The crucial role of substantiation for charitable deductions

Donors who give to charitable organizations can benefit from any tax advantages that come with the gift. Although a charitable income tax deduction is not often the primary motivating factor for making a donation, it is a consideration for prudent donors. However, for a gift to qualify for a charitable income tax deduction, the donor must comply with all applicable procedures outlined in IRC § 170 and related Treasury regulations, including strict adherence to substantiation rules for both contemporaneous written acknowledgments and qualified appraisals.

It is the donor’s responsibility to review all documentation and appraisals when making a gift to charity—an area where professional guidance can mean the difference between a successful gift and a gift gone wrong. Donors who fail to meet substantiation and appraisal requirements risk being denied significant charitable income tax deductions and may also face penalties when valuations are inaccurate.[1]

Contemporaneous written acknowledgments

To substantiate a charitable contribution of $250 or more, a taxpayer must obtain and maintain a contemporaneous written acknowledgment from the donee organization that includes the following:

  • The amount of a cash contribution and/or a description (but not value) of a noncash contribution
  • Whether the donee organization provided any goods or services in consideration for the property
  • A description and good faith estimate of the value of goods or services, if any, that the donee organization provided in return for the contribution[2]

The taxpayer must receive the acknowledgment on or before the earlier of (1) the date the donor files a tax return for the year in which the contribution was made or (2) the due date (including extensions) for filing the return.[3] A taxpayer who fails to meet these statutory and regulatory requirements[4] may not deduct the contribution.

Albrecht v. Commissioner:

Make sure the charity’s acknowledgment meets all requirements

In Albrecht v. Commissioner,[5] Ms. Albrecht, a widow, donated approximately 120 pieces of Native American jewelry and artifacts to a museum celebrating the American Indian. She transferred all her rights to the property (unless otherwise stated in a separate Gift Agreement). While Ms. Albrecht had a Deed of Gift, the museum did not provide her with further written documentation about the donation. When she reported the donation on Schedule A, Itemized Deductions, of her income tax return, she attached a copy of the Deed of Gift, which detailed the donated property but did not have a statement from the museum that addressed the other required information—whether she had received any goods or services in exchange for her gift, and if so, a description of the value of those goods or services. In addition, she did not attach a Gift Agreement, even though the Deed of Gift mentioned it.

The Tax Court found that Ms. Albrecht had substantially complied with the statutory requirements of the Code, but “[s]ubstantial compliance, unfortunately for petitioner, does not satisfy the strict requirements of section 170(f)(8)(B).” The court determined that the Deed of Gift was insufficient to meet the contemporaneous written acknowledgment requirements of IRC § 170(f)(8)(B); therefore, Ms. Albrecht was not entitled to the $464,000 charitable deduction she had claimed for her gift.

Qualified appraisal requirement

To combat inflated valuations of donated property, the Treasury Department has promulgated dozens of requirements for contributions—requirements that increase with the size of the gift. Donors who do not meet all substantiation criteria are not entitled to the deduction.

  • Cash donation of $250 or more. The Code requires the donor to obtain a contemporaneous written acknowledgment for the donation.[6]
  • Gifts of property over $500. The donor must include a description of the donated property with their federal income tax return on IRS Form 8283 (Noncash Charitable Contributions).[7]
  • Gifts of property worth $5,000 or more. The donor must obtain a qualified appraisal of the donated property and include an appraisal summary with the tax return.[8] If the donation is non-publicly traded stock, certain publicly traded securities, or a contribution by a C corporation, the donor must maintain additional records.[9] However, the donor does not need to obtain an appraisal for contributions of non-publicly traded stock (if the amount claimed or reported as a deduction exceeds $5,000 but is less than $10,000) or publicly traded stock for which market quotations are “readily available.”[10]
  • Gifts of property worth more than $500,000. When a donor claims a deduction of more than $500,000 (not including publicly traded securities), the taxpayer must attach a qualified appraisal to the tax return, along with IRS Form 8283.[11]

Qualified appraisals must follow generally accepted appraisal standards.[12] They must also be conducted by qualified appraisers who meet IRS standards, including education and experience in valuing the type of property donated.[13] The qualified appraiser must sign and date the appraisal.

