Case:

Karl was a man with the golden touch. Throughout his life, it seemed every investment idea that he touched turned to gold. Karl's passion was real estate and he was very successful in his investments.

Karl continued to buy and sell real estate at the age of 85. His latest venture led him to a great investment property. It was a "fixer-upper" commercial building in a great area. While other nearby buildings sold for over $2 million, the seller needed to sell quickly and was asking just $1 million.

The condition of the building turned many buyers away. It was being sold as-is, but Karl was not deterred. He could see great potential with the building and knew it would not take much to get it to market condition. Therefore, Karl swooped in, bought the building for $1 million and instantly hired contractors to refurbish the place.

After three months of hard work refurbishing the building, the place looked like new. In the end, Karl invested $250,000 in the building bringing his total investment in the property to $1.25 million. One month after the completion of the work, Karl was contacted informally by a company that expressed an interest in the building – a $2 million interest. This was no surprise to Karl. He knew the building was another great buy.

After Karl learned about the benefits of a FLIP CRUT, he eagerly wanted to move forward. (See Parts 1 and 2 for a full discussion of this decision) It looked like the perfect solution. However, Karl did still have some important questions.

Question:

Karl wanted to know what steps are needed in order to substantiate his charitable income tax deduction? He knew the IRS would not just "take his word for it."

Solution:

This is a very important question as it is crucial that Karl follows the valuation and substantiation rules closely. Indeed, taxpayers are consistently denied their charitable income tax deductions when the required record keeping and documentation are not obtained by the IRS required deadlines.

The appraisal. When a donor makes a gift of property (other than cash or public securities) over $5,000, a qualified appraisal is required. However, there is an exception for non-publicly traded stocks if the value does not exceed $10,000. The appraisal must be performed no earlier than 60 days prior to the gift and no later than the due date of the donor's income tax return, including extensions. This appraisal timeline provides donors with flexibility regarding the completion of the appraisal. However, the appraisal must value the property as of the "date of the gift," irrespective of the actual date the appraisal was completed.

The appraisal must include many items of information, including the following:

1) A detailed description of the property
2) The physical condition of the property
3) The date or expected date of the gift
4) Any agreement or restriction regarding the use of the property
5) The name, address and tax ID number of the appraiser
6) The appraiser's qualifications
7) A statement that the appraisal was done for income tax purposes
8) The fair market value of the property and cost basis
9) The method by which the asset was acquired and approximate date
10) The method and basis for property valuation
11) The date of appraisal
12) The appraiser declaration and signature

The appraiser. Because of the tax and legal implications inherent with charitable income tax deductions, it is required that a qualified appraiser perform the appraisal. There are several important factors for determining the qualification of an appraiser.

The appraiser will be qualified if he or she has an appraisal designation from a recognized organization, has otherwise met comparable education experience requirements, regularly performs and is paid for appraisals, has verifiable education and experience with the type of property appraised, has not been prohibited from practicing before the IRS and has not been excluded by Treasury regulations from serving as an appraiser. Sec. 170(f)(11)(E)(ii).

For real property gifts, the appraiser meets the required standards if he or she is licensed or certified for the type of real property by the appropriate state agency. Some state agencies have a separate certification for certain types of real estate, such as residential and commercial real estate. In these states, the appraiser must have the appropriate designation for the type of real estate gifted to charity. Notice 2006-96; 2006-46 IRB 1.

For gifts that are not real property, the appraiser must fulfill three requirements. He or she must have completed "college or professional-level coursework," must have two years of experience in buying, selling or valuing the type of gifted property and must thoroughly describe, in the appraisal, his or her education and qualifying experience.

Generally, appraisals will qualify if consistent with the Uniform Standards of Professional Appraisal Practice set forth by the Appraisal Standards Board of the Appraisal Foundation. Notice 2006-96, Section 3.03.

Appraisals must also include a statement that the appraiser recognizes that a substantial or gross valuation misstatement that he or she knew or reasonably should have known would be used on a tax document could lead to a civil penalty. Sec. 6695A(b). The appraiser penalties for incorrect appraisals are the greater of $1,000 or 10% of the underpayment from a substantial or gross valuation misstatement, with a cap of 125% of the appraiser's gross income from the appraisal. Sec. 6695A(b). The IRS may also discipline appraisers after notice and a hearing. Disciplinary action may include suspending or barring an appraiser from preparing or presenting appraisals to the IRS.

In addition to the factors listed above, there are rules that prevent certain individuals from being the appraiser. For instance, the donor, an employee of the donor, persons related to the donor and the charitable donee will not be considered qualified appraisers.

Based upon this information, Karl wisely hires a prominent and respectable independent real estate firm to value his building. Not surprisingly, the firm's extensive experience in providing appraisals for income tax purposes gives Karl a great deal of comfort and peace of mind.

Editor's Note: In Part 12 of this case study series, we will address the need for Form 8283 and the rules regarding its filing.