DC Circuit Agrees With Tax Court That Failure to Disclose Basis of Contributed Property Results in Denial of a $33 Million Contribution Deduction

Courts prefer to decide issues on narrow grounds if they can, and a failure in completing Form 8283, which Forbes online contributor called an error that “would be a review comment that a senior accountant with three years experience would have given an associate,”[1] was the issue the Tax Court had focused on to deny a $33 million deduction to a partnership in the 2017 case of RERI Holdings I LLC v. Commissioner, 149 TC No. 1.

The Sixth Circuit did not come to the rescue of the taxpayer in this case, agreeing with the Tax Court that the failure to include basis information on the tax return was sufficient to allow a denial of the entire deduction. (Jeff Blau, et al v. Commissioner, USCA DC, Case No. 17-1266)[2]

The key issue in question is the taxpayer’s compliance with Reg. §1.170A-13(c)(2) that requires a taxpayer making a contribution of property other than publicly traded securities to:

  • Obtain a qualified appraisal;

  • Attach a completed appraisal summary, including the basis of the property, on Form 8283; and

  • Maintain records containing various specified items of information.

This case was covered when it was originally decided by the Tax Court this blog and a detailed analysis of that holding is found in that article.[3]  As was noted in that article, there were a number of issues with the contribution. 

But the fact that the Tax Court latched onto was the failure of the partnership to enter an amount in on Form 8283 for the basis of the property donated.  In this case, that basis would have been $2.95 million, while a deduction was later claimed for a donation of the property of over $33 million.[4]

As a condition of the donation, the University of Michigan agreed that it would hold onto the interest for two years before disposing of it.  At the end of that time the University sold the property in question—for $1,940,000 to a partnership that was owned in part by one of the donating partnership’s members.[5]  Suffice it to say that, while the parties conceded the sale by the University was not at fair market value,[6] it certainly seems that the $33,000,000 value was a bit on the aggressive side.

But, as was noted, the Tax Court and Sixth Circuit found that the failure to disclose the basis in this situation doomed the deduction even if that $33,000,000 value could be justified.  While panel refused to go as far as the IRS requested and rule that any failure to disclose required information is fatal (that is, a showing of substantial compliance wouldn’t be enough to excuse the failure and allow the deduction), it ruled that in this case the partnership would fail even if there is a substantial compliance defense.[7]

As the panel notes:

We conclude that, even if a taxpayer can fulfill the requirements of § 1.170A-13 through substantial compliance, RERI failed substantially to comply because it did not disclose its basis in the donated property; accordingly, we assume but do not decide that substantial compliance suffices. As we read the Tax Court's decision, a taxpayer must supply its basis (or an explanation for failing to do so) in order to “provide[ ] sufficient information to permit the Commissioner to evaluate the reported contributions, as intended by Congress.” 149 T.C. at 16. If that is correct, and we think it is despite RERI's several arguments to the contrary, then we need not choose between the Tax Court's standard for substantial compliance and the IRS's more exacting one.[8]

The panel agreed with the Tax Court’s view that even though the basis is not necessary to compute the allowable deduction, the disclosure rules of the law and regulations exist not merely to allow computation of the deduction, but also to bring to the IRS’s attention situations that look unusual, as this one clearly would have:

RERI fails to recognize that the purpose of the substantiation requirements is not merely to collect the information necessary to compute the value of donated property. The requirements have the broader purposes of assisting the IRS in detecting and deterring inflated valuations. Because the cost or other basis in property typically corresponds with its FMV at the time the taxpayer acquired it, an unusually large difference between the claimed deduction and the basis alerts the IRS to a potential over-valuation, particularly if the acquisition date, which must also be reported, is not much earlier than the date of the donation. In addition, as the Tax Court recognized, there are circumstances under which the basis affects the amount of the deduction allowed. 149 T.C. at 17 n.11 (citing § 170(e)(1)(A), under which the amount of a deduction must be reduced by “the amount of gain which would not have been long-term capital gain,” had the property “been sold . . . at its fair market value”). It is therefore unsurprising that the DRA expressly lists “the cost basis . . . of the contributed property” as information to be provided in substantiation of a charitable deduction. Though the Congress left it to the discretion of the Secretary of the Treasury to impose additional reporting requirements, the Congress specifically identified the basis and the date of acquisition as the bare minimum that a taxpayer must provide. We should be very reluctant to set to naught what the Congress deemed essential.[9]