Estate of Hoensheid v. Commissioner:

Make sure a qualified appraisal meets all requirements

In Estate of Hoensheid v. Commissioner,[14] an estate claimed a charitable deduction for a donation of noncash assets (interests in closely held business entities) to a qualified organization. Taxpayers must substantiate such noncash charitable contributions with a qualified appraisal that complies with strict statutory and regulatory guidelines. In this case, however, the IRS challenged the estate’s use of the deduction, asserting that the appraisal attached to the submitted tax return failed to meet the requirements of a qualified appraisal outlined in 26 CFR § 1.170A-13. Specifically, the IRS argued that the appraisal provided insufficient detail in its description of the property and valuation methods and was not conducted by a qualified appraiser. The Tax Court sided with the IRS and disallowed the charitable deduction for the following reasons:

  1. The appraisal lacked critical elements. For example, it didn’t contain the correct date of the contribution, a proper valuation method, or a statement that a qualified appraiser prepared it for federal income tax purposes. The appraisal did not meet the definition of a qualified appraisal, and the appraiser did not meet the qualifications of a qualified appraiser.
  2. The taxpayer failed to meet the “substantial compliance” standard. Although the IRS might excuse minor or technical errors, it cannot overlook significant omissions. In this case, the court ruled that the taxpayer’s appraisal did not fulfill the main or essential requirements due to multiple substantive defects.
  3. The court rejected the reasonable cause defense. The taxpayer’s reliance on a certified public accountant was not deemed a “reasonable cause” for noncompliance. The court noted that the taxpayer was actively involved in the transaction and should have ensured compliance with applicable laws and regulations.

Braen, et al. v. Commissioner:

Make sure valuation is accurate and donative intent is clear

In Braen, et al. v. Commissioner,[15] the donors also found out the hard way that substantial compliance isn’t good enough when substantiating a charitable income tax deduction. This case involves a family-owned S corporation, Braen, focused on mining; its holdings included several quarries. Braen entered into an option agreement to purchase a 445.5-acre lot in the unincorporated portion of Ramapo (a New York town) and a 58.5-acre lot in an incorporated village within Ramapo for $3.5 million, believing the land had significant deposits of granite and other materials.

Braen planned to develop the land into a granite quarry but faced significant regulatory and environmental hurdles, so for several years after the purchase, the project made little progress. Further complications arose when Ramapo rezoned part of the property to restrict industrial use (the zoning classification Braen required for its plans), prompting Braen to sue Ramapo in New York State Court.

Following court-ordered mediation, the parties reached a settlement where Ramapo purchased 425.5 acres from Braen for $5.25 million and rezoned the remaining 80 acres Braen retained back to its former industrial use designation. At the closing, a Ramapo representative signed Form 8283, Noncash Charitable Contributions, so Braen might claim a charitable contribution deduction for the difference between the property’s fair market value (FMV) and the purchase price. Ramapo left the form blank except for the phrase “see attached qualified appraisal report,” but it had no appraisal attached. Braen hired a mineral appraiser and a real estate appraiser to prepare the qualified appraisals required to claim a charitable contribution deduction.

On its tax return for that year, Braen claimed a $5.22 million charitable income tax deduction, asserting the sale was a “bargain sale” with donative intent. Braen stated that the FMV of the property was $17,472,000 but that it would only claim a charitable contribution of $5.22 million to avoid a dispute with the IRS over the value of the sale and a potential substantial or gross valuation misstatement penalty, subsequently reducing the FMV to $10,472,000.

Even so, the IRS audited Braen’s return and disallowed the charitable income tax deductions claimed by the Braen family-member owners on their tax returns. The IRS contended that the Braens failed to establish the value of all the consideration they received as part of the purported bargain sale—particularly the zoning reversion—and did not meet substantiation requirements.

