Donating real property to a charity can both further your philanthropic goals and provide valuable tax deductions. But the IRS imposes strict rules on charitable deductions that you must follow if you want to reap the tax savings you expect.
The IRS generally requires taxpayers to obtain a qualified appraisal for charitable deductions that exceed $5,000. You also must complete Form 8283, Section B, and attach it to your tax return. If you claim a deduction of more than $500,000, you also must attach the appraisal to your tax return.
For real estate, the appraisal must contain a complete description of the property. While “complete description” isn’t specifically defined, the IRS provides guidance that the description may include certain items. For instance, a complete description may include such details as street address, legal description, lot and block number, physical features, condition, dimensions, zoning and permitted uses, the property’s actual use, and its potential use for other higher and better uses.
The appraisal also must include:
- The donation date,
- Terms of any agreement entered by or on behalf of the donor that relates to the use, sale or other disposition of the property,
- The name, address and taxpayer identification number of the qualified appraiser (see the sidebar “Who’s a ‘qualified appraiser’?”) and, if applicable, the same information for the person or partnership that employs the appraiser,
- The appraiser’s qualifications, including background, experience, and memberships in professional appraisal associations,
- A statement that the appraisal was prepared for income tax purposes,
- The date(s) the property was valued,
- The appraised fair market value (FMV) on the date of donation,
- The method of valuation used to determine FMV, and
- The specific basis for the valuation, such as any specific comparable sales transaction.
The appraisal itself must have been performed not earlier than 60 days preceding the date of donation. And, you must receive the appraisal report before the due date, including extensions, of the tax return on which the deduction is first claimed. If you’re first claiming the deduction on an amended return, you must receive the appraisal before the date the amended return is filed.
An appraisal may require the combined use of two, or even all three, of these valuation methods:
Comparable sales. This method compares the donated property with similar properties that have been sold. The sale prices — after adjustments for differences in date of sale, size, condition, location and other factors — indicate the estimated FMV of the donated property.
For each comparable sale, an appraisal must include the buyer’s and seller’s names, deed book and page number, date of sale, selling price, property description, amounts and terms of mortgages, property surveys, assessed value, and tax rate, along with the tax assessor’s appraised FMV. The appraiser should also document each item of adjustment.
Capitalization of income. The income method capitalizes the property’s net income at a rate that represents a fair return on the particular investment at the particular time, considering the risks involved, such as nonpayment of rent.
Replacement cost. This method isn’t typically used alone to determine FMV — it’s instead used to support the value reached using other methods. Replacement cost is calculated by considering the materials, quality of workmanship and number of square feet in the building. Consideration is also given to physical deterioration, functional obsolescence and economic obsolescence. When this method is applied to improved real property, the land and improvements are valued separately.
Importance of accuracy
Don’t underestimate the importance of an accurate appraisal. If the value is understated, you’ll miss out on your full tax-saving opportunity.
If the value is overstated and this causes you to underpay your tax by more than $5,000, you could be liable for a penalty on the resulting underpayment. A 20% penalty applies if the value or adjusted basis claimed is 150% or more of the correct amount. A 40% penalty applies if the value or adjusted basis claimed is 200% or more of the correct amount.
A charitable donation of real property can provide a significant tax deduction. Work with your tax advisor to ensure you don’t make any missteps that could unnecessarily reduce or eliminate your deduction or subject you to underpayment penalties.