Thursday, March 7, 2013

Can You Deduct Burning Down Your House?

Can you take a deduction for burning your house to the ground?

You may laugh, but I was reviewing a recent case on this issue. It is the third case involving a home barbeque I can remember over as many years.

The case from 3 years ago was Rolfs v Commissioner. It was – understandably – considered quite outside the box.

Theodore Rolfs and his wife (the Rolfs) owned a house on a 3-acre lakefront property in Wisconsin. The house was modest, built around 1900 and it would be fair to say that it was in need of an upgrade.

The Rolfs wanted to renovate, but the work required was so extensive that tearing down the house and constructing anew was a very viable option.

They estimated it would cost $10,000 to $15,000 to demolish the house and remove the debris.

They went a different path and donated the house to the fire department. There were restrictions on the donation: the fire department was to use the house for training exercises, with the understanding that the training would happen shortly after the donation. The Rolfs donated only the house. They did not donate the land on which the house sat.

The Rolfs needed a value for their donation. They contacted Richard Larkin, president of Larkin Appraisals, Inc. who valued the house at $76,000.

The Rolfs donated the house and took a charitable deduction of $76,000 on their tax return. They attached the appraisal report and a letter from the fire chief thanking them for the donation.

The IRS disallowed the charitable contribution.

The IRS argued that a charitable donor does not expect a financial benefit in exchange for the donation. The Rolfs however expected a substantial benefit: the $10,000 to $15,000 in avoided demolition costs, for example, not to mention the benefit of the tax deduction itself.

The IRS further argued that the restrictions the Rolfs imposed affected the value of any donation. The fire department could only use the house for training purposes, and the house was to be destroyed shortly after the donation.

The Rolfs countered that they had an appraisal for $76,000.  And what was the IRS talking about with “restrictions?” After the fire department did its thing, there was NO house standing. The fire department did not want a house. They wanted a house they could burn to the ground. Whatever “restrictions” the IRS was talking about went up in smoke.

The case went to Tax Court.

In a Solomonic gesture, the Court reasoned that there might be a donation, but the amount of any donation would be the value of the house over the value of any demolition and clean-up services received.

The Court observed that the Rolfs donated the house without its underlying land. This meant that an independent buyer would have to move the house. The house was very old and badly in need of renovation. What would someone pay for this? Not surprisingly, the house was almost worthless.

The house was not worth more than the demolition and removal services received from the fire department. The Court decided there was no donation. The Rolfs lost their case.

But they made the tax literature.

There are variations that might have resulted in a different outcome. For example, what if the house had enough value to make it worth the cost and effort of moving?

There is another way to help tax-subsidize a house demolition, however. Have you heard of “deconstruction?” This involves dismantling the house rather than razing it under a bulldozer. It is more expensive, but with deconstruction more home materials remain in usable condition. The materials are then donated, generating a tax deduction. If the value of the tax deduction exceeds the additional cost of the teardown, one has effectively tax-subsidized his/her demolition costs.

The value of the materials can add up. I was reading an article where the lighting fixtures alone were worth over $100 thousand. Can you imagine?

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