IRS “Red Flags” and Non-Cash Charitable Donations: Why You Need an Appraisal
We at Arcadia Appraisals know that IRS audits aren’t fun. In the best of circumstances, IRS audits are time-consuming hassles, requiring you to organize and produce documentation evidencing the legitimacy of your deductions as well as the entirety of your taxable income. In the middle case, IRS audits are just expensive, necessitating the retention of accountants and/or lawyers to defend your tax filing—a costly and time-consuming proposition. In the worst-case scenario, an audit will result in your having to pay more taxes, onerous penalties, and interest in addition to the cost of procuring professional services from accountants and lawyers. Ouch!
You don’t have to be a criminal to want to avoid an IRS audit. Let’s be honest. Many people have legitimate deductions but have not been diligent about their record keeping and cannot adequately evidence all or part of a deduction to which they are legitimately entitled. Nevertheless, many taxpayers still take the deduction, hoping that the IRS won’t come knocking.
The IRS comes a-knocking in two ways. First, random audits, and second, triggered audits. Random audits are just that—random. Your social security number is placed in a digital hat and plucked lottery-style, the “winner” getting an audit. Thankfully, random audits are rare. Statistically, a tax payer has less than a 0.8% chance of being randomly audited.
Triggered audits occur when an IRS agent spots a so-called “red flag” on the tax payer’s return that suggests that too little income is being reported or too many deductions are being claimed. The chances of a red flag on your return triggering an audit are not easily calculable because some deductions against income are more widely abused than others.
One oft-abused deduction is the non-cash (also called, “in-kind”) charitable donation. In other words, non-cash charitable donations taken as deductions on your return are “red flags” that will dramatically increase your chances of triggering an audit upon initial review of your return. Taxpayers frequently inflate the value of their non-cash donation, ignore fair market value criteria, and/or fail to keep or produce cost basis evidence such as purchase receipts, credit card statements and canceled checks. Also, most charitable institutions receiving your donation will NOT provide you with a receipt evidencing value, and even if they did, the IRS is almost certainly going to ignore it.
Does this mean that you shouldn’t deduct the value of the art work, furniture, books, equipment or antiques that you’ve donated? Absolutely not! What it does mean, however, is that, to avoid your donation from triggering an audit, you have to be smart about how your donation is presented, described and evidenced to Uncle Sam.
The first mistake made by many taxpayers is to fail to obtain an appraisal simply because the IRS does not absolutely require one. Although there are exceptions to the rule, the IRS does not require you to obtain an appraisal for donated artwork, antique, collectible or other tangible personal property if the total amount of your deduction is less than $5,000. Many taxpayers mistakenly believe that there is no reason, therefore, to obtain such an appraisal if they are claiming a deduction of less than $5,000 for their non-cash contribution. Wrong, wrong, wrong!
Non-cash contributions exceeding just a few thousand dollars are audit red flags when appearing as nothing other than number values on line 17 of Schedule A of your tax return. Period. However, if you submit your return with a well-documented, professionally-looking qualified appraisal, your IRS examiner is likely to disregard what is ordinarily a red flag triggering an audit. In fact, a high-quality appraisal attached to your return has a positive spill-over effect, identifying you as a meticulously-honest taxpayer whose other deductions are likely to be well-documented, too.
At Arcadia Appraisals, we recommend that you invest in obtaining appraisals for significant charitable donations even if they are under the $5,000 threshold where appraisals are not mandated by the IRS. Why? Ask yourself this question: If I were told tomorrow that I could avoid attending an IRS-ordered field audit simply by paying the price of an appraisal (say $200 or $300), would I do it? Only masochists or insane people would answer, “No.”
Furthermore, even though the IRS does not require the attachment of an appraisal to the return itself (except in the context of very large non-cash donations), we believe that such appraisals should always be attached as affirmative, upfront proof of your veracity and as a means to deflect the chances of an audit. Finally, even though the IRS does not always require the signature of your appraiser on form 8283 (which form is required for all non-cash contributions exceeding $250), we believe that, if you go through the expense of obtaining an appraisal, it is wise to add validity and credibility to your return by having your qualified appraiser sign off on form 8283. We, at Arcadia Appraisers, are happy to do that for all our clients regardless of the size of their donations.