In 1998, Theodore Rolfs and Julia Gallagher decided to demolish their house and build a new one. They donated the house to the local fire department, which burned it down. This saved the couple the expense of hiring a demolition company to tear it down. On their tax returns, Rolfs and Gallagher took a charitable deduction of $235,350 (the cost to rebuild) for the donation and the IRS claimed foul.
The question to the Tax Court centered on whether there was a charitable contribution. The Court found that the couple received a substantial benefit by making the donation. The United States Supreme Court held in United States v. Am. Bar Endowment, 477 U.S. 105 (1986) that taxpayers are not entitled to a charitable contribution deduction where the fair market value of property donated does not exceed the fair market value of the benefit they received in exchange Sec. 1.170A-a(c)(1) of the Income Tax Regulations defines Fair Market Value as “the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of the relevant facts.”
In making the donation to the fire department, the couple “severed” the house from the property it was sitting on. If the taxpayers had tried to sell the house with the requirement that it be moved, rather than be burned down, it would have been virtually worthless. The couple benefited by saving money on demolition costs, estimated to be about $10,000. Obviously that exceeded the value of the worthless house, and the deduction was denied.
This case involved an unsettled area of the law. Consequently, the Tax Court held the couple was not liable for accuracy-related penalties.
