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Thursday, October 7, 2010

How could Dudley's house have been worth $350,000?

The appraisal that supported gubernatorial hopeful Chris Dudley's $350,000 tax writeoff in 2004 for donating his house to the Lake Oswego fire department makes for fascinating reading. The logic of it is crystal clear: Since Dudley's house and the land under it were worth $1.2 million, and the empty lot would have been worth $850,000, the building must have been worth $350,000.

A problem with this logic, however, is that in federal tax valuation matters, the whole is often worth more than the sum of the parts. Take for example a company with a net worth of $3 million. If its stock is held by three unrelated parties, who own one third each, is each of their blocks of stock worth $1 million? Probably not, because any buyer of a single one-third block would know that he or she could be outvoted by the other owners. Each of the three blocks, if they had to be appraised separately, would have a fair market value of less than $1 million, to reflect the minority discount. And it would be that lower value that would control the amount of the deduction if any of them gave his or her block to charity while the other two held on to theirs.

So it may be with Dudley's homestead. The whole thing may have been worth $1.2 million, and the land may have been worth $850,000, but it doesn't necessarily follow that the building was worth the difference between the two. Anyone who bought just the building, and not the land under it, would have had to either move the house or start paying the landowner rent for the land under the house. That reality would likely depress the value of the house substantially. And so yes, that would mean that valued separately, which they would have to be for tax purposes, the house and the land didn't have values that add up to the $1.2 million total value that they had when combined.

The IRS must not have audited Dudley, or if they did, they let this one slide. But if the revenuers had raised issues about it, the valuation technique that was used would surely have been one of the main targets of the government attack.

Comments (46)

Dudley's not the dog I'm backing in this fight, but to be fair, shouldn't the blame for this questionable and potentially illegal deduction attach not to Dudley but to the accountant that advised him or prepared his tax return? Dudley's willingness to seek out and employ aggressive tax-minimization strategies doesn't win any points with me, but I'm having a hard time blaming him for this. When you pay someone to give you professional advice and that advice turns out later to be wrong or is later contravened or overruled, is it the fault of the professional or the client that hired him or her? It also sounds like the IRS was not of a firm opinion on this deduction until fairly recently.

Again, I'm not voting for Dudley, but for reasons other than his following advice that others of us could have theoretically followed as well.

County tax statement?

Dudley said his accountant told him the $350,000 deduction was legit, but Dudley is more sophisticated than the average taxpayer. He has his own business consulting ultra-wealthy clients to pursue "appropriate tax minimization" strategies. What kind of advice has he been giving to them and is that advice legitimate?

A CPA has no particular expertise in real property appraisals but probably should have understood what valuation standards were appropriate in this context. The CPA has some potential exposure from participating in tax scams, but the ultimate responsibility is the taxpayer's.

I get what you are saying, Jack. I live in a sub code "shack" on a large lot next to a gated community. I had an honest chat with a nice gal at the assessors office about values. My land+structure value is contingent on the cost of demo (cement block = can't burn)of the house making a very valuable building lot. So in actuality the structure is a negative value against its property market value.
I think the IRS just doesn't currently want to put a dog in this fight. A lot like cars being donated to charity. Now if the local fired department was doing weekly "practice burns" that would change the story I'm sure.

Jack, I was wondering why you were so easy on Dudley in your first post? Even this post is way to easy on him.

This deduction is completely illegitimate. Coupled with the evidence regarding his state tax issues, it's clear Dudley is a tax cheat. He is an educated man and knows he is cheating.

It seems the posters defending Dudley are doing so because they condone tax cheating because they disagree with the country's tax law.

I just don't see the big deal here. Heaven forbid someone try to legally limit what they pay in taxes. It's like it is a bad thing to make money in this state anymore, no wonder Oregon's economy will never improve.

Dudley may not be "perfect" but he is sure better than Gov. Retread. Why isn't anyone making a big deal about Gov. Retread's highly unusual and shady home loan?

Full (or partial) transfer of risk. Take Eric's comment above and apply it towards Town and Country Resources.

T&C is the Bay Area employment agency that processed Nicky Diaz back in 2000. In the HR world (or so you'd hope) it is an agency's legal responsibility to first determine whether or not an applicant is legally able to work (or not on the lam) in USA before making a placement.

