Fourth Circuit Affirms Denial of Charitable Deduction for "Donation" of Home

(Parker Tax Publishing January 2021)

The Fourth Circuit affirmed a district court's denial of a married couple's charitable donation of a house, and the personal property in it, to a charitable organization that provides job training to disadvantaged individuals through the salvaging of building materials from demolished homes. Because the wife was liable for property taxes on both the land and the house throughout the project, the court concluded that she neither conveyed her entire interest in the property nor even an undivided portion of the entire interest in the property and thus no charitable deduction was appropriate. Mann v. U.S., 2021 PTC 5 (2021).

Background

In 2011, Lawrence and Linda Mann bought a colonial-style house in Bethesda, Maryland, which was titled in Linda's name. They decided to demolish the house and build a new one. Before the demolition, the couple contacted Second Chance, a Code Sec. 501(c)(3) organization that engages in property "deconstruction," and asked about donating their house. Second Chance salvages building materials, fixtures, and furniture from properties that are demolished and also sells some salvaged items at its retail store. Second Chance does not perform demolition services, although its deconstruction efforts at times result in destruction of parts of the subject property, either because disassembly requires some destruction or because destruction is useful in training employees. To defray its costs, donors are asked to supplement their property donations with cash donations. The Manns signed a contract conveying to Second Chance all of their rights, title, and interest in the improvements, the building, and the fixtures on the property.

The agreement was not recorded in the county land records. By a separate agreement, Mrs. Mann also conveyed various pieces of furniture and other personal property in and around the house.

Second Chance told the Manns that donors could claim a deduction for all material that "crosses the threshold" of the Second Chance warehouse. Second Chance said it expected the deconstruction to yield items with a fair market value of $150,000 at a minimum, which would translate to a tax savings for the Manns of approximately $45,000. The Manns also made cash donations of $10,000 in 2011 and $1,500 in 2012. In response to both contributions, Second Chance sent a letter stating that the Manns received nothing of value in exchange for the donation and that the entire amount was tax deductible. After Second Chance completed the deconstruction in 2012, it informed the Manns that they had not been able to extract as much salvage material from the house as they had hoped. Second Chance did not keep a manifest or other record of exactly what materials were salvaged. Second Chance incurred approximately $13,100 in expenses in deconstructing the house. The deconstruction did not reduce the cost to the Manns of the subsequent demolition of the house.

The Manns obtained three appraisals in connection with their donations, two for the house and one for the personal property inside it. Appraisal A valued the house at $675,000 based on consideration of the highest and best use of the house, which the appraiser determined was keeping it intact and moving it to another site for use as a residence. Appraisal B established the donation value of the deconstructed house at $313,353. This figure was derived by calculating the cost to construct the house with new materials, then subtracting out labor and administrative costs, and then accounting for depreciation. This approach was used because of the lack of a well-established second hand market for all building materials used in the construction of the house. An appraisal valued the personal property at approximately $24,200.

On their 2011 tax return, the Manns claimed charitable donations of $675,000 for the value of the house, $24,200 for the personal property, and $10,000 for the cash donation. They claimed the $1,500 donation to Second Chance on their 2012 return. After the IRS disallowed all of these deductions, the Manns paid the taxes and sued for refunds in a Maryland district court. In 2016, in an effort to avoid litigating the 2011 deductions, the Manns filed an amended 2011 tax return, adjusting the deduction for the house donation from $675,000 to $313,353. In 2017, the Manns filed suit seeking a determination that their original claimed deductions were valid and a full refund of the additional taxes paid in 2011 and 2012 as a result of the disallowance of the deductions.

The IRS argued that the Manns could not deduct either the $675,000 fair market value or the amended $313,353 deconstructed value of the house because they donated only a partial interest in the property. The IRS also contended that the Manns could not deduct the donation of their personal property inside the house because the appraisal was deficient in several respects. As for the cash donations to Second Chance, the IRS asserted that they were nondeductible as quid pro quo for Second Chance's deconstruction services. According to the IRS, the Manns received the specific benefit of the deconstruction services in exchange for the cash donation and it noted that such services are available from for-profit businesses.