The tax court found the following issues:

  1. The property’s claimed value was misstated. Concerning the property’s FMV, the court determined that the property’s highest and best use was residential development, not quarrying. The court found no reasonable probability that the Braens could procure the approvals, zoning changes, and permits required for quarrying within a reasonable amount of time. Consequently, the court valued the land at $5.23 million, far below Braen’s claimed value of $10,472,000 on its tax return.
  2. Unproven valuation put the bargain sale in question. The valuation did not consider the land purchase agreement and the zoning litigation settlement. In this case, the land purchase agreement specifically mentioned that the zoning litigation was settled “as part of the conveyance of the property,” and the settlement agreement referenced the land purchase agreement. The court found that the Braens did not establish the value of all consideration Braen received as part of the purported bargain sale—the zoning reversion was a significant benefit that should’ve been valued as part of the transaction.
  3. Appraisals did not meet the requirements for qualified appraisals. To claim a charitable deduction in connection with a bargain sale, the FMV of the donated property must exceed the value of the benefits received, and the taxpayer must obtain a contemporaneous written acknowledgment from the recipient substantiating the contribution. Unfortunately, the Braens failed to provide a proper written acknowledgment from Ramapo because the appraisals were not qualified appraisals for substantiation purposes—a fatal defect. The appraisals failed to include the terms of either the settlement or the purchase agreement.
  4. Unproven donative intent undermined the deduction. The Braens argued that the sale of the 425.5 acres represented a bargain sale made with donative intent, entitling them to deduct the difference between the fair market value of the portion of the property sold and the purchase price. Because the court found that the Braens failed to identify or value all the consideration received for the transaction, they were not entitled to the claimed charitable deduction. Without donative intent, there is no § 170 deduction, regardless of the size of the bargain.[16] However, the court didn’t address whether Braen had donative intent relating to the sale; it disallowed the charitable income tax deduction on other grounds.[17]

The court denied the claimed charitable income tax deductions and imposed penalties based on both the Braens’ substantial understatement of income tax and substantial valuation misstatement.

Mark R. Ohde v. Commissioner:

Make sure to establish FMV properly

In Mark R. Ohde v. Commissioner,[18] the taxpayer claimed a noncash charitable deduction of $145,250 for a series of donations to Goodwill Industries, specifically claiming donations of more than 20,000 distinct items during the tax year (clothes, accessories, furniture, books, etc.). The taxpayer provided no acceptable evidence to establish the cost basis or fair market value of any of the items. The taxpayer attached Form 8283 to his return but did not include appraisals, and the forms weren’t executed by the donee or an appraiser, as required for contributions exceeding $5,000. Not surprisingly, the court didn’t find the taxpayer’s outsized Goodwill donations credible and denied all but $250 of the charitable income tax deduction because the taxpayer had “failed woefully to satisfy the substantiation requirements for these alleged gifts.”[19]

Applying the lessons learned:

Understanding the substantiation requirements

The lesson from these cases is clear—substantial compliance is not sufficient. Although charitable organizations should be fastidious in issuing contemporaneous written acknowledgments of gifts, in the eyes of the law, the burden is on donors to ensure all documentation is complete, accurate, and compliant with applicable Code sections and regulations. Guidance from financial and/or legal professionals is crucial, as the IRS may disallow a charitable deduction for even seemingly minor oversights. IRS substantiation rules are unforgiving, so when it comes to your clients, consider the following steps:

  • Inform clients about the specific requirements for gift substantiation. Educate clients on exactly what is needed for their particular charitable donation. Make sure they understand the concepts enough to evaluate substantiation documentation critically. While expert guidance is vital, donors should be able to spot anything that looks off, which can lead them to investigate the matter further or consult the relevant professional while there is still time.
  • Insist on a contemporaneous written acknowledgment for any gift exceeding $250. Clients making larger donations must obtain this documentation at the time of the gift, ensure that it contains all required information, and hold onto the paperwork. No matter how generous a donor is, tax law demands meticulous documentation and compliance with the legal and regulatory framework governing the donation.
  • Investigate whether a qualified appraisal is necessary. Qualified appraisals are essential for protecting taxpayers and ensuring valid deductions—but they must meet statutory and regulatory standards. If your client needs a qualified appraisal, make sure they use a qualified appraiser who has expertise relevant to the asset being valued and uses credible valuation methodologies (and attach the appraisal when required). Appraisals aren’t always quick, so donors should allow adequate lead time to meet this requirement.
  • Instill a healthy respect for the obligation. Reinforce the critical nature of adhering to IRS substantiation rules to protect your client’s rights (and valuable deduction) during IRS scrutiny. As we’ve seen, the IRS and courts cannot overlook procedural and substantive failures. Help clients review all documentation carefully and proactively address any discrepancies.

