The valuation of property for charitable contribution deductions represents one of the most challenging areas of tax compliance for both practitioners and taxpayers. While the tax code encourages charitable giving through deductions, it also demands rigorous substantiation and accurate valuations to prevent abuse.
For real estate donations in particular, determining the appropriate value requires careful consideration of market conditions, property characteristics, and valuation methodologies. Even small errors in these assessments can result in substantial tax deficiencies and penalties.
When taxpayers claim charitable contribution deductions based on property appraisals, they must navigate complex requirements for both technical compliance and substantive accuracy. The consequences of failing to meet these requirements can be severe, potentially resulting in complete disallowance of the deduction and substantial penalties.
A recent Tax Court case, Leo v. Commissioner, T.C. Memo. 2025-X (January 29, 2025), provides an opportunity to examine how courts evaluate property valuations in the charitable contribution context.
Facts and Procedural History
The controversy originated when Karl and Fay Leo, through their LLC (Vanguard Properties), donated an industrial property in Union County, Mississippi, to the Mercy Foundation. The donation was structured as a bargain sale transaction completed on December 31, 2013. The property consisted of 136.4 acres of land and multiple industrial buildings totaling approximately 1.09 million square feet.
On their 2013 Form 1040, the taxpayers attached an appraisal valuing the property at $15.8 million. They claimed a charitable contribution deduction of $15.225 million, representing the difference between the appraised value and the $575,000 received in the bargain sale transaction.
Due to the annual limitations on charitable contributions, the deduction was carried forward to subsequent tax years. The taxpayers utilized $3,249,390 of the deduction in 2013, $1,923,346 in 2014, and $2,041,594 in 2015.
The IRS Tax Audits division selected the returns for examination, resulting in the issuance of an IRS Notice of Deficiency on October 20, 2020. The notice determined deficiencies of $855,262 for 2016 and $979,885 for 2017, along with substantial valuation misstatement penalties under Section 6662(h).
The taxpayers challenged these determinations through Tax Litigation in the U.S. Tax Court, where the primary dispute centered on the property’s true fair market value. The IRS’s position that the property was worth only $4.3 million stood in stark contrast to the taxpayers’ claimed value of $15.8 million.
Section 170 Charitable Contribution Requirements
Section 170 of the tax code provides the foundational framework for charitable contribution deductions. This section establishes both the basic requirements for deductibility and the specific rules governing property contributions.
For any charitable contribution to be deductible, Section 170(a) requires that the donation be made to a qualified organization. The regulations under this section further require that the contribution be properly substantiated and, in the case of property contributions, accurately valued.
When dealing with property contributions, particularly through bargain sales, Section 170 requires careful analysis of fair market value. Treasury Regulation §1.170A-1(c)(2) defines this as the price at which property would change hands between willing parties, both having reasonable knowledge of relevant facts and neither being under compulsion to buy or sell.
The substantiation requirements increase in complexity as the value of donated property increases. Section 170(f)(11) imposes specific requirements for contributions of property valued over certain thresholds, with particularly stringent requirements for property valued over $500,000.
For high-value property contributions, taxpayers must obtain and attach a qualified appraisal to their return. The regulations define specific requirements for what constitutes a qualified appraisal and who qualifies as an appraiser.
The timing of appraisals is also strictly regulated. They must be performed no earlier than 60 days before the contribution and no later than the due date of the return, including extensions.
Qualified Appraisal Requirements
Treasury Regulation §1.170A-13(c) sets forth detailed requirements for qualified appraisals. These requirements aim to ensure that valuations are performed by competent professionals following established methodology.
A qualified appraisal must include specific information about the property, including detailed descriptions of its physical condition and characteristics that affect value. The appraiser must describe the valuation methodology used and explain why that methodology is appropriate.
The regulations require appraisers to be qualified through education and experience to value the type of property being donated. This requirement recognizes that different types of property require different expertise to properly value.
The appraisal must specifically discuss the property’s highest and best use, as this determination can significantly impact value. This analysis must consider physical possibility, legal permissibility, financial feasibility, and maximum productivity.
Appraisers must also specifically consider and discuss any restrictions or limitations on the property’s use or disposition. This includes both existing restrictions and those that will apply after the charitable contribution.
The regulations require discussion of all factors that impact the property’s value, including physical condition, market conditions, and any recent sales or offerings of the property or comparable properties.
Valuation Methodology Standards
In the context of real estate valuations, professional standards and tax court precedent recognize three primary approaches to determining market value. Each approach provides different insights into value and may be more or less appropriate depending on the property’s characteristics.
The sales comparison approach examines recent sales of similar properties, making adjustments for differences in characteristics. This approach typically receives significant weight when sufficient comparable sales exist.
The income approach analyzes the property’s income-producing potential through careful examination of market rents, vacancy rates, operating expenses, and appropriate capitalization rates. This approach becomes particularly relevant for income-producing properties.
The cost approach considers the cost to construct similar improvements, less appropriate depreciation, plus land value. This approach often provides a useful check on other approaches but rarely serves as the primary valuation method for older properties.
Courts generally expect appraisers to consider all three approaches, even if they ultimately rely more heavily on one method. The choice of primary methodology should reflect the property’s characteristics and the market in which it operates.
The Leo case emphasized that regardless of the primary methodology chosen, appraisers must adequately consider and address actual market evidence. This includes recent sales, actual rental rates achieved, and market response to attempts to lease or sell the property.
The Gross Valuation Misstatement Penalty
Section 6662(h) imposes a particularly severe penalty for gross valuation misstatements. This penalty equals 40% of the portion of any underpayment attributable to a gross valuation misstatement.
A gross valuation misstatement occurs when the value claimed on a return exceeds 200% of the amount determined to be correct. This threshold reflects Congress’s determination to strongly discourage significant overvaluation.
The penalty applies not only to the initial year of the contribution but also to carryforward years. This makes the consequences of overvaluation particularly severe for large charitable contributions that must be carried forward due to annual limitations.
Unlike many other accuracy-related penalties, Section 6662(h) provides no reasonable cause exception for gross valuation misstatements. This reflects a policy determination that taxpayers should obtain reliable valuations before claiming large deductions.
The penalty calculation can result in substantial amounts. In the Leo case, the penalties totaled $342,104.80 for 2016 and $391,954 for 2017, demonstrating the severe consequences of overvaluation.
The Takeaway
The Tax Court’s decision in Leo fundamentally changes how courts will evaluate property appraisals in charitable contribution cases. The court rejected the taxpayers’ $15.8 million valuation as unsupportable because it ignored crucial market evidence, including actual rental history and a subsequent sale for just $1.13 million. Instead, the court accepted the IRS expert’s $4.05 million valuation, which properly considered the property’s poor condition and market performance. This decision establishes that theoretical valuations disconnected from market realities will not withstand scrutiny, impacting how the Tax Court and practitioners approach property valuations across all tax contexts, from Real Estate Tax Advice to estate planning.