disruptions in operations due to lack of funding from donations. Another phenomenon of “grouping” charitable donations into a single tax year in order to exceed the standard deduction will make fiscal planning by churches, charities, nonprofits and schools difficult to accomplish.
The Wall Street Journal reported on June 18th, 2019 that charitable donations by individuals did indeed drop after the first year of TCJA implementation but a dip in the stock market at year-end could have also played a factor. The article states it is too early to gauge the long-term effects on charitable giving, especially given how many taxpayers did not understand the TCJA and how it would affect their ability to take the standard vs. itemized deduction. 4 As a CPA of a small firm catering mostly to individuals and small businesses, the majority of my clients were surprised when they found out they could not deduct the contributions they made throughout the year due to the insurmountable standard deduction. The majority of my tax clients are middle-class individuals and small businesses.
However, let us turn our attention to ramifications for the non-monetary donation contribution. Per IRS guidelines, a qualified appraisal by a qualified appraiser is necessary for a taxpayer to claim a donation to a nonprofit for both individuals and corporations. Couple this with the new tax rates enacted under the TCJA, which include lower rates and wider brackets. This typically results in a lower effective tax rate at the individual level. Corporate tax rates are now 21%. This means that for an individual or corporate non-monetary property donation, the value of the donation is only worth the effective tax rate, which is lower than it was in pre-TCJA years. A donation might have been worth an effective tax rate of 35% federal 5% state before and is now worth 19% federal and 5% state.
What could this mean for the personal property appraisal industry?
- 1.Fewer individuals may choose to donate personal property and/or deconstructed building materials because they cannot itemize deductions. This means there will be fewer appraisals produced for individuals.
- 2.For those individuals and corporations who do make donations, the net effect on their tax deduction will be much lower than in earlier years. This could provide an unethical appraiser the motivation to artificially inflate values at the behest of the client, the nonprofit, the deconstruction contractor or another outside influential source.
All forthcoming examples are based on hypothetical situations and not based on particular industry observations.
Motivations for Appraiser Inflations
If the two assumptions above hold true, an appraiser will have fewer appraisals to produce each year resulting in a lower net income for the company. Prices charged to clients will probably start to edge upwards to make up for the loss in appraisal volume. Many appraisal clients come as referrals from friends and neighbors who deconstructed their homes or donated personal property and were able to realize a significant tax deduction on their 1040 Schedule A. Appraisals resulting in a lower dollar-value tax deduction may seem less worthwhile to taxpayers so referrals to the appraisal company may drop. Appraisers may realize this after 2019 taxes are completed and they hear back from clients regarding their low deductibility value due to a lower effective tax rate or their inability to take the deduction if they cannot overcome the standard deduction. An unethical appraiser may choose to inflate appraisals to subvert this inevitable trend. Artificial and unethical inflations can be achieved in myriad ways:
- 1.Increasing the quantity of materials, especially for materials that may not be easily inventoried by the nonprofits (ex: 500 2x4 wood pieces are donated and the appraiser changes it from 500 to 550.) There are no external industry-implemented checks on produced appraisals. Small manipulations like this could easily be fabricated throughout an appraisal with little chance of detection.
- 2.Quality of materials may be manipulated towards a higher-valued material (donation of stone may be classified as a different and more expensive type of stone.) Again, there are little to no external checks on inflations like this. The only chance of exposing this type of inflation is if the client’s tax return is pulled into a review. Even then, the appraiser could compose a rebuttal letter and claim that either quantity or quality is correct. The nonprofit may have no way of providing substantiation if the materials have already been sold or given away to their clients and if their inventories were not complete with accurate description and quantities. It should also be mentioned here that when a taxpayer is audited, the signatories on the 8283 (appraiser and nonprofit or government entity) are not always contacted. As an industry, we have no way of knowing who has been audited and do not have access to the associated appraisals to determine fraudulent valuations.
- 3.Some appraisers make use of software called RS Means to value donated materials. RS Means is software used by the construction industry to value new construction materials based on quantity and quality of materials while also bringing in regional price differences. After combing through IRS codifications and tax policy research, there is no indication this software was ever meant to be used to value deconstructed materials. In the majority of cases, use of the software results in inflated valuations. Of additional concern, the software allows easy data manipulation not just of quantity and quality but also depreciation. An unethical appraiser can change depreciation rates to life of assets that are way too high in years for applicable materials. Example: A refrigerator may have a useful life of 10 years and it could be calculated as a useful life of 30 years resulting in less depreciation and a higher valuation. Again, there is no external source to review these appraisals nor is there a review process in place by the IRS for appraisers who use software unsuitable to material valuation.
Motivations for Nonprofit Inflations
Some nonprofits are dependent on deconstructed material and property donations to accomplish their mission, whether it be a mission of waste diversion or providing construction materials or home furnishings affordable to an underserved community. If we assume the same effects from the TCJA implementation that we did in the appraiser examples above, we must examine how nonprofits could behave unethically.
