I. (A) : DONATION-REDEMPTION-DISPOSITION
1967-1 C.B. 64, 1967 WL 15392 (I.R.S.)
Internal Revenue Service (I.R.S.)
Revenue Ruling: 78-197
Published: 1967
(Also Section 1012; 1.1012-1.)
When a donor transfers, without consideration, stock to a charitable organization under a 'gentlemen's agreement' which allows him to reacquire the stock one month later at its then fair market value, the amount of the cash paid to the organization in reacquiring the stock, and not the fair market value of the stock when transferred, is a charitable contribution within the meaning of section 170 of the Internal Revenue Code of 1954, and is deductible to the extent provided by such section. The basis of the stock in the hands of the donor remains the same as it was before he transferred the stock.
Advice has been requested whether, under the circumstances described below, a taxpayer who transfers shares of stock to a charitable organization without consideration, and who later reacquires them from the organization at their fair market value at the time of reacquisition, is entitled to a charitable contribution deduction based on the fair market value of the stock at the time of his transfer, or on the cost of reacquisition, and whether such transaction will affect the basis of his stock.
The taxpayer in the instant case transferred, without consideration, 300 shares of stock in M Corporation, having a fair market value of 4x dollars per share, to an organization described in section 170(c) of the Internal Revenue Code of 1954. The taxpayer's adjusted basis in the stock was 2x dollars per share.
During the month following the transfer and in the same taxable year, the taxpayer repurchased the 300 shares at 4x dollars per share. The books of M reflected both changes in ownership. The charitable organization had in its possession a large number of shares of stock of M which had been received from other donors. While such shares were allegedly held for sale to any prospective purchaser, the majority of them (as well as the shares acquired from the taxpayer) were, in fact, held under a 'gentlemen's agreement' for resale to the donors. The transactions were handled in this manner for the purpose of enabling the donors to obtain a charitable deduction and to acquire a stepped-up basis for the stock while avoiding the recognition of gain.
Section 170(a) of the Code provides, in part, as follows: (1) General Rule.There shall be allowed as a deduction any charitable contribution payment of which is made within the taxable year. It is clear that the taxpayer has made a charitable contribution within the taxable year. The questions, however, are (1) in which of the transactions was the contribution effected, and (2) whether the transfer and repurchase of the stock under such a 'gentlemen's agreement' should affect the basis of the stock.
It is well settled that the Internal Revenue Service will look to the substance of a transaction. Commissioner v. Court Holding Co., 324 U.S. 331 (1945), Ct. D. 1636, C.B. 1945, 58. Upon a determination that the form employed to carry out a transaction is unreal or a sham, the Service may disregard its effect. Higgins v. John Thomas Smith, 308 U.S. 473 (1940), Ct. D. 1434, C.B. 1940-1, 127.
In the instant case title to the stock was actually transferred on the books of the corporation. Nevertheless, the facts indicate that the taxpayer had no intention of relinquishing his rights of ownership in the stock; that the stock was held by the donee under an agreement for return to the donor in the form of a sale; and that by means of this device the donor hoped to obtain a stepped-up basis for such stock.
On the basis of these facts, the transfer and repurchase of the stock are to be disregarded. However, the amount paid in order to reacquire the stock is a charitable contribution within the meaning of section 170 of the Code and is deductible in the year paid in the manner and to the extent provided by such section. The basis of the stock in the hands of the taxpayer after his reacquisition remains the same as it was before he transferred the stock. Rev. Rul. 67-178, 1967-1 C.B. 64, 1967 WL 15392 (I.R.S.)
26 CFR 1.302-1: General
Redemption; charitable contribution followed by prearranged redemption. A taxpayer with voting control of a corporation and an exempt private foundation who donates shares of the corporation's stock to the foundation and, pursuant to a prearranged plan, causes the corporation to redeem does not realize income as a result of the redemption. The Service will treat the proceeds as income to the donor under facts similar to those in the Palmer decision only if the donee is legally bound, or can be compelled by the corporation, to surrender the shares for redemption.
1978-1 C.B. 83, 1978 WL 42302 (I.R.S.)
Internal Revenue Service (I.R.S.)