All the fury Gloria Allred has unleashed against Meg Whitman so that Jerry Brown can sway some of the Hispanic vote in California by attrition should instead be redirected toward T&C for not using E-Verify (or similar) back in 2000. By not doing that T&C fully exposed itself to resulting liabilities that Whitman transferred to the agency at the time by choosing to vet and hire through them. Just throwing that out there.

Logic dictates that if an unlucky bunch of folks survived a plane crash because the wing fell off upon takeoff the class action lawsuit would for sure include the aircraft manufacturer, not stop with solely fingering the pilot.

I'm not a real estate appraiser but $350K for a 4 bed, 4 bath, 4,927 sf house in LO in 2004 does not sound particularly fishy to me.

And only a lawyer would say such a document makes for fascinating reading!

The replacement cost on a 4900 sq ft house would be way more than $350K. $100 per sq ft is a decent rule of thumb in this area so that gives you $490K for new construction. Minus wear and tear and the $350K seems to be roughly reasonable.

I happened to use a similiar tax reduction method a few years ago myself. I had a greenhouse on my property that I had been leasing to a farmer. I wanted to build a shop so I sold the greenhouse and had it removed. The greenhouse had a book value of $30K so that amount was written off of my taxable income for the year. One could argue that the greenhouse had zero value to me since I wanted it removed anyway but it did have book value and it was capable of generating income so obviously it did have value. Just because one person doesn't want an item anymore doesn't mean that the item doesn't have value.

He's not donating a house. He's letting the fire department demolish it, which he would be doing anyway. The fire dept. would never pay $350,000 to use his house for this purpose. The deduction should be what it is worth to the fire dept. to burn down the house. It's not like he gave the house to the fire dept in perpetuity. He let them use it for a week to do there drill.

The whole point is this isn't a legal deduction. He only got off because he evidently wasn't audited and now the statute of limitations bars the IRS from going after it. It doesn't mean that it isn't illegal, only he wasn't caught.

I am beginning to see why we are stuck with the choices we have. Who in their right mind would want to go through this never ending c**p.

I guess we do get the government we deserve.

He's not donating a house.

No, it was decided in Scharf v. Commissioner, a 1973 U.S. Tax Court memo case, that it is a donation of the house, and it does give rise to a deduction. Of some amount.

A lot like cars being donated to charity.

Congress has stopped the valuation abuse there. Nowadays you get to deduct only what the charity actually sells the car for, not what an appraiser says it is worth.

This deduction is completely illegitimate. Coupled with the evidence regarding his state tax issues, it's clear Dudley is a tax cheat.

No, Scharf v. Commissioner is ample authority for what he did.

The replacement cost on a 4900 sq ft house would be way more than $350K.
$100 per sq ft is a decent rule of thumb in this area so that gives you
$490K for new construction. Minus wear and tear and the $350K seems to be
roughly reasonable.

First of all, replacement cost is rarely, if ever, used for single-family residences. And in this case, the house was 55 years old and no doubt nearing or past the end of its useful life.

Even though he may have been able to take a deduction, I don't think it's all that complicated to see the deduction is way overstated and dishonest. I believe it's illegitmate in that it's completely overstated.

Once again I give you:
"Anyone may arrange his affairs so that his taxes shall be as low as
possible; he is not bound to choose that pattern which best pays the
treasury. There is not even a patriotic duty to increase one's taxes.
Over and over again the Courts have said that there is nothing sinister
in so arranging affairs as to keep taxes as low as possible. Everyone
does it, rich and poor alike and all do right, for nobody owes any
public duty to pay more than the law demands." - Judge Learned Hand

Jack, I totally disagree with you that a 45 year old house is "nearing or past its useful life". I wouldn't be in business if that was the thinking of many of my clients.

In the past two decades it was very common for people to buy homes on or near Lake Oswego lake with beautiful landscaped yards and all. The homes had been comfortably lived in right up until my clients, or others, desired to build the McMansions with updated technology, style and comforts. It was merely that some particular buyer saw the present house as expedient to be torn down to build their dream home; or others just saw the need to update a few features, and some just to paint and enjoy the ambiance as is. Dudley was the former, but that doesn't mean the value of $350,000 was wrong, because someone else would very likely, like most or all of the existing.

the house was 45 years old and no doubt nearing or past the end of its useful life.

