Ashes to Taxes: Feeling the Burn

Ashes to Taxes: Feeling the Burn

Article posted in Treasury Decisions on 5 October 2016| comments
audience: National Publication, Dennis Walsh, CPA | last updated: 6 October 2016


An interesting case teaches us important lessons about gifts with restrictions.

By: Dennis Walsh, CPA

Watch out, you might get what you’re after.  So begins the 1983 hit single by Talking Heads, “Burning Down the House.”

This is a suitable admonition to those who might pursue an interesting charitable gift idea that rekindles from time to time.  Before venturing, know what you’re after.

In 1996, Theodore Rolfs bought a lake house in Waukesha County, Wisconsin.  The house was built around 1900 and was in generally good condition but in need of remodeling.

Rolfs was undecided whether to remodel the house or to tear it down and rebuild.  He determined that it would cost approximately $10,000 to $15,000 to have the house demolished and site cleared.

After learning of someone who claimed a tax deduction for donating a house to a local fire department for burning, he decided to donate the house for firefighter and police training exercises and eventual demolition.

In early 1998 Rolfs sent a letter to the local fire department chief stating his intention to donate the house, and within a short period of time the fire department conducted two training exercises at the house and burned it down.

The fire chief later sent a letter to Rolfs acknowledging receipt of a $1,000 cash contribution to help defray costs of the live training and for donation of the use of the property, describing the nature of the training conducted.

Rolfs married in 1998 and along with his wife filed a joint tax return, claiming a charitable contribution deduction of $76,000 for donation of the house to the fire department.  They filed IRS Form 8283 with their return, which included the required signature acknowledgment by the donee organization and declaration of appraiser.

Rolfs professional appraiser used a “before and after” approach to determine the fair market value of the house as $76,000, based on comparable sales, measured by the difference between the value of the property with the house  and the value of the land with no structural improvements.

Upon audit, the IRS determined that the couple was not entitled to any deduction because they received, in exchange for the donation, a substantial benefit in the form of demolition services, the value of which exceeded the value of the property donated.  The IRS assessed a tax deficiency of $19,940.

Tax Court review

Rolfs petitioned the U.S. Tax Court {1}, and in 2010 the Court upheld the IRS position, applying a quid pro quo analysis from United States v. Am. Bar Endowment {2}.  Rolfs failed to prove that the value of the house, taking into account its severance from the land and restrictions on its use, exceeded the value of demolition services provided by the fire department. 

At trial, a professional house mover testified that it would cost $100,000 to relocate the house, complicated by a stone façade and tree clearing that would be required as part of such a move, and that in his opinion no one would undertake such an effort because of the modest value of the home in relation to the high cost of land in the lake area.  He also opined that any salvage value to the structural components would be more than offset by the cost of labor to remove them.

The Tax Court found that by transferring the lake house to the fire department without the land, Rolfs created a substantial restric­tion or condition on the property’s marketability, since it could not remain indefinitely on the land upon which it was sited.

Rolfs attached two additional restrictions or conditions on the house incident to its donation.  The permissible use of the house was restricted to firefighter and police training exercises, and there was a condition that the house be burned down relatively soon after the conveyance.  Rolfs’ appraisal was based on the house being available for residential use and affixed to the site indefinitely.

The IRS and the courts have long held that any conditions on a donation or any rrestrictions as to a donee’s use of charitable contribution property existing at the time of the contribution must be taken into account in the determination of fair market value {3}. 

Court of Appeals

Rolfs appealed to the U.S. Court of Appeals {4}, and in 2012 the 7th Circuit affirmed the Tax Court decision.  The Appeals Court noted that proper consideration of the economic effect of the condition that the house be destroyed reduces the fair market value of the gift so much that no net value is ever likely to be available for a deduction.

The Court posed the following question:  What is the fair market value of a house, severed from the land, and donated on the condition that it soon be burned down? There is no evidence of a functional market of willing sellers and buyers of houses to burn.  Any valuation must rely on analogy.

The Court went on to note that Perhaps the best value comparison might have been a price the fire department would have to pay to rent use of a burn tower for the length of time it conducted exercises around the lake house, such as what was available at a nearby technical college.

U.S. v. American Bar Endowment

In 1986, the Supreme Court set forth in Am. Bar Endowment {2} the principle that a payment of money generally cannot constitute a charitable contribution if the contributor expects a substantial benefit in return. The essential ingredient of a charitable contribution is a transfer of money or property without adequate consideration.

However, the Court also recognized that a taxpayer’s payment to a charitable organization that is accompanied by receipt of a benefit may have a ‘dual character of a pur­chase and a contribution” if the payment exceeds the value of the benefit received in return.  Where the size of the payment is clearly out of proportion to the benefit received," taxpayers can deduct the excess, provided that they objectively intended it as a gift.