The importance of timing for pre-sale gifts of business interests

Donors can often reap powerful tax advantages by looking beyond quick and easy gifts of cash and considering donations funded with other assets. For example, those who put in the extra time and effort to properly execute a donation of appreciated shares of a closely held business may avoid paying capital gains tax on the appreciation while also qualifying for a charitable income tax deduction for the full fair market value (up to annual IRS limits). Unfortunately, these gifts are complex and can go awry without scrupulous attention to the details.

Estate of Hoensheid v. Commissioner:

Make sure a gift is complete before a sale is a foregone conclusion

Before Estate of Hoensheid v. Commissioner,[20] many donors and practitioners believed that the tax benefits of gifting appreciated stock were available as long as there was no legally enforceable agreement to sell the property in place at the time of the donation—a bright-line test to determine if a pre-arranged sale occurred. This case clarifies that there is no bright-line test—the IRS can examine all facts and circumstances of a sale transaction.

Hoensheid involves a common fact pattern. The taxpayer, Scott Hoensheid, and his two brothers were equal owners of a closely held business. When Scott announced his intent to retire, the owners decided to sell the company. Scott and his wife (“the taxpayers”) wanted to contribute part of his shares to a tax-exempt donor-advised fund (DAF).

Like most business owners, they wanted to wait as long as possible before making the actual DAF contribution in case the sale did not go through (Scott would have a reduced ownership interest in the company). During the sale negotiations, his tax advisor explained that he could avoid recognizing capital gains on the donated shares if the transfer occurred before a definite agreement. The taxpayers claimed a charitable deduction of $3,282,511 and did not report any capital gains associated with the sale of the donated shares. The IRS denied the deduction, finding a $647,489 deficiency, and held that the capital gain was included in the taxpayers’ income.

The Tax Court analyzed the requirements under state law to determine when the gift was complete. It concluded that the gift occurred two days before the business sale closed. One of the dispositive questions in this case involved determining whether an anticipatory assignment of income had occurred, considering the substance of all the circumstances. If the sale was all but certain to occur, there was an anticipatory assignment of income, in which the taxpayer, not the charity, is taxed on the proceeds.

In this case, the factors at issue in determining whether the sale of the shares was virtually certain to occur include:

  • Whether the donee had a legal obligation to sell the property
  • The actions already taken by the parties to effectuate the transaction
  • The existence of unresolved transactional contingencies
  • The status of the corporate formalities required to finalize the transaction

Based on the analysis of these factors, the Tax Court found that the charity did not have a legal obligation to sell the donated shares at the time of the gift, but the sale of the company was a foregone conclusion, as evidenced by the facts and circumstances. The Tax Court found that the taxpayers had unreported capital gains, even though the DAF received the proceeds from the sale. (As discussed in the previous section, the court also denied the charitable deduction because the taxpayers failed to provide a qualified appraisal to substantiate the value of the shares at the time of the gift.)

It is essential to provide careful guidance to any client contemplating donating shares in a closely held business as part of a buy-sell transaction. At the time of contribution, clients must bear at least some risk that the sale will not close—otherwise, they risk a determination of anticipatory assignment of income (and the tax consequences that go along with such a determination). A bright-line test does not determine how much time should separate a gift and a later sale; rather, the IRS may examine all the facts and circumstances of a sale during an audit.