If that's the standard, then I guess all the old houses in Alameda and Irvington are worthless and should be torn down to make way for new development. ; )

Gee - why isn't this much time and energy being devoted to examining every minute detail of Dr. Failure's life? How about that home loan from a Brokerage House? Or his loss of memory about serving on a Board of Directors?

Hey, it's just another way for rich people to scam the tax system, what's the big deal?

If the house was forty-five years old, I wonder how much asbestos was in there?

Those of you thinking that the $350K valuation put on the house should keep in mind (a) that the ground it was on was not available to anyone acquiring it; and (b) it would have been expensive and difficult — perhaps even impossible — to move it to another location. These factors make the valuation method used inappropriate and, in all likelihood, the valuation amount unreasonably high.

. . . that the $350K valuation put on the house was reasonable . . .

Dave A. - Got BLOG? of your own?

Hey Jack, can you clear up what is confusing me about all this?

I had been under the impression that donations to public agencies, like if I give money to my kids' schools (or the local fire department), are not tax-deductible because they don't qualify as charitable contributions because those are public agencies and not 501(c)3 organizations.

Why isn't this the case?



Pub526 may clear up some of your confusion, or add to it :-)

Well it certainly clears up that you can deduct donations to government agencies, but it also says in there that you can't receive or expect to receive anything of equal value.

Anyone know how much it costs to hire someone to demolish a home (along with permits that I'm sure would have to be covered if it weren't donated to the fire department)?

Other Eric,

Houses built in the mid 60s probably are crap that is falling apart while those 90+ year old houses in Irvington etc. will be there and still great 90 years from now:-)

"Anyone know how much it costs to hire someone to demolish a home (along with permits that I'm sure would have to be covered if it weren't donated to the fire department"

A fire doesn't burn it down to ashes and then one builds on top of it. I am sure it costs just as much to remove burned rubble as it would just to tear it down and haul it away.

A house around 4500 s/f could be demolished and hauled away for about $40,000 (give or take $10k). If there was asbestos, that would have to be sealed and hauled to Arlington for disposal.

Permits for a demo aren't overly expensive, probably under $500.

Just guesses. On the plus side of a demolition: you get to wave the onerous SDC fees, which in 2004 were probably in the neighborhood of $25,000. (Again, just estimates)


Scharf v. Commissioner does not give authority for what he did. The case pre-dates the provisions of IRC 170(f) and Reg. 1.170A-7(a).
As has been discussed the code and regs provide for denial of charitable deductions in cases of certain contributions of partial interests in property.
Also fair market value is defined as "the price which property will bring when it is offered for sale by one who is willing but is not obligated to sell it." In this instance "property" relates to the price of the structure based on the condition that it must be removed from the land.
Scharf v. Commissioner does not justify the amount of the deduction.

Jack [poster]

Assuming that you have a tax background based on your comment, how is Dudley supposed to know how to handle this if two tax experts can't agree?

I agree that Scharf does not justify the amount of the deduction. That's what this blog post says. But the case does support the basic concept that the donation is deductible.

Yes, Scharf pre-dates Code section 170(f)(3), and it predates Code section 280B, which also may disallow the deduction here. But it's not clear that those sections preclude the deduction.

Dudley gave the fire department more than the mere right to occupy the land and building. He gave them possession of the building, with the right to destroy it, thus converting it. That may very well be enough to justify a charitable contribution deduction, even under current law.

If Congress wants to outlaw deductions in cases like this, it would be easy for it to do so expressly. But it hasn't.

These questionable appraisals often seem to lead back to my business' lovely ex landlord and his partners or former partners. I recognized the address of the firm as a building owned by Dave Pietka.

Mark Hepner, the appraiser in this case, is with a firm formerly known as PGP (Palmer, Groth, Pietka). PGP was the firm responsible for this prior controversial appraisal: https://bojack.org/2006/12/a_hideous_stench.html

Dudley sure knows who to turn to...

Why is the value to the fire department for having an opportunity to have a training exercise not the FMV of whatever he donated? The reality of what happened is he saved himself thousands in the cost of demolition and removal and gave the fire department a training opportunity, and then took deduction for the full appraised value of the house, which, given his tax bracket converted thousands of dollars in demolition costs into a six figure tax savings. Can I get the fire department to demo my basement and take the loss in value to my property as a deduction before I remodel? I presume he had concluded that even without the deduction, the cost of demolition and the combined value of the property and the new house was going to sufficiently enhance the FMV of the entirety, such that the rebuild made economic sense. I can't imagine Congress intended to help finance this kind of a personal real estate upgrade by a top 1 %er. They wouldn't do that right?