Revenue Ruling
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I. (B) : DONATION-REDEMPTION-DISPOSITION (continued)
Published: 1978
26 CFR 1.302-1:
General. Redemption; charitable contribution followed by prearranged redemption. A taxpayer with voting control of a corporation and an exempt private foundation who donates shares of the corporation's stock to the foundation and, pursuant to a prearranged plan, causes the corporation to redeem the shares from the foundation does not realize income as a result of the redemption. The Service will treat the proceeds as income to the donor under facts similar to those in the Palmer decision only if the donee is legally bound, or can be compelled by the corporation, to surrender the shares for redemption.
In Palmer v. Commissioner, 62 T.C. 684 (1974), aff'd on another issue, 523 F.2d 1308 (8th Cir. 1975), the United States Tax Court held that the Internal Revenue Service incorrectly treated a gift of stock to an organization exempt from income taxation pursuant to section 511(c)(3) of the Internal Revenue Code of 1954, followed by a prearranged redemption of the stock, as a redemption of the stock from the donor followed by a gift of the redemption proceeds to the donee. The Service will follow Palmer on this issue, acq., page 6, this Bulletin. In Palmer, the taxpayer had voting control of both a corporation and a tax- exempt private foundation. Pursuant to a single plan, the taxpayer donated shares of the corporation's stock to the foundation and then caused the corporation to redeem the stock from the foundation. It was the position of the Service that the substance of the transaction was a redemption of the stock from the taxpayer, taxable under section 301 of the Code, followed by a gift of the redemption proceeds by the taxpayer to the foundation. The United States Tax Court rejected this argument and treated the transaction according to its form because the foundation was not a sham, the transfer of stock to the foundation was a valid gift, and the foundation was not bound to go through with the redemption at the time it received title to the shares.
Also see, Grove v. Commissioner, 490 F.2d 241 (2nd Cir. 1973); Behrend v. United States, No. 72-1153, 72-1156 (4th Cir. 1972); and Carrington v. Commissioner, 467 F.2d 704 (5th Cir. 1973).
The Service will treat the proceeds of a redemption of stock under facts similar to those in Palmer as income to the donor only if the donee is legally bound, or can be compelled by the corporation, to surrender the shares for redemption.
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I. (C) : DOUBLE DEDUCTIONS
Section 312. Effect on Earnings and Profits
26CFR 1.312-1: Adjustment to earnings and profits reflecting distributions by corporations. (Also Section 170; 170A-1.)
Earnings and profits; charitable contribution of appreciated property. A corporation that donates appreciated property to a city may reduce its current earnings and profits under section 312 of the Code only by the adjusted basis of the property, even though in computing its taxable income it may deduct under section 170 an amount equal to the property's fair market value.
Rev.Rul. 78-123
Advice has been requested regarding the effect of a charitable contribution upon the current earnings and profits of a corporation, under the circumstances described below.
The taxpayer, a domestic corporation, is the lessee of certain land under a 99-year lease agreement with state X. In 1976, the taxpayer donated to city Y its leasehold interest in the land for a civic betterment program that benefited the entire community. The land is unimproved and has never been utilized in the taxpayer's business. The leasehold interest, which had been held in excess of 2 years by the taxpayer, had appreciated in value. In 1976 the taxpayer had current earnings and profits in excess of the fair market value of the donated property.
The specific question is whether the taxpayer may reduce its current earnings and profits by the fair market value of the leasehold donated to city Y.
Section 170 (a) of the Internal Revenue Code of 1954 provides, in part, that there shall be allowed as a deduction any charitable contribution, payment of which is made within the taxable year.
Section 1.170A-1(c)(1) of the Income Tax Regulations provides that if a charitable contribution is made in property other than money, the amount of the contribution is the fair market value of the property at the time of the contribution reduced as provided in section 170 (e) (1) of the Code and section 1.170A-4(a).
Section 312(a) (3) of the Code provides that on the distribution of property, other than cash and obligations of the distributing corporation, by a corporation with respect to its stock, the earnings and profits of the corporation shall be decreased by the adjusted basis of the other property so distributed.
Section 1.312-1(b) of the regulations provides that the adjustment provided in section 312(a) (3) of the Code shall be made notwithstanding the fact that such property has appreciated or depreciated in value since acquisition.
Under section 1.312-6(b) of the regulations, the effect of a transaction upon earnings and profits is not necessarily dependent upon the tax treatment of the transaction in determining net taxable income for a given year.