- 1.Nonprofits often recommend appraisers or provide a list of “Qualified Appraisers” within a geographic region or nationwide. They will quickly determine which appraisers provide higher value-range quotes—initial estimates of value prior to the actual produced appraisal. It would be foolish to ignore the possibility that nonprofits push clients towards certain appraisers for inflated valuations
- 2.Another complicating variable occurs when nonprofits also provide deconstruction services. Industry leaders have reported that some nonprofits base their deconstruction service price on the initial value-range quote given by the appraiser. This suggests deconstruction costs could somehow be tied to the value of salvaged construction materials. The proposition is completely absurd, yet it remains a common practice for some nonprofits. Deconstruction costs have zero correlation with the value of the materials being taken apart. Additionally, some nonprofits communicate to the client that they can deduct the cost of the deconstruction services as a monetary charitable contribution. This is in direct violation of the IRS codifications stating a service cannot be provided for money donated or it is considered a fee-for-service and not a straight donation. To combat this, some nonprofits have suggested a small portion of the monetary donation not be claimed due to this fee-for-service issue but have left that value to be determined by the client.
- 3.Nonprofits may seek to control all three areas of the donation triad: appraisal production, nonprofit receipt of inventory and deconstruction services. They may insist a client contract with one of their “approved appraisers,” hence removing the independence of the appraiser with regard to oversight by the nonprofit. A suggestion to combat this would be an independent appraisal organization, USPAP or IRS to provide an updated list of all personal property appraisers, their education credentials, membership to an appraisal organization and, we hope, eventual licensure. This would also provide one point of reference should an appraiser be deemed unqualified by the IRS and unable to produce appraisals by law. Nonprofits have also been found to insist a donor work with specific deconstruction contractors and have also sought to have deconstruction contractors subcontract to work exclusively with the nonprofit. Not only do these subcontracts include terms requiring the deconstruction contractor to work exclusively for the nonprofit but they also must commit to sales and marketing strategies for the nonprofit. Said subcontracts often include non-compete clauses completely removing the independence of the deconstruction contractor with regard to the services they provide the client.
Motivations for Deconstruction Contractors
Deconstruction contractors are highly-skilled craftspeople with the ability to work backwards through construction processes. Because of the high level of skill, reputable and able companies are sometimes difficult to secure. However, with local deconstruction ordinances implemented in places including Portland, OR, San Francisco, CA, Palo Alto, CA and Milwaukee, WI, the demand for deconstruction contractors should rise. With the increase in demand, some deconstruction contractors may want to work closely with appraisers and nonprofits to secure work. While there is nothing wrong with networking to ensure market-demand is met with skilled supply, the same motivations that would drive appraisers and nonprofits to inflate valuations exist for deconstruction contractors. We should also remember point number two above under nonprofit motivations—many nonprofits also offer deconstruction services.
- 1.Deconstruction contractors may claim to have salvaged more materials than they actually did. This could be accomplished simply by adding fictitious building supplies to a list of salvaged-inventory given to the appraiser and the nonprofit. Some have claimed deconstruction contractors and nonprofits have actually dumped materials and then included them on the list of materials to be appraised. Because there is no system in place to police each deconstruction job, as an industry we must be vigilant to ensure this is never practiced. We can accomplish this by working closely, as an industry, to “see something-say something.” We will construct a website with hopes of gathering anonymous tips from the industry. We can also encourage recycling of materials not fit to be salvaged but that can still avoid the waste-stream. Increased targeted training of deconstruction contractors can also help increase the salvage/waste diversion rate so materials can be legitimately valued and donated.
- 2.Along the same lines as the hazards listed as potential nonprofit inflations, deconstruction contractors must be able to operate independently of pressures by nonprofits or appraisers.
We have a long way to go as an industry to rectify the abuses that have cropped up over the past twenty-or-so years since deconstruction and personal property valuation and donation became practiced. The tax deductions must remain intact to produce waste-diversion practices by both individuals and corporations. We cannot expect the IRS to act as the police, especially given their budget cuts and understaffing. Changes must be made within the industry by bringing together all those who practice ethically and embrace the larger waste-diversion mission. Healthy competition is good for any industry and typically leads to superior goods and services. However, appraisers, nonprofits and deconstruction contractors must not view the others within their specific sector as enemies. Working together to effect feasible and measurable change is tantamount. Prior articles have addressed the specific changes we suggest with regard to better policing of the “Qualified Appraisers.” Currently, the only check on unethical practices are when a taxpayer or corporation is audited as the onus is on them when it comes to underpayment penalties and disallowance. We have recently seen court cases where taxpayers have attempted to refute a disqualified appraisal with no change in resultant industry leader practices. As we conclude, the request goes out to industry representatives as to how we can better implement ethical practices across the three sectors. How can we institute regulations and safeguards to avoid the potential unethical and potentially fraudulent activities outlined above? How do we make this a positive coalition for change and not a nasty race-to-the-bottom with finger pointing and name calling? We continue to stand by our primary mission of waste diversion, carbon and methane reduction, maintenance of a clean groundwater supply and the many other positive effects of sustainable practice and policy. The ancillary mission of moving deconstructed materials and personal property into a reuse/recycle paradigm is accomplished only when the industry leaders come together to offer real solutions.