Fair market value is not the value to the fire department, or the value to Dudley. It is the price that the property would obtain in the marketplace. What would someone pay for that building (without the land beneath it)?

The return benefit to Dudley would reduce the size of the deduction, but the Scharf case says that it would not negate it entirely.

As I say, there's a big valuation issue here.

Houses built in the mid 60s probably are crap

Dudley's house had been built in 1949, and so it was 55 years old at the time of its incineration.

But the fire company didn't buy it to use it as a dwelling. I guess it all still doesn't pass the smelly fish test to me (and I was ho hum on this when you first posted it) because the FMV he claimed ($350K) is obviously nothing a reasonable fire department or similarly situated party would pay for such a house for the sole purpose of burning it down for training. Hell they could probably build dozens of knockdown houses for that price. Similarly, if he donated it to a lumber or construction product recycling outfit , like the Rebuilding Center over on Mississippi, to dismantle and reuse the timber, doors, windows, etc., I can't imagine it would have been deductible for its value as a dwelling, rather then as a source of building materials. It just seems such a fiction to let him give it a $350k value as a dwelling residence, when he and everyone else knew no one would pay anything close to one tenth that amount for the house for the purpose for which it was conveyed, as a knockdown. I seriously doubt the fire department had the option to keep it and use it as a dwelling for its employees.

That's the thing about fair market value -- it doesn't look at value to the actual transferor or the value to the actual transferee. It looks at the price a hypothetical party would pay, who would use the property for its highest and best use.

With donated used cars, people used to use blue book value, even when the charities were selling the cars for a fraction of that. Congress had to change the law to make sure people didn't deduct more than the actual sale price that the charity realized. "Fair market value" allowed donors to deduct more.

Congress hasn't done anything like that with donated tear-down houses.

BTW, note that the appraisal was done more than six months after the house was already gone. Appraisals of property by people who have never seen the property don't usually get much weight.

The $350k FMV only makes sense to me if the buyer got at least a life estate in the house or a long term lease for the land under it and an access easement. But here I doubt the fire company got (or he actually donated) any legal right to put the house to its highest and best use, which is what he claimed for a deduction. At least the donated car can be used by the accepting charity for any legal purpose it wants (personal use, re-sale, recycling etc.), a true transfer of all indicia of ownership. In contrast, I seriously doubt the fire company had the right to turn around and sell the house, rather than burn it down. I also doubt it got any right to live in it. He didn't donate and they didn't receive any right to put the 4,900 ft. single family residence to its highest and best use. So as I see it he did not donate all that he deducted, rather, he donated some limited legal right in the house and his property. As a practical matter all the fire company really got was a license to come on his property and destroy a structure he didn't want. In my view the FMV of that legal entitlement is all he honestly should have deducted.
Not arguing the tax law precedent with you Jack, just pointing out the dishonesty inherent in the legal fiction, as I see it.

Oh no, you are 100% right. If I were a judge writing on a clean slate, I'd laugh Dudley's deduction right out of my courtroom.

But the slate isn't clean. There's precedent for allowing the deduction here. The place where there's still an open issue is valuation. And on that issue, Dudley was highly aggressive.

I enjoyed some quality time with Ted Rall this evening.

He's in town for two presentations on Saturday at Wordstock.

At such a geeky intellectual event as a celebration of books, poets, editorial cartoonists (Rall is past president of their national guild), which candidate would you more expect to meet there, among his peeps, on the hustings for votes: Kitzaher or duhDudley?

Speaking of 'celebrating,' LIARS Larson claims he has conned a half-dozen Rightwing wackos (so-called 'social Republicans' including Dudley -- all anti-abortion, all the time -- not to be confused with 'fiscal Republicans'), to appear downtown in LIARS' studio for 'debates' (against empty folding chairs) on-air during LIARS' programming, as he walks among them and pauses to touch each one with his fawning approval lipsticking the black kiss of political death on their foreheads.

shouldn't the blame for this questionable and potentially illegal deduction attach not to Dudley but to the accountant that advised him or prepared his tax return?

Of course not. He's not a republican running for office in Oregon.

I love these posts in which you bring your professional expertise to bear on Oregon politics. They are excellent!

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