Rev. Rul. 75-515, 1975-2 C.B. 117, provides, in part: "In general, the computation of earnings and profits of a corporation for dividend purposes is based upon reasonable accounting concepts that take into account the economic realities of corporate transactions as well as those resulting from the application of tax law. Thus, losses and expenses that are disallowed as a deduction for Federal income tax purposes, charitable contributions in excess of the limitations provided therefor, and other items that have actually depleted the assets of the corporation, even though not reflected in the income computation, are allowable as deductions in computing earnings and profits."
When a corporation makes a disposition of property with respect to stock, such as a dividend paid in property, earnings and profits must be reduced by the adjusted basis of the distributed property rather than its fair market value because it is the adjusted basis that is reflected in the earnings and profits of the taxpayer. The unrealized appreciation in the value of the property distributed is not reflected in the earnings and profits and therefore does not constitute a reduction of earnings and profits available for the payment of dividends, See section 312(a)(3) of the Code and section 1.312-1(b) of the regulations. Likewise, when a charitable contribution is made in property other than money, the adjusted cost basis of the property in the hands of the donating taxpayer is the amount reflected in earnings and profits. The fact that the taxpayer may be allowed to take a deduction for Federal income tax purposes based on the fair market value of the donated property does not mean that the fair market value is also used to reduce earnings and profits.
In Kaplan v. Commissioner, 43 T.C. 580 (1965), the Tax Court of the United States allowed earnings and profits to be reduced by the fair market value of appreciated property given as a charitable contribution The Internal Revenue Service will not follow the decision in Kaplan. See nonacquiescence, page 2, this Bulletin.
The effect on earnings and profits in the instant situation is as follows: In computing its taxable income, the taxpayer is allowed to deduct, under section 170 of the Code, an amount equal to the fair market value of the property other than money contributed to a recognized charity. This deduction reduces the corporation's taxable income and results in a corresponding lesser amount of income being included in the current earnings and profits. However, under section 312, the unrealized appreciation in value of the property may not reduce earnings and profits. Therefore, current earnings and profits must be increased by the difference between the fair market value of the donated property and the taxpayer's adjusted basis of the donated property. Consequently, the final result, for earnings and profits purposes, is that current earnings and profits have been decreased by the taxpayer's adjusted basis of donated property.
Accordingly, in the instant situation, the taxpayer may not reduce its current earnings and profits by the fair market value of the leasehold interest donated to city Y.
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I. (D) : NON-PROFIT WORKS PRIMARILY AS A FOR-PROFIT
Rev Rul. 98-15 provides long-overdue precedential guidance to the effect that an exempt organization can satisfy the operational test through its participation in a pass-through entity, such as a partnership or LLC. This is the approach endorsed, essentially in Plumstead Theatre Society, Inc. 675 F.2d 244, 49 AFTR2d 82-1390 (CA-9, 1982), almost 20 years ago and accepted, grudgingly, by the Service during the ensuing period. In addition, Rev. Rul. 98-15 provides welcome clarification concerning the continued public charity status of organizations that carry on their principal, if not only, exempt activity through a pass-through entity. In this Ruling, the principal activity was the operation of a hospital, and thus the Service acknowledged the continued public charity status of the transferor organization as a Section 170(b) (1) (A) (iii) organization. In other instances, however, such as the operation of skilled nursing facilities or low-income housing, a similar approach would seem appropriate for purposes of Section 509(a)(2) based on this Ruling.
Additionally, Rev. Rul.98-15, provides a relatively straight-forward example of an arrangement where an organization transfers its principal activities and assets to a pass-through entity, and is entitled to continue its exempt status. A very safe template for operations is thus set forth in the ruling.
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I. (E) : INVENTORY DONOR GETS BASIS PLUS 50% PROJECTED GAIN
Charitable contributions; dated products. A corporation that donates products to a charitable organization immediately prior to their expiration date is allowed as a charitable contribution deduction an amount equal to the corporation's basis in the property plus one-half of the unrealized appreciation, not to exceed twice the corporation's basis in such property.
Rev. Rul. 83-29
Thus, as a general rule, the deduction for charitable contributions of appreciated inventory property is limited to the taxpayer's basis in the contributed property.
However, section 170(e)(3) (A) of the Code provides an exception to the general rule regarding qualified corporate contributions of inventory to be used for the care of the ill, the needy, or infants.
Section 170(e)(C)(B) of the Code provides that the amount of the charitable contribution deduction for qualified contributions of inventory is equal to the taxpayer's basis in the property plus one-half of the unrealized appreciation, not to exceed twice the taxpayer's basis in such property.