The Court con­sequently adopted a two-part test (first articulated in IRS Revenue Ruling 67–246 {5}, determining when part of a dual payment is deductible.

First, the payment is deduct­ible only if and to the extent it exceeds the market value of the benefit received.  Second, the excess payment must be made with the intention of making a gift.  The Am. Bar Endowment test has since been incorporated into the Treasury Regulations {6}. 

Public benefit

On facts similar to Rolfs, the Tax Court decided in an earlier Memorandum Opinion, Scharf v. Commissioner {7}, that a taxpayer was entitled to a charitable contribution deduction for the donation of a building that had been partially destroyed by fire, to be used for burn training by a local volunteer fire department.  The taxpayer was allowed a deduction equal to the value of the house for insurance purposes.

The Court reasoned that the benefit flowing back to the taxpayer, consisting of clearer land was far less than the greater benefit flowing to the volunteer fire department’s training and equipment testing operations, that the petitioner benefited only incidentally from the demolition of the building, and that the community was primarily benefited in its fire control and prevention operations.

The test applied in Scharf, which examined whether the value of the public benefit of the donation exceeds the value of the benefit received by the donor, differs from the Supreme Court’s test announced 13 years later in Am. Bar Endowment.  The Am. Bar Endowment test examines whether the fair market value of the contributed property exceeds the fair market value of the benefit received by the donor. In Rolfs, the Tax Court concluded, and the 7th Circuit agreed, that the test applied in Scharf has no vitality after Am. Bar Endowment.

Partial interest rule

In 2006, Upen and Avanti Patel purchased property in Fairfax County, Virginia, with the intention to demolish an existing house and construct a new one on the site.  Their realtor told them about the local fire and rescue department’s “Acquired Structures Program,” where a property owner allows the department to conduct live fire training exercises on the property.  After the Patels obtained a demolition permit and completed other requirements, they executed documents granting the fire department the right to conduct training exercises and to destroy the house by burning.

On their 2006 Federal income tax return, the Patels reported a charitable contribution of $339,504 for the donation of the house to the fire department, $92,865 of which was deducted after application of the Sec. 170(b) annual percentage limitation.

Upon examination the IRS disallowed the deduction and asserted that it was a contribution of a partial interest in property, a deduction for which is denied by sec. 170(f)(3).  The Patels were assessed a tax deficiency of $32,672.

Tax Court review

In 2011 the Patels appealed to the U.S. Tax Court {8}, which held for the IRS, concluding that A landowner’s grant to a fire department of the right to conduct training exercises on his property and destroy a building during the exercise is a mere license that permits the fire department to do an act which without such a grant would be illegal and which conveys no interest in the property.  The Court found that Section 170(f)(3) denies them a charitable contribution deduction for the donation of the use of their property regardless of the value of that use.

Section 170(f)(3) provides that a contribution by a taxpayer of the right to use property is treated as a contribution of less than the taxpayer’s entire interest in such property.  The taxpayer will not be allowed a charitable contribution deduc­tion unless the donated interest falls within the exceptions of section 170(f)(3)(B), which include a contribution of a remainder interest in a personal residence or farm, an undivided portion of the taxpayer’s entire interest in property, or a qualified conservation contribution.  The Court concluded that none of these exceptions applied.

The Tax Court analysis in Patel underscores the importance of close attention to state law when planning gifts of noncash property.

The Court stated in part that under Virginia law, a structure is regarded as part of the land unless it is actually or constructively severed.  To effect a constructive severance, the transfer ordinarily must be in a writing in a form sufficient for a conveyance of land. 

The grant of an easement, lease, or license will not constructively sever a building from the land.  For an instrument to constitute more than a license there must be an exclu­sive right of possession vested in the grantee.  The fire department does not acquire the right to eject the landowner from the building and cannot force the land­owner to allow the destruction of the building should he change his mind before the house has been destroyed.

By comparison, against IRS objection, in Rolfs the Court found that under the facts of the case that a constructive severance and conveyance of the house to the fire department occurred under Wisconsin law, even though the transfer was effected only in the form of letters exchanged between Rolfs and the fire chief.  Here too, the Tax Court stated that to effect a constructive severance of a building from land, the transfer ordi­narily must be in a writing in a form sufficient for a conveyance of land.

The IRS contended that the transfer did not fully satisfy the requirements of the Wisconsin Statute of Frauds.  But the Court concluded that a conveyance that does not satisfy every requirement of the Statute may nevertheless be enforced, observing from the same law that an exception exists in the case of detrimental reliance, where the fire department conducted the burn in reliance on Rolfs' letter.

