Tuesday January 28, 2020
Article of the Month
Substantiation Requirements for Charitable Contributions, Part IV
The Internal Revenue Service requires donors who claim charitable income tax deductions to substantiate the value of their charitable contributions. Donors may not understand the specific substantiation requirements when making charitable donations. The Service's substantiation rules are strict, and if these rules are not closely followed, a donor may lose his or her entire charitable deduction. Advisors should be prepared to explain these requirements, guide their clients through the process of substantiating charitable gifts and work with charities to meet the Service's requirements.
This article series explores the substantiation requirements for charitable contributions. Part IV of this series will review the final regulations for qualified appraisals. This series will discuss the specific requirements to meet the Service's qualified appraisal standards. By understanding the substantiation rules under the final regulations, advisors can help ensure that their clients obtain qualified appraisals to substantiate their charitable donations.
Qualified Appraisal Requirements
On July 27, 2018, the Internal Revenue Service published final regulations on the requirements for qualified appraisals and qualified appraisers. The final regulations are effective for charitable contributions made on or after January 1, 2019 and may be relied upon for appraisals prepared for returns or submissions filed after August 17, 2006. Reg. 1.170A-17(c). For a full discussion of when a qualified appraisal is required see Parts II and III of this series.
The Service's definition of a qualified appraisal is "an appraisal document that is prepared by a qualified appraiser." Reg. 1.170A-17(a)(1). The appraisal must comply with "generally accepted appraisal standards" and the remaining requirements contained in paragraph (a). Reg. 1.170A-17(a)(1).
For donations of items not in a group of similar items of property, the donor is required to obtain a separate qualified appraisal for each item. Reg. 1.170A-17(a)(7). A similar item of property is defined as "property of the same generic category or type." The Service provides examples of category groups in Reg. 1.170A-13(c)(7)(iii).
ExampleA qualified appraisal may be acquired as early as 60 days prior to the date of the charitable contribution, but no later than the due date of the tax return, including any extensions. Reg. 1.170A-17(a)(4). A qualified appraisal must be received by the donor prior to the due date, including any extensions, of the tax return on which the charitable tax deduction is first claimed. Reg. 1.170A-17(a)(8). The same timing applies if the charitable deduction is passed through from a partnership or S Corporation to the individual taxpayer. If a charitable deduction is first claimed on an amended tax return, the qualified appraisal must be received by the date on which the amended return is filed. Reg. 1.170A-17(a)(8).
Rose, an avid art enthusiast, visited many museums and art collections. Over time, Rose became quite the art collector, with various beautiful paintings proudly displayed in her home. She found that she was running out of wall space. Rose wanted to continue supporting the arts. She decided it was the right time to donate her Impressionist art collection to her favorite charity. She had owned all of the paintings for over a year. Later that same year, she decided to contribute her Realist art collection, which she acquired in the early 1980's, to the same charity. In response to an end of the year campaign conducted by her favorite charity, Rose decided to donate a photograph collection she purchased some time ago.
When Rose inquired about an appraisal, she was informed that she would need two qualified appraisals. One appraisal valued the Impressionist and Realist art collections and the other valued the photographs. The appraisal of the paintings was permissible because all of the art in each collection was comprised of paintings and thus satisfied the Service's definition of "similar items of property." Reg. 1.170A-13(c)(7)(iii). The photographs did not satisfy the meaning of the "same generic category or type," which is why she was required to obtain a separate appraisal for that donation.
Information About the Property
A qualified appraisal must contain a sufficiently detailed description of the property, taking into account the value of the property, so that a person not "generally familiar" with the type of property could ascertain that the appraised property is the contributed property. Reg. 1.170A-17(a)(3)(i)(A). If the appraised property is real estate or tangible personal property, the qualified appraisal must describe the condition of the property. Reg. 1.170A-17(a)(3)(i)(B).
If the property donated to charity is a partial interest, the qualified appraisal must be of the partial interest. Reg. 1.170A-17(a)(12). If a donor wishes to fund a charitable remainder trust with real estate, the entire property must be appraised, because the entire property will be donated. The deduction factors will then be applied to the full fair market value of the property to calculate the donor's charitable contribution. On the other hand, if a donor wishes to donate only a 10% undivided interest in the remainder of a property, the qualified appraisal must be of the contributed portion. Namely, the qualified appraisal would value the 10% undivided interest in the remainder of the property. Rev. Rul. 87-37.
Qualified appraisals may be obtained prior to or even after the property is contributed to charity (see Parts I and II for a discussion of cash and noncash gift substantiation requirements). The qualified appraisal must state the valuation effective date, which may differ from the date of the appraisal. Reg. 1.170A-17(a)(3)(i)(C).
Qualified appraisals must determine the fair market value of the contributed property on the valuation effective date. Reg. 1.170A-17(a)(3)(i)(D). The fair market value is "the price at which the property would change hands between a willing buyer and a willing seller." Reg. 1.170A-1(c)(2).
Agreements Regarding Contributed Property
Due to the requirements of Form 8283, if a contributed property valued over $5,000 is disposed of within three years of the date of the gift, the charity is required to report that disposition to the Service on Form 8282. The reporting on Form 8282 may require the donor to reconsider the reported value of his or her charitable deduction. In some cases, the Service may challenge the value of the original charitable deduction if the Form 8282 value is vastly different from the claimed deduction amount.
Therefore, the final regulations require that if the donor and charity have entered an agreement or understanding that relates to the use, sale or other disposition of the contributed property, it must be disclosed in the qualified appraisal. Reg. 1.170A-17(a)(3)(ii). Qualified appraisals must list restrictions to the charity's right to use or dispose of the contributed property, even if it is a temporary restriction. Reg. 1.170A-17(a)(3)(ii)(A).