District Court's Decision

The district court granted summary judgment for the IRS as to the house and personal property deductions. The court found that under Maryland law, ownership of improvements to land follows title to the land; thus, for someone other than the record landowner to own the improvements, there must be a recorded deed showing the transfer of title to the improvements. In other words, record ownership, not contractual ownership, demonstrates ownership of improvements in Maryland. The court noted that the Manns tried to convey their interest in the house through a contract with Second Chance but never recorded the transaction. Thus, the house had not been properly severed from the land and transferred. In the court's view, the Manns' donation was comparable to the granting of a license to access and use the house for salvage and training purposes.

The court also determined that, even if the conveyance had been valid, the Manns would not be entitled to a deduction because neither of their appraisals were qualified appraisals. The court found that Appraisal A was invalid because it calculated the value of the house at its highest and best use, which did not apply to its use by Second Chance. Appraisal B, in the court's view, was invalid because it determined the fair market value of the house's building components when sold on the secondhand market, which was also not consistent with the use of the house for Second Chance's program. The proper way to calculate a tax deduction, according to the court, was to determine the resale value of the specific building materials and contents actually taken from the site. However, the court upheld the Manns' deductions for their cash donations because it found that the Manns received no specific benefit in return for the donations.

The Manns appealed the disallowance of the deductions. In maintaining that they were entitled to the $313,353 deduction - which represented the aggregate value of all of the house's components - the Manns argued that (1) they effectively severed the house from the real property by their written donation agreement; (2) they donated their entire interest in the house to Second Chance; and (3) the value of the house so donated was properly appraised in the $313,353 appraisal. They contended that their donation agreement "constructively" severed the house from the underlying land and that, under Maryland law, severance does not require recordation of the transfer, contrary to the finding of the district court. Moreover, they asserted, because they donated the house "in its entirety to Second Chance," it was appropriate for the appraisal to determine the value of "all of the materials in the house." Having accepted and received the donation, they said, Second Chance either salvaged the appraised materials or consumed them in its deconstruction training program, but that fact did not diminish the value of the donation.

Analysis

The Fourth Circuit affirmed the district court's holding. With respect to the Mann's argument that Maryland law has never required recordation of an agreement constructively severing an improvement from its underlying land, the court found that argument was not dispositive because, while Second Chance may have become the contractual owner of the house through the parties' donation agreement, Linda Mann nonetheless retained record ownership of the house and, accordingly, remained liable for paying property taxes on the house despite the parties' contract. Under Maryland law, the court noted, the term "real property" includes both land and improvements to land and, because improvements affixed to the land are considered part of the real property, ownership of the improvements follows title to the land. The court cited the decision in Supervisor of Assessments of Baltimore County v. Greater Balt. Med. Ctr. (GBMC), 32 A.3d 174 (Md. Ct. Spec. App. 2011), in which the court held that, under Maryland law, real property includes both land and improvements to land. Because improvements affixed to the land are considered part of the real property, the court said, ownership of the improvements follows title to the land.

In GBMC, the Maryland Court of Special Appeals concluded that the "owner of real property according to the land records" is also the "record landowner" of "the improvements built thereon" - and thus responsible for paying property taxes with respect to the improvements - unless there is "a recorded deed or other instrument of record showing a transfer of the title to the improvements to another owner." It was clear to the Fourth Circuit that, because the transfer to Second Chance of the Mann's house was never recorded in the public land records, Linda Mann always retained record ownership of the house. And this meant that, during the period between when Linda and Second Chance executed the donation agreement and the date of the house's demolition in July 2012, Linda was liable for property taxes on both the land and the house. And because Linda retained this aspect of ownership, the court concluded that the Manns neither conveyed their entire interest in the property nor even an undivided portion of their entire interest in the property. Thus, they did not qualify for a deduction of a partial interest in property as allowed for deduction by Code Sec. 170(f)(3)(B)(ii).

For a discussion of charitable contributions of partial interests in property, see Parker Tax ¶84,155. For a discussion of recordkeeping and substantiation requirements, see Parker Tax ¶84,190.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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