When it comes to the charitable donation of art, the Internal Revenue Service (IRS) has increasingly adopted a predictable strategy, as outlined in part two of this series. Similar to cases involving conservation easements, the IRS can even take the position that donated art is worth $0. While this is the IRS’s most extreme position in terms of valuation, it will often deploy a valuation strategy of no more than what the taxpayer paid for it. The Tax Court, however, has repeatedly rejected this strategy and has even suggested that the IRS’s $0 position is unhelpful. Inherently, this make a lot of sense as practitioners are typically working in good faith and that, too often, the parties should be able to reach a resolution prior to the case reaching Tax Court. It would not take one long to find examples of the Tax Court’s irritation of being required to place value on art donations. A few of those examples can be found below.
- Rhoads v. Commissioner. For example, in 1979, two taxpayers bought a pair of opals as an investment, paying approximately $10,500.00 for the smaller of the two (Rhoads v. Commissioner, T.C. Memo. 1988-279). Two years after purchasing the rare set of opals, and after receiving three appraisals by respected gem appraisers that all placed the value of the opals much higher than what the taxpayers paid for them, the taxpayers donated the smaller opal to the geology department at Stanford University. After receiving another appraisal from one of the appraisers they retained before, the taxpayers claimed a charitable act deduction of $70,000.00.
But the IRS believed that the opal was not worth anything more than what the taxpayers had originally paid for it and determined a deficiency in the taxpayers’ 1981 federal income taxes. The IRS also proposed assessments pursuant to penalties detailed in IRC § 6653(a) and IRC § 6659. The IRS argued that “the purchase price … is the only reliable basis for determining the fair market value at the time of the contribution.” after the disagreement had eventually led to Tax Court litigation. The Tax Court disagreed with the IRS’s valuation of the opal, instead finding that the opal’s decrease in value was only due to the separation of the original pair. Ultimately, the Tax Court determined that the value should be $50,000.00. Accordingly, the taxpayers were entitled to a charitable contribution in that amount, and they were not found liable for proposed assessment pursuant to IRC § 6653(a)(1) or IRC § 6659.
- Mast v. Commissioner. In 1977, the largest assembled collection of stereoscopic negative glass plates, prints, file copies, and other materials was donated by taxpayers to the University of California, in which they claimed a charitable act deduction of approximately $1.4 million (Mast v. Commissioner, T.C. Memo 1989-119). Although this amount was based on an appraisal they had obtained, the IRS issued notices of deficiency, completely denying the taxpayer’s charitable deductions, and instead adopting the position that the noteworthy set was worth exactly $0.
The Tax Court expressed its frustration with the IRS’s extreme position during litigation, and implied that normal standards should be mitigated due to the IRS’s unreasonable starting point and lackluster proof at trial. The IRS did not provide any additional evidence to support their $0 position, while the taxpayers had provided testimonies of several experts, one of which had been originally retained by the IRS, as evidence of the collection’s value. Usually, the taxpayers would bear the burden of proving that the IRS’s determination was incorrect, but due to the IRS’s extreme position and lack of evidence, the Tax Court stated that the taxpayers’ burden may be somewhat lightened. This is a dramatic result in a case where the opposite is normally the case.
The Tax Court concluded that the collection was worth $1.25 million, but noted several times throughout trial that questions of fair market value are better resolved through settlement negotiation rather than litigation:
“In the absence of settlement, we are left to adjudicate the validity of [opinions by conflicting experts] who are convinced that both their conclusions and methods are correct. Unfortunately, since settlement was not forthcoming in this case, we are forced to make such a pronouncement.”
The real takeaway from this case is that the Tax Court does not like to be put in the position to decide between appraised amounts. Though, at times, this cannot be avoided. However, it most certainly does not want to choose between one side presenting a fair approximation of value and the other side presenting a complete fallacy in terms of value. As mentioned in earlier posts in this series, it is important to present the IRS with a valid approximation of value.
- Ferrari v. Commissioner. In another case, the Tax Court’s exasperation at being required to place value on art donations seemed to increase throughout its analysis in the decision (Ferrari v. Commissioner, T.C. Memo 1989-521). In this case, 21 pieces of pre-Columbian art were donated to Duke University Museum of Art over four tax years. The taxpayers claimed charitable deductions over the four years the items were donated, and the IRS responded in the examination by disallowing the charitable contributions made in each year, causing deficiencies in the income tax liability of the taxpayers.
The Tax Court started their opinion by stating that this was an instance in which, again, the Court was called upon to value a relatively obscure collection of art on the basis of testimony by individuals who are experts in their field were unable to come to an agreement on all of the of the pieces donated. The Tax Court believed that this case was the perfect example where judgement by another expert in pre-Columbian art would have been a far better method of arriving to an agreement in a valuation controversy. Rather, the Tax Court was called upon to determine it’s judgement in an area far outside of trial judge’s expertise and training.
As detailed here and in parts one and two of this series, a taxpayer who wishes to claim a charitable act deduction through donation of art should take several precautionary steps in anticipation of the IRS’s refusal. Due in part to the Inflation Reduction Act of 2022 funding, the IRS has made efforts to crack down on illegitimate deductions. The IRS will typically follow a similar set of tactics when challenging a charitable art donation, sometimes even claiming that the donation is worth $0, or no more than what the taxpayer originally paid for it. As outlined in the above mentioned cases, the IRS’s $0 position is working less and less frequently in Tax Court, and the Tax Court has mentioned time and time again that these types of cases are best handled by third party experts, not in litigation.