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I. (F) : AIR-RIGHTS DONATIONS
In Mattie Fair v. Commissioner of Internal Revenue, 27 T.C. 866 (1957), the Taxpayers owned a two-story building which had been constructed with a view to subsequent expansion, the walls and columns being adaptable to the addition of several stories above the existing building. The Taxpayers later transferred to a charity the right to use the air space above the existing two stories for the construction of several stories to be used by the charity for its charitable purposes. In the transfer agreement it was provided that if the first two floors should ever be destroyed by casualty of any nature, the rights of the charitable foundation would end at that time. Nevertheless, the Tax Court held this was a transfer of a 'present irrevocable interest' and determined that the Taxpayers were entitled to a deduction measured by the present value of the air space and the right to build on the existing building.
It has long been the position of this Court that air above land may constitute a property right separate from the land itself. Sexton v. Commissioner, 42 T.C. 1094 (1964); Fair v. Commissioner, 27 T.C. 866, 872 (1957). In Sexton v. Commissioner, supra, the taxpayer sought to depreciate air rights consumed in the operation of a garbage dump on land purchased for that purpose.
The site was a manmade excavation created by the digging of clay for bricks prior to the time that the taxpayer acquired the land. Records were kept of the amount of space utilized each year through annual surveys. This Court held that "Since rights in space have been recognized as property subject to transfer separately from the related land, we perceive no reason why such rights should not be the subject of depreciation as wasting assets in the business of this taxpayer." ( 42 T.C. at 1102.)
The Court in Sexton allowed unit depreciation since the taxpayer had proved the amount of space exhausted each year and the value of each cubic yard of space consumed. The respondent argues that a fatal difference exists between Sexton and the instant litigation since the O'Neill tract was not purchased solely for use as a dump site. Respondent concedes that such a use was "an important consideration in the selection" of the O'Neill tract, but argues that the petitioners' development motive precludes the Sexton exception to the general rule that land is not depreciable.
We disagree. The facts make it abundantly clear that petitioners' overwhelming purpose in the acquisition of the O'Neill tract was for use as a dump site. They never would have purchased it had they been able to lease it. Respondent argues that petitioners' attempt to rezone the O'Neill tract indicates a development purpose. We think it only reasonable that petitioners would want to increase the residual commercial attractiveness of the O'Neill tract for sale or development once it was no longer useful as a dump site. Respondent argues further that the instant case differs from Sexton v. Commissioner, supra, since the O'Neill tract was not a manmade excavation. This is a distinction without a difference. It is clear that the O'Neill tract was particularly well suited for a dump site due to its size, location, and shape. We see no real difference between the two factual patterns. In both situations, the primary objective of the purchase was to acquire usable space for dumping. The holding in Sexton did not depend upon a manmade excavation nor, in fact, any excavation. Of primary importance there, was that the property was purchased for use as a dump site. Air rights may be a separate property right from the land whether the property is flat or concave. See Fair v. Commissioner, supra.
Charitable contributions are recognized as paid and deductible even though made in property. Priscilla M. Sullivan, 16 T.C. 228, 231; Mattie Fair, 27 T.C. 866; Champlin v. Broderick, 38 A.F.T.R. 1533, 48-2 U.S.T.C.par. 9332; Regs. 111, sec. 29.23(o)-1; sec. 1.170-1, Income Tax Regs. (T.D. 6285, 1958-1 C.B. 127, 131).
A payment need not be cash and even a debt can be paid in property if the debtor is willing to accept the property as payment. There is no reason why a contribution to a pension trust could not be made in property and still be deductible. The transfer which the petitioner made to its pension trust bore no resemblance to a promissory note nor was it a mere promise to pay something in the future. It was a present transfer of an asset worth at least $389,165.52. The petitioner was not obligated to repurchase the bank site or to pay anything on the purchase price fixed in the option. The stipulation shows that the trust could have sold the real estate subject to the lease and option for at least $389,165.52. There was nothing in the agreement between the petitioner and the pension trust to prevent such a sale. The transfer was immediately and irrevocably beneficial to the trust and the donee.
In Mattie Fair, 27 T.C. 866 (1957), acq. 1957-2 C.B. 4, a gift was made to a charitable foundation of the right to build and maintain a five-story addition above an existing two-story building. We upheld the right of the donors to claim a deduction for a charitable contribution of the value of the rights and interests so conveyed. We there said (