The IRS had also raised the partial interest rule in the earlier Rolfs decision as an alternate theory for denying a deduction.  But the 7th Circuit did not reach this issue and instead affirmed that Rolfs did not make a charitable contribution on the basis that he received a substantial benefit in the form of demolition services, the value of which exceeded the value of the interest in the lake house.

Contrasting Patel with Scharf, the Tax Court observed that the donation in Scharf was made in 1967 before the addition of the current Section 170(f) as part of the Tax Reform Act of 1969.  Additionally, the standard applied in Scharf was subsequently superseded by the quid pro quo standard for charitable contribution deductions established by the Supreme Court in Am. Bar Endowment.

Concluding thoughts

Boiling it all down, it appears that a taxpayer’s best chance for sustaining any amount of deduction for this type of gift would require transfer of title to the donee organization fee simple, along with relocation of the structure to a site specified by the donee for future use in a time and manner independently determined by the donee.  This should render the donation free of the types of conditions and restrictions that might otherwise be fatal to a deduction.

However, a volunteer fire department, or even large municipal entity, may not be willing or able to accommodate such a donation.  And obtaining a credible appraisal presents a formidable challenge, since a comparable sales approach is not likely to be viewed as appropriate for valuing a structure as being separate from its site.

Even so, unless the property has unusual value, such as that of a historic structure, it is doubtful that the tax savings available through a charitable deduction might exceed the cost incurred by the donor to relocate the structure, although tax saved from a separate cash contribution to cover such costs might make the difference in a few cases.  But it is improbable that property with such intrinsic value would be gifted for police or fire training purposes.

A more realistic alternative might be to strip any usable materials from the structure in advance of donation and give them to a charity for use in a program such as construction of low-income housing.

However, if the donee is a non-governmental organization and is also involved in the removal of such materials, it must provide the donor with a good faith estimate of the value of any personal benefit provided, such as the value of labor or hauling away materials, as required by the Section 6115 quid pro quo reporting rule.  A donor may not wish to impose such a burden on the charity. 

Further, if any such benefit is provided to a donor, the donor must reduce the value of the donated property by the value of the benefit, regardless of whether the charity complies with the reporting requirement.  The donor must also substantiate the value of the property, reflecting its age and condition, and obtain a qualified appraisal if claiming a deduction of more than $5,000.

Despite the developments since Scharf, taxpayers will undoubtedly continue claiming charitable deductions for this type of gift, bolstered by misinformed bloggers and those having escaped IRS audit.  But is the juice worth the squeeze?

Samuel Anders, a North Carolina CPA and volunteer Assistant Fire Chief for the Oak Ridge Fire and Rescue Company, has participated in burning down a number of structures in addition to counseling clients on this type of gift.  He said that he has never had a client attempt a deduction for this after discussing the issues.

“In nearly 28 years of public practice and 36 years of fire service experience, no one has ever produced an appraisal or any documentation to show the value of a burn house,” said Anders.

  • 1. Rolfs v. Commissioner, 135 T.C. 471 (2010), affd. F.3d 888 (7th Cir. 2012)
  • 2. a. b. United States v. Am. Bar Endowment, 477 U.S. 105 (1986)
  • 3. Cooley v. Commissioner, 33 T.C. 223, 225 (1959), affd. 238 F.2d 945 (2d Cir. 1960); Deukmejian v. Commissioner, T.C. Memo. 1981-24; Dresser v. Commissioner, T.C. Memo. 1956–54; Rev. Rul. 85–99, 1985-2 C.B. 83
  • 4. Rolfs v. Commissioner, 668 F.3d 888 (7th Cir. 2012)
  • 5. Rev. Rul. 67-246, 1967-2 C.B. 104.
  • 6. 26 C.F.R. sec. 1.170A–1(h); T.D. 8690, 1997-1 C.B. 68
  • 7. Scharf v. Commissioner, T.C. Memo. 1973–265
  • 8. Patel v. Commissioner, 138 T.C. 23 (2012)

Add comment

Login or register to post comments


Group details



This group offers an RSS feed.
7520 Rates:  October 3.4%  September 3.4%  August 3.4%

Already a member?

Learn, Share, Gain Insight, Connect, Advance

Join Today For Free!

Join the PGDC community and…

  • Learn through thousands of pages of content, newsletters and forums
  • Share by commenting on and rating content, answering questions in the forums, and writing
  • Gain insight into other disciplines in the field
  • Connect – Interact – Grow
  • Opt-in to Include your profile in our searchable national directory. By default, your identity is protected

…Market yourself to a growing industry