The panel notes that, in this case, the difference between the basis of the donated property and the claimed deduction took the matter beyond merely hypothesizing that that giving the basis would have put the IRS on notice that the value reported might be in excess of the actual fair value.[10]

The panel also rejected the partnership’s view that the IRS should have viewed the blank entry as a zero basis which should have put the IRS on notice of the potential valuation issue.  As the panel notes:

RERI contends in the alternative that the omission of a number in a tax filing is typically construed as a zero, and that a zero provides the same red flag as does an unusually low basis. The point would have some force had the Secretary not provided for the donor to substitute an explanatory statement if it is “unable” to provide information on the cost basis. § 1.170A-13(c)(4)(iv)(C)(1). Because a taxpayer may lack information about its basis, the IRS reasonably chose not automatically to treat a blank box as a zero. RERI did not lack information about its basis or have any other excuse for its failure to report its basis.[11]

Finding that they couldn’t get a deduction due to a failure to document it property, the panel was able to nicely avoid entirely having to dig into the messy issue of whether the appraisal submitted met the requirements of a qualified appraisal under Reg. §1.170A-13(c)(3).[12]

This case illustrates that care must be taken to comply with all requirements, even ones that may seem “not important” and that don’t directly impact the calculation of tax.  Peter Reilly, in the column cited at the beginning of this blog, notes that this confirms one of his laws of tax planning:  read the instructions.  And, as he continued:

The Tax Court went with zero deduction, but not based on the sham theory.  On its own, the Tax Court came up with failure to substantiate based on that missing number on Form 8283.  There is something really satisfying with that result.  All these smart people with complicated math stuff planning the deal and attacking it and the Tax Court blows it up with what would be a review comment that a senior accountant with three years experience would have given an associate. RTI. (Read the instructions).[13]

[1] Peter J. Reilly, “Denial Of $33M Deduction That Yielded $2M To University Of Michigan Upheld On Appeal,” Forbes website, 5/26/18, https://www.forbes.com/sites/peterjreilly/2019/05/26/denial-of-33m-deduction-that-yielded-2m-to-university-of-michigan-upheld-on-appeal/#25d4f8da4ebe (website retrieved May 29, 2019)

[2] https://www.cadc.uscourts.gov/internet/opinions.nsf/24259E66C2EAE51F85258404004EBA72/$file/17-1266.pdf, retrieved on May 29, 2019

[3] Ed Zollars, “Failure to Report Basis of Property Donated Fatal to Charitable Contribution,” Current Federal Tax Developments website, July 5, 2017, https://www.currentfederaltaxdevelopments.com/blog/2017/7/5/failure-to-report-basis-of-property-donated-fatal-to-charitable-contribution?rq=RERI, retrieved from website May 29, 2019

[4] Ibid

[5] Jeff Blau, et al v. Commissioner, USCA DC, Case No. 17-1266 Court posted PDF of opinion, May 24, 2019, p. 5

[6] Ibid

[7] Ibid, p. 10

[8] Ibid

[9] Ibid, p. 11

[10] Ibid, p. 11

[11] Ibid, p. 12

[12] Ibid, p. 13

[13] Peter J. Reilly, “Denial Of $33M Deduction That Yielded $2M To University Of Michigan Upheld On Appeal,” Forbes website, 5/26/18, https://www.forbes.com/sites/peterjreilly/2019/05/26/denial-of-33m-deduction-that-yielded-2m-to-university-of-michigan-upheld-on-appeal/#25d4f8da4ebe (website retrieved May 29, 2019)