In 2014, Tax Court observers were baffled when the court allowed an odd charitable contribution case that centered on the value of a remainder interest in income-producing property to go to trial. The deduction claim relied on a plainly defective appraisal summary. The recent decision, which includes the court’s formula for valuing the contested interest, gives real estate and business valuators much to chew on.

The petitioner in this convoluted tax shelter case was a partnership called RERI Holdings (RERI). During its short life, RERI donated a successor member interest (SMI) whose underlying asset was property that was leased to AT&T. An appraisal valued the property at $47 million as of August 2001. The SMI was to become possessory in January 2021. RERI acquired the SMI for $2.95 million in March 2002 and donated it to a university in August 2003. RERI claimed a $33 million deduction for the gift based on an appraisal that relied on present-value tables promulgated under the Internal Revenue Code’s Section 7520. The appraisal stated an “investment value” for SMI. Section 7520 assures that the values of the present interest and future interest add up to the value of the property underlying the time-divided interests, without discounts. In December 2005, the university sold the SMI for $1.94 million.

In a final partnership administrative adjustment (FPAA), the IRS initially argued the value of the contribution was $3.9 million. In a later amendment, it said RERI had no right to any deduction because the underlying transaction was a sham. Alternatively, the deduction should be limited to $1.94 million, the amount the university obtained when it sold the contributed property. RERI petitioned the Tax Court for review.

The court decided two major procedural issues in favor of the IRS. One, it found that the appraisal summary RERI submitted was deficient, which justified “the full disallowance of its claimed deduction.” Moreover, Section 7520 did not apply because the holder of the SMI did not have adequate protection until the interest became possessory. When the Section 7520 tables cannot be used, the remainder interest had to be valued based on “actual fair market value,” the court explained.

The court’s valuation formula produced an FMV of about $3.5 million for the SMI. Besides disallowing the deduction, the court found the gross valuation misstatement penalty applied.

A digest of RERI Holdings I, LLC v. Commissioner, 2017 U.S. Tax Ct. LEXIS 33 (July 3, 2017), and the court’s opinion, will be available soon at BVLaw.