Applying the lessons learned:

Timing and proactive planning

Timing matters. It’s a chief concern in gift and estate planning, especially as it relates to the completion of gifts for tax purposes. Timing is not merely a logistical concern; it can directly impact tax liability and the validity of gifts. When it comes to your clients, consider the following steps:

  • Encourage proactive planning. Clients must allow sufficient time to complete all necessary transactions and comply fully with tax laws. Emphasize the need to start planning well in advance of any anticipated life event or tax deadlines.
  • Explain the impact of state laws. For example, when contemplating a donation of shares of stock (or other appreciated property) to a DAF or charity as part of a buy-sell transaction, followed by a sale of those shares by the charity, donors must put in the extra time and effort to avoid being taxed on income not received without the benefit of an offsetting deduction.
  • Emphasize how critical timing is for gift substantiation. For example, donors must have the contemporary written acknowledgment in hand no later than the due date of their tax filing. It will not suffice to provide a late or corrected submission after the tax filing deadline. Further, the IRS can disallow any claimed charitable income tax deduction made after the tax year has ended.

Charting the right path and avoiding costly missteps

Poor planning often invites disaster. We began by looking at the Donner party—pioneers who attempted a rugged new route and didn’t pack enough food and supplies to survive an unexpected snowfall. These seemingly simple mistakes turned into something far worse.

You never want your client’s philanthropic journey to become a cautionary tale. The examples discussed in this issue demonstrate that proactive planning, meticulous documentation, and strict adherence to IRS rules are critical when it comes to successful gift planning. Your expert guidance can help clients prepare to meet requirements, successfully navigate the treacherous tax law terrain to make a meaningful difference, and secure important planning benefits.

Endnotes

  1. IRC § 6662.[↵]
  2. IRC § 170(f)(8).[↵]
  3. IRC § 170(f)(8)(C).[↵]
  4. Treas. Reg. § 1.170A-13.[↵]
  5. Albrecht v. Comm'r of Internal Revenue, No. 13314-20 (U.S.T.C. May. 25, 2022).[↵]
  6. IRC § 170(f)(8)(A).[↵]
  7. IRC § 170(f)(11)(B); Treas. Reg. § 1.170A-16(c)(3)(v); Treas. Reg. § 1.170A-16(d)(3)(ix).[↵]
  8. Treas. Reg. § 1.170A-13(c)(2)(i)(B).[↵]
  9. Treas. Reg. § 1.170A-13(c)(2)(ii).[↵]
  10. Treas. Reg. § 1.170A-13(c)(2)(ii)(A); Treas. Reg. § 1.170A-13(c)(7)(xi)(A).[↵]
  11. Treas. Reg. § 1.170A-16(e); "Publication 561: Determining the Value of Donated Property," Internal Revenue Service, December 2024. https://www.irs.gov/pub/irs-pdf/p561.pdf.[↵]
  12. IRC § 170(f)(11)(E)(i).[↵]
  13. IRC § 170(f)(11)(E)(ii).[↵]
  14. Hoensheid v. Comm'r of Internal Revenue, No. 18606-19 (U.S.T.C. Mar. 15, 2023).[↵]
  15. Braen, et al. v. Comm’r of Internal Revenue, No. 27003-17 (U.S.T.C. Jul. 11, 2023).[↵]
  16. Bryan Camp, “Lesson From The Tax Court: Size Does Not Matter,” TaxProf Blog, July 24, 2023. https://taxprof.typepad.com/taxprof_blog/2023/07/lesson-from-the-tax-court-size-does-not-matter.html.[↵]
  17. Id. OP. at 16. (The Tax Court found that the resolution of the case depended on the requirements to claim a charitable contribution deduction in connection with a bargain sale: (1) the fair market value of the benefits received and (2) whether the taxpayer supplied a contemporaneous written acknowledgment substantiating the contribution.)[↵]
  18. Ohde v. Comm'r, T.C. Memo. 2017-137 (U.S.T.C. Jul. 10, 2017).[↵]
  19. Id. at 10. (“Petitioners contend that they donated to Goodwill during 2011 more than 20,000 items of property with a fair market value of at least $145,000. They have failed woefully to satisfy the substantiation requirements for these alleged gifts.”)[↵]
  20. Hoensheid v. Comm'r of Internal Revenue, No. 18606-19 (U.S.T.C. Mar. 15, 2023).[↵]