Tax Court Disallows $4.5 Million Charitable Deduction Because of Misleading Gift Substantiation Letter

By Bruce R. Hopkins, EditorFebruary 27, 2012 | Print

(Originally published in the March 2012 issue of Bruce R. Hopkins Nonprofit Counsel, available electronically to subscribers on publication.)

The US Tax Court, on January 10, decided that donors of real property interests, having a value of more than $4.5 million, are not entitled to charitable contribution deductions because the charitable donee’s substantiation letter was misleading, in that it omitted reference to certain material forms of consideration accorded the donors (
Cohan v. Commissioner).


The properties involved, and interests in property, concern valuable farm property on Martha’s Vineyard. A group of individuals held various rights to the property through a limited liability company by the name of Herring Creek Acquisition Co. (HCAC). The donee is The Nature Conservancy (TNC).

The properties and rights involved include various lots, two leases, an option on land, a right-of-way, road modifications, and rights as to beachfront property. A cast of individuals had been quarreling about whether the farm property should be commercially developed. TNC proposed that it, as part of its “conservation buyer program,” acquire the property. Following “difficult and complex” negotiations, HCAC agreed to sell certain rights of first refusal to TNC. In return, HCAC was to receive 12 discrete elements of consideration, including parcels of real estate, leases, and reimbursement of legal fees. TNC agreed to place conservation restrictions on the farm. These terms were embodied in a bargain sale gift agreement.

TNC provided HCAC with a gift substantiation letter; it described the rights of first refusal that were transferred to TNC, and disclosed some of the items of consideration received by HCAC and their estimated values. The letter, however, did not disclose other items of consideration, such as two leases, a right-of-way relocation, an option, and certain land bank fees paid on behalf of HCAC.


A donor is not entitled to an otherwise valid charitable contribution deduction of $250 or more unless the donor has substantiation of the contribution, provided by the charitable donee, in the form of a contemporaneous written acknowledgment (IRC § 170(f)(8)(A)). This substantiation must include a description of any noncash property contributed and a statement as to whether the donee provided any goods or services in consideration for the gift (IRC § 170(f)(8)(B)). If goods or services were so provided, the substantiation document must include a good-faith estimate of their value.

The term goods or services generally includes cash, property, services, benefits, and privileges (Reg. § 1.170A-13(f)(5), (6), (8)). A good-faith estimate means the donee’s estimate of the fair market value of the goods and/or services provided (Reg. § 1.170A-13(f)(7)). A donor may not use a charitable organization’s estimate of the value of goods or services if the donor knows, or has reason to know, that the estimate is unreasonable (Reg. § 1.170A-1(h)(4)(ii)).


The court opened its analysis of the case by noting that TNC had an “incentive” to exclude from its substantiation letter issued to HCAC part of the consideration involved, because that would support claims of greater charitable deductions and reduce TNC’s reimbursement and indemnification obligations. The court found that the parties, because of the extensive negotiations, knew of each of the items of consideration and their value (because of appraisals), and negotiated which items of consideration to include in the gift agreement and thus in the substantiation letter. The trial did not yield any answers satisfactory to the court in explanation for these omissions.

The court wrote that the “record strongly suggests that representatives of TNC and HCAC made a conscious decision to exclude items of consideration received in the . . . transaction in calculating the amount of the bargain sale gift and to play the audit lottery with the hope of minimizing the tax indemnification amount.” It concluded that the substantiation letter did not include the requisite description or good-faith estimate of the total consideration HCAC received in the bargain sale transaction.

The court then addressed the question as to whether the donors reasonably relied on the substantiation letter. It noted that neither the donors nor HCAC’s lawyers questioned the substantiation letter’s omissions. There were some requests for the appraisal of the omitted items, but it was never provided.

The court wrote that the donors and their lawyers “knew about all of the items of consideration in the final agreement, and they knew or should have known that certain of these items were omitted in calculating the bargain sale gift amount.” It concluded that the donors “blindly relied” on the substantiation letter and thus did not reasonably rely on the letter in calculating their charitable contribution deductions.

The court refused to apply the substantial compliance doctrine in this case, noting that the donors “failed to disclose anywhere on their returns information relating to the total consideration received from TNC that was necessary for determining the amounts, if any, of the charitable contribution deductions.” The court also imposed accuracy-related penalties, finding that the donors did not act with reasonable cause and in good faith. [21.4]

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