With the holiday shopping season in full swing, many consumers enjoy the search for a bargain. In the world of philanthropy, there are “bargains” as well. The recently decided case of Braen v. Commissioner1 shows how easily the benefits of a bargain may be lost without proper documentation and calculation of the “net” provided to charity.
Overview
The most common form of bargain is the charitable gift annuity. That involves the transfer of an asset to a charity for less than full and adequate consideration with a gift annuity agreement documenting the charitable intent. The charitable income tax deduction is the difference between the fair market value (FMV) of the asset less anything of value received by the transferor from the charity.2 The difference between the value of the cash and or property surrendered less the value of the income payments going to the annuitants will be the charitable deduction. A contemporaneous written acknowledgment (CWA) will so state the difference.3
Sale of Real Estate
The rarer form of bargain involves the sale of appreciated real estate. The appeal to a donor is not only supporting a favorite charity but also generating a multi-year cash flow and a charitable deduction. So long as the donor is content to incur a partial capital gains tax in the year of transfer and able to restructure any debt on the property before the closing, this transaction can make sense.
The appeal to the charity often is certainty of result. The sale secures the immediate possession of the property at a fraction of its FMV. For larger charities, with access to cash and a reliable due diligence process to assess environmental risk, this approach may be attractive, especially when the real estate is near the charity.
Sale to government entities. Typically,when a taxpayer transfers property to a local government or political subdivision and a change in zoning or an approval of a subdivision follows, enhancing the value of the surrounding property of the donor, the courts won’t allow a charitable deduction.4 “If it is understood property will not pass unless the taxpayer receives a specific benefit then the transfer does not qualify for the charitable deduction.”5
Sometimes the taxpayer can argue successfully that any benefit realized is incidental, in which case a charitable deduction is allowed.6 For example, a taxpayer was allowed a deduction for the cost of a highway interchange constructed and given to a public highway authority notwithstanding the interchange increased the accessibility of the taxpayer’s property being prepared for development.7 That case makes clear the burden is on the seller to prove any consideration received is less than what’s paid to the purchaser.
“Bargain” in Braen
Taxpayers as owners of an S corporation litigated for years in securing a mining permit from the town of Ramapo, N.Y. Part of the consideration was the rezoning of the property to be retained by the sellers as industrial and permitting quarrying. So in effect, the taxpayers sold 425.5 undeveloped acres, while receiving the right to mine on the surrounding 78 acres. The taxpayers failed to document the value of the consideration received from the purchaser. The court rejected their argument that they were legally entitled to the zoning change and would have prevailed in litigation.
Even though there was an allusion in the acknowledgment letter to the litigation between the taxpayers and the governmental body, there wasn’t an explicit enough statement of that being something that was received. Thus, the taxpayers failed to satisfy Internal Revenue Code Section 170(f)(8)’s CWA requirement to include a description and good faith estimate of value of any goods or services received as consideration. The acknowledgment incorrectly stated that the town didn’t provide “any goods or services . . . as consideration” other than cash.
So, how could the taxpayer approach the valuing of the consideration received? An excellent starting point would be the “before and after approach” used for valuing a perpetual easement restriction. Treasury Regulations Section 1.170A-14(h)(3) would be especially useful to study, as it addresses valuation of consideration regardless of whether the remaining property of the donor is contiguous to the donated property. Specifically, the taxpayers should have determined the value of the underlying property before and after the sale.
Braen shows the care with which charitable intent must be documented and the awareness required as to what the seller might receive from the purchaser. Notwithstanding the dramatic difference of $12.3 million between the sales price and appraised FMV, the 70% discount didn’t, by itself, prove donative intent. Charitable intent also is needed to secure the charitable deduction for split-interest gifts like charitable remainder trusts and charitable gift annuities as well as outright gifts.
Braen also shows the consequences of a defective CWA and appraisal.
Noncompliance with the documentation and substantiation not only eliminates the tax savings but also exposes the counsel and accountants to tax malpractice. Accountants, lawyers and financial advisors be warned!
Endnotes
1. Braen, et al. v. Commissioner, T.C. Memo. 2023-85 (July 11, 2023).
2. Treasury Regulations Section 1.1011-2(b).
3. Treas. Regs. Section 1.170A-13(f)(3).
4. Pollard v. Comm’r, T.C. Memo. 2013-38; Boone Operations LLC, Fairfax Cos v. Comm’r, T.C. Memo. 2013-101.
5. Costello v. Comm’r, T.C. Memo. 2015-1987.
6. Private Letter Ruling 8421018 (Feb. 15, 1984) and Osborne v. Comm’r, 87 T.C. 575 (1986).
7. Seventeen Seventy Sherman St. LLC v. Comm’r, T.C. Memo. 2014-124.