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NEW YORK (Reuters) - A California entrepreneur got a harsh lesson on the rules of charitable contributions this week when the U.S. Tax Court denied his $18.5 million deduction for real estate donations —not because he inflated their values, but because he didn't follow the rules.
You may be feeling a little schadenfreude that a member of the 1 percent got some tax comeuppance, but pay attention: It could happen to you.
Joseph Mohamed, Sr., the entrepreneur in question, is a Sacramento real estate broker and certified appraiser. He and his wife, Shirley, donated six properties worth at least $18.5 million to a charitable remainder trust in 2003 and 2004. (A charitable remainder trust typically pays the donors income for life, and at their deaths the remainder of the assets in the trust go to charity.)
The Internal Revenue Service audited their returns, and the case wound up before the Tax Court. It denied their deduction completely, despite noting that "the property was quite likely more valuable than the Mohameds reported on their tax returns." The issue: They didn't attach a qualified appraisal of the property to the donation form.
Typically when you think about deductions being prohibited by the IRS, you might figure the taxpayer pushed the limits to get a bigger tax write-off than deserved. So the Tax Court's decision, released on Tuesday and available online at (here), is a particularly important reminder of how the tax rules actually work: You have to follow them to the letter, and if you're going to fill out your tax returns yourself (as Mohamed did), you'd better read the instructions (which he admitted he did not).
As the Court wrote in its memorandum: "We recognize that this result is harsh… But the problems of misvalued property are so great that Congress was quite specific about what the charitably inclined have to do to defend their deductions, and we cannot in a single sympathetic case undermine those rules."
The rules for charitable deductions have gotten tighter in recent years as the Treasury has looked to close the tax gap - the hundreds of billions of dollars difference between the taxes owed and those actually received.
For donated property valued above $5,000, you have to get a qualified appraisal, and there are very specific requirements on just what qualifies as a "qualified appraisal." The details on charitable contributions are laid out in Publication 526, available at the IRS website (here).
As Tony Nitti, a tax partner in the Aspen, Colorado, office of WithumSmith+Brown, notes on the tax blog, Double Taxation, which first wrote about the case: "Any tax adviser who has ever been saddled with the unenviable task of reporting a client's charitable contribution of real estate knows that it's a colossal pain."
For those looking to donate big bucks to charity, here's the takeaway:
-- First: Do not do your own tax return. Especially if you have anything remotely as complex as millions of dollars of property you're giving away through a charitable trust.
-- Second: Read the instructions. If you must do your own return, don't assume that you can do it without learning the finer points of the forms. If you don't want to read the seven small-print pages of arcane instructions for Form 8283 - Noncash Charitable Contributions, for example, return to rule No. 1 and hire someone else to do your return.
-- Three: Get educated. Even if you're not wealthy enough to be setting up charitable remainder trusts or donating multi-million dollar property, you still need to understand the rules on record-keeping. If you want to take a tax deduction for donating some antique jewelry of your grandmother's that you figure is worth $6,000, for example, you should get a qualified appraisal.
If the IRS audits you, it's not going to be enough to say that you kept to the spirit of the rules if you didn't actually do what they said.
(The writer is a Reuters columnist. The opinions expressed are her own.)
Editing by Linda Stern and Dan Grebler