Image by By Arturo Espinosa SeguirJacques Derrida for PIFALPencil on Fabriano. – This piece really has nothing to do with the kind of deconstruction that Derrida pioneered, but I could not resist the opportunity to upgrade the intellectual standing of the blog.
Chad and Dana Loube thought that they had found a great deal. They had purchased a property that was a teardown. They learned that there was a more tax-efficient socially responsible step on the way to achieving the vacant lot that they wanted to build on.
Deconstruction – The Real World Kind
Before final demolition Second Chance Inc, a 501(c)(3) organization, would send in a team to “deconstruct” salvaging material that might be re-purposed. The social good is manifold.
The team was composed largely of recently released prisoners who need, you know, a second chance and can learn how a building it put together by helping to take it apart. Second Chance calls the work created to be “green-collar jobs”. There is less stuff going into the landfill and the material can be sold at affordable prices to those in need.
On top of the satisfaction of helping the community, the Loubes get a tax deduction for the fair market value of the material salvaged.
Deduction Denied
Only they didn’t get the $297,000 deduction claimed on their 2013 tax return. They got an IRS audit resulting in a deficiency notice for $117,612, which was upheld in Judge Copeland’s Tax Court decision earlier this month (January 8, 2020).
I spoke with Mr. Loube and he thinks that he got a raw deal. He was dealing with a not-for-profit that has IRS approval and relied on their assurances and had a bad outcome. You and I both know that the IRS has close to zero capacity to regulate the not-for-profit sector, but I can still sympathize with Mr. Loube’s point of view.
About Second Chance
I spoke with Mark Foster, founder and executive director of Second Chance Inc. (salary of $254,000 for 2017, if you care about that sort of thing). His inspiration for starting the organization was trying to find particular items to do an authentic renovation, but from there he saw the opportunity to employ people who had a great deal of trouble finding working and have a positive environmental impact.
This all is fueled significantly by a tax subsidy, which frankly puts my bs detector on high alert. I asked Mr. Foster if the items from a deconstruction project will be sold by Second Chance for as much as they are appraised and he allowed that they might not be. It reminds me just a little bit of what was going on with used cars quite a few years ago.
The IRS Has A Problem
The fair market appraised value of what is salvaged does not seem to have a real-world anchor. The taxpayers pay cash for the deconstruction and the appraisal, but there does not appear to be the option to just sell the stuff to somebody, which, in principle, would dictate the amount of the charitable contribution.
So there are indications that the IRS has an overall problem with the deals. Second Chance Inc faced a class-action lawsuit from a disgruntled donor who had a bad experience with the IRS and thought it was part of a larger pattern.
The lawsuit fell apart, though and Second Chance pressed for an apology as part of the dismissal. Mr. Foster provided me with a copy. I have not heard back from the plaintiffs or their attorneys.
Go For The Gotchas
It appears the IRS is taking a similar approach to what it has been doing, up until to recently with easement donations. Rather than tackling valuation, they go over deals with a fine-tooth comb looking for technical foot faults to deny the deduction altogether.
We conclude that petitioners failed to strictly comply with DEFRA sec. 155 and the regulations thereunder because they failed to provide, among other information, the basis and the acquisition date of the contributed property on the appraisal summary. Petitioners also failed to attach to the appraisal summary an explanation of reasonable cause for their inability to provide the basis, acquisition date, or other information related to the contributed property. (Emphasis added)
So at the end of the day, the disallowance falls on the return preparer. Two of Reilly’s Laws of Tax Planning come into play here. The Fourth Law – Execution isn’t everything, but it is a lot – and the Seventh Law – Read the instructions. Implicit in the Seventh Law is the notion that you should answer all the questions or to put it another way, fill out the form thoroughly.
Another Disallowance Last January
This is not the first IRS rodeo with Second Chance Inc. Lawrence and Linda Mann sued for refund in district court over a $675,000 deduction for the donation of their house. That one turned on another execution failure
As to house, even though taxpayers sought to convey undivided interest to org. via private contract, because they never recorded their transaction in accord with Maryland law, house wasn’t properly severed from underlying property and ownership wasn’t transferred to org., leaving donation as more in nature of license to org. and not valid transfer of entire interest in real property…
It Might Work Even If It Should Not
I hold two seemingly contradictory opinions on Second Chance Inc. I think what they are doing is good and that their leadership is sincere. And I think that they are being fueled by deductions that are fundamentally unsound.
If the salvageable material from deconstructing your house is worth hundreds of thousands of dollars, you should not need to pay somebody to take the house apart so that you can give the pieces to charity. There should be people waving money in front of your face to come in and take it apart.
As it happens, though, the IRS has won in court only against taxpayers who did not execute well. So if you are thinking about using this technique, see that you dot all the i’s and cross all the t’s and use a substantial firm for the preparation. And set aside your tax savings, just in case. I’m not going to recommend it, but I probably wouldn’t try that hard to talk you out of it.
For You Literary Types
If you came to this piece expecting me to be writing about the relationship between text and meaning and Jacques Derrida, the joke is on you. I don’t think I’ll ever understand semiotics, but you probably don’t understand the 704(b) regulations and how to think in double entry. So there’s that.
Other Coverage
Lew Taishoff, back in 2018, made note of an attempt by Second Chance Inc to come into the case as an amicus. There was a brief filed on May 22, 2018, but thanks to the Tax Court’s lack of transparency, I can’t get my hands on it timely. So there may be more on this case from me.
Theresa Schliep has something behind the Law360 paywall.
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