Earlier this month I wrote about Second Chance, a not for profit in Baltimore that combines environmental concerns with job creation. In order to cover the story of a Tax Court decision concerning a donation to Second Chance, I had to learn a bit about deconstruction.
Not That Kind Of Deconstruction
I know. You are wondering how semiotics, Jacques Derrida and the relationship between text and meaning can connect to tax issues. I’m sure they can, but since I don’t understand that sort of deconstruction at all, I can’t help you.
The deconstruction Second Chance is involved in is of the sort that even a preschooler could grasp conceptually. If we think of construction as putting a building together, then logically deconstruction is taking it apart-with some care so that much of the material can be reused. It is more work and takes longer and is not as much fun as demolition, but certainly more environmentally responsible.
The feedback that I have gotten from the piece about Second Chance had taught me a bit more about deconstruction, which is sort of a cross between an industry and a movement.
Big Deductions Are Questionable
The big takeaway from the comments I received is that the very large deductions disallowed in two cases ($297,000 and $675,000) make Second Chance something of an outlier. One rule of thumb I got was that the value of the material coming out of a deconstruction will be from $20 to $50 per square foot.
Another person I spoke to indicated that it is more like $5 to $10 per square foot. He appraises used business material by visiting the places it is sold and noting the prices. This use of retail value is endorsed by the IRS in Publication 526 for clothing. They caution that for donations of things in quantity it should be what is paid for that sort of quantity. On cars they recommend the private sale price in the blue books not the dealer retail.
Of course, IRS pubs are not authority, but they give you some sense of what might or might not work. I think it is pretty clear that if you are deducting more than the charity is putting it on the shelf for there is a problem. And even that might be a little on the high side.
Concern
Included in the feedback that I have received is a concern that abusive valuations might lead to problems with more modest deals. Jessica Marschall is working on developing standards. She recently wrote an article – Deconstruction – CPA Calls For Appraisal Standards For Deductions – for Your Tax Matters Partner.
She describes the flawed technique that is used to arrive at the higher valuations.
“In both Mann and Loube, the appraiser used software called RS Means, a cloud-based estimating software giving access to a comprehensive database of construction costs in the United States. While the software provides valid estimates for new construction it should never be used for deconstruction appraisal valuations. The Sales Comparison Approach is the predominant method to be used for charitable contributions per USPAP. This method uses the most appropriate market research to locate comparable items and material, which have sold or been listed for sale in the past on which an opinion of value can be based. “
If the software gives a much higher value and is a lot less work, what’s not to like about it? It’s that by its own description it is meant for construction not valuing the pieces after deconstruction. Still, I have to give whoever thought of using it that way, high marks for cleverness.
The rule of thumb that Ms. Marschall gave me is that the tax benefit of the material donation will often approximate the extra cost involved in deconstruction.
A Similar Drama
The reaction of those who are toiling away in the deconstruction field to the Second Chance story is similar to what is going on with conservation easements. At least on an individual transaction level, the stakes there are significantly higher, but the tax principle is the same.
Partnership For Conservation is a trade association (501(c)(6)) that works in the interest of those who are syndicating conservation easements. They have a running debate with other organizations in the field that find the syndications inherently abusive.
“The real question is, do we need more credentials and forms, or do we need to just say no when someone buys vacant property for $2 million, sells shares to investors a year later for $8 million, and then — a day later — gives all of those investors a big profit by telling Uncle Sam that they deserve $40 million in tax deductions for donating an easement on that land?”
The intellectual justification for why syndications can work is that there is this other value to be placed on land for purposes of charitable deduction – the discounted cash flow from a hypothetical highest and best use. In that view, it does not matter what anybody is currently willing to pay for the land any more than it matters what the used building materials will go on the shelf for in the aggressive deconstruction deductions.
I doubt that the deconstruction deductions will end up creating as much drama as the conservation easements, but we will see.
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