Charitable contribution deductions - an alternative to capitalization of demolition costs.

Sec. 280B prohibits a deduction for the owner or lessee of a structure for the cost incurred to demolish or raze such structure. instead, the cost of demolition and the loss sustained must be added to the basis of the underlying land. A deduction may thus be postponed indefinitely (since land is not a depreciable asset). As a planning alternative, taxpayers should consider making a charitable contribution of the structure to a local fire department for use in training drills.

Prior to 1984, the taxpayer's intent on acquisition of property generally governed the tax treatment of costs incurred to demolish an existing structure; that is, a current deduction was allowed if the intent to demolish the structure was formed subsequent to the time of acquisition, while capitalization was required if the intent to demolish existed at the time of purchase. For tax years beginning after 1983, Sec. 280B prohibits a current deduction for the cost of demolition, regardless of when the intent to demolish was formed. Instead, the cost of demolition and any loss incurred is added to the basis of the underlying land, and not to the basis of any replacement structure. The determination as to when the taxpayer actually made the decision to demolish a structure has effectively been eliminated by Sec. 280B.

Despite the stringent results under Sec. 280B, a taxpayer may be able to obtain a charitable deduction under Sec. 170 if a building used in a trade or business or held for rent is donated to a local fire department for use in fire training drills (i.e., a controlled burning exercise). Sec. 170(c)(1) provides, in part, that a charitable contribution includes a contribution or gift to or for the use of a state, or any political subdivision thereof, but only if the contribution or gift is made for exclusively public purposes. A donation to a "volunteer" fire department should also qualify as a charitable contribution. Rev. Rul. 71-47 clarified the application of the statute to include contributions to a volunteer fire department on the grounds that the contributions relieve a political subdivision of a state of the burden of a function normally performed by a municipality.

The Scharf case

In Scharf, TC Memo 1973-265, the Tax Court held that the taxpayer was entitled to a charitable contribution deduction for the fair market value (FMV) of a building donated to a volunteer fire department for use in fire drills. in this case, a building owned by the taxpayer was partially destroyed by fire. The building was so badly damaged that it could not be rented without substantial renovation and, in 1968, was about to be condemned because of its unsafe condition. After encouragement by local authorities, the taxpayer gave permission to the volunteer fire department to conduct fire drills in the building (as evidenced by a formal written agreement). Three fire drills were conducted, and the building was burned down through these controlled burning exercises. The taxpayer reported a charitable contribution deduction for the value of the building, which he claimed had been donated to the fire department.

The IRS argued that since the taxpayer wanted to destroy the building rather than repair it, and since the primary motive for the contribution was to obtain a benefit by enhancing the value of the remaining property, the deduction should be disallowed. While acknowledging that the donor's subjective intent is frequently difficult to determine, the Tax Court found the benefits flowing back to the taxpayer i.e., clearer land) were far less than the greater benefits bestowed on the fire department and the community. The mere fact that the taxpayer incidentally benefited from the donation was not sufficient to deny the deduction. Finally, in an attempt to reduce the value of the contribution, the Service also argued that the taxpayers donated only the use of the building. The court further held that under the circumstances of the case, donation of the right to destroy a building is the same as donation of the building itself.

Valuation of contribution

The deduction of a charitable contribution of property is measured by the FMV at the time of contribution. In the case of a depreciable structure, Sec. 1245/1250 recapture must also be considered (Sec. 170(e)(1)(A)). In determining the FMV of the donation in Scharf, the court considered all relevant factors, including the property's cost, its selling price, sales of comparable properties, the present condition of the property, opinion evidence and market conditions. Since the property was previously damaged by fire, the court used the original value of the building for insurance loss purposes, less the insurance proceeds recovered, as an estimate of value for charitable purposes. A determination of FMV is obviously subjective and a formal appraisal would be recommended, particularly in light of the penalty provisions for valuation misstatements under Sec. 6662. As a final note, a taxpayer acquiring property with an intent to raze an existing structure should be able to assign value to such structure.

Reporting requirements

Form 8283, Noncash Charitable Contributions, may be required to report such a contribution of property. Section B of the form must be completed for amounts in excess of $5,000; furthermore, Part IV must be completed by the donee and a written appraisal may be required. As a result of the Revenue Reconciliation Act of 1993, the appreciation inherent in the property is no longer an adjustment for alternative minimum tax purposes; however, the recapture rules previously noted should be considered.

Confronted with the stringent capitalization rules under Sec. 280B and the prospect of a tax deduction postponed indefinitely if property will not be sold in the foreseeable future, a taxpayer may want to explore the current benefit of a contribution to a local fire department for a controlled burning exercise. The Scharf case supports this idea and tax return position.