If the charity does not have the full power and authority to designate the recipient of the contributed property's income, possession or rights to acquire, this must be disclosed in the qualified appraisal. Reg. 1.170A-17(a)(3)(ii)(B). This includes whether or not the right to vote contributed securities is fully vested in the charity. Reg. 1.170A-17(a)(3)(ii)(B). Any earmarks or designations for a particular use must also be disclosed in the qualified appraisal. Reg. 1.170A-17(a)(3)(ii)(C). The appraisal must also list the expected date of the contribution. Reg. 1.170A-17(a)(3)(iii).
Information About the Appraiser
The Service requires the name, address and taxpayer identification number of the appraiser to be included in the qualified appraisal. Reg. 1.170A-17(a)(3)(iv)(A). The appraiser is not required to use his or her social security number, because that raises privacy and identity theft concerns. An appraiser may obtain an employer identification number (EIN) from the Service to comply with the taxpayer identification number requirements.
The appraiser's qualifications regarding the type of property being valued must be included in the qualified appraisal. Reg. 1.170A-17(a)(3)(iv)(B). This must include the appraiser's relevant education and experience. Reg. 1.170A-17(a)(3)(iv)(B). Appraiser qualifications will be explored in a forthcoming article.
The appraiser must disclose if he or she is acting in the capacity as a partner in a partnership, an employee of any person or as an independent contractor engaged by someone other than the donor. Reg. 1.170A-17(a)(3)(iv)(C). If the appraiser is acting in one of the above named capacities, the name, address and taxpayer identification number of the partnership or person employing the appraiser must be listed. Reg. 1.170A-17(a)(3)(iv)(C). A person engaging the services of the appraiser may be an individual, corporation or partnership.
Specific Information Requirements
The appraisal must include the signature of the appraiser and the appraisal report date. Reg. 1.170A-17(a)(3)(v). The appraisal must state that it was prepared for "income tax purposes." Reg. 1.170A-17(a)(3)(vii). If an appraisal is lacking any required information, the entire charitable deduction may be disallowed. The final regulations do not include exceptions for reasonable cause or substantial compliance. Thus, it is vital that the appraisal includes all of the required information.
The appraisal must include a specific declaration from the appraiser, found in Reg. 1.170A-17(a)(3)(vi), which reads as follows: "I understand that my appraisal will be used in connection with a return or claim for refund. I also understand that, if there is a substantial or gross valuation misstatement of the value of the property claimed on the return or claim for refund that is based on my appraisal, I may be subject to a penalty under section 6695A of the Internal Revenue Code, as well as other applicable penalties. I affirm that I have not been at any time in the three-year period ending on the date of the appraisal barred from presenting evidence or testimony before the Department of the Treasury or the Internal Revenue Service pursuant to 31 U.S.C. 330(c)."
Information About the Appraisal Process
The final regulations specifically name three valuation methods that may be used for determining the value of an asset for a qualified appraisal. These include the "income approach," the "market-data approach" and the "replacement-cost-less-depreciation" approach. Reg. 1.170A-17(a)(3)(viii). Using one of the three specifically mentioned valuation methods may be helpful to ensure that the appraisal meets the Service's regulations.
In addition to a valuation method, the appraisal must include the "specific basis" used for the valuation. Reg. 1.170A-17(a)(3)(ix). The specific basis may include specific comparable sales transactions or statistical sampling. Any basis for the valuation must include "justification" of the use of the sampling and an explanation of the procedures used for sampling. Reg. 1.170A-17(a)(3)(ix).
Timing of the Appraisal
The qualified appraisal must state the valuation effective date. Reg. 1.170A-17(a)(5)(i). The donor may obtain a qualified appraisal prior to or after donating property to charity. If an appraisal is obtained prior to the date of the gift, the valuation effective date on the appraisal must be no earlier than 60 days prior to the gift date and no later than the donation date. Reg. 1.170A-17(a)(5)(ii). If an appraisal is obtained on or after the donation date, the qualified appraisal must have a valuation effective date that matches the gift date. Reg. 1.170A-17(a)(5)(ii).
The Service included warnings to donors in Reg. 1.170A-17. A donor may meet all of the requirements of the regulations in their appraisal, but if the donor withholds or misrepresents facts that may affect the value of the property, the appraisal will not be considered a qualified appraisal. Reg. 1.170A-17(a)(6). This rule applies even if the withheld or misstated facts did not affect the property's appraised value. If the Service makes a finding of a failure to disclose or a misrepresentation of facts, the qualified appraisal fails and the charitable deduction will be disallowed.
Donors must retain qualified appraisals "for as long as it may be relevant in the administration of any internal revenue law." Reg. 1.170A-17(a)(10). The cost of the qualified appraisal must not be dependent on the appraised value of the property. Reg. 1.170A-17(a)(9).
A qualified appraisal may be disregarded if at any time during the three-year period prior to the date on the appraisal the appraiser was prohibited from practicing before the Service under 31 U.S.C. Sec. 3330(c). Reg. 1.170A-17(a)(11). There is one narrow exception. If the appraisal meets all of the other qualified appraisal requirements and the donor has no knowledge that the signature, date or declaration of the appraiser was false when it was signed by the appraiser, then the appraisal will be considered a qualified appraisal, but the value of the asset will be disregarded. Reg. 1.170A-17(a)(11).
Advisors may be asked to assist their clients by finding a qualified appraiser for purposes of substantiating a charitable deduction. It is important for professional advisors to understand the qualified appraisal requirements under the final regulations.
Advisors and charities should be aware of the qualified appraisal requirements to ensure that appraisals are completed fully before they are submitted to the Service. It is essential that qualified appraisals are completed accurately and timely by an appropriate appraiser in order to allow donors to substantiate charitable deductions in the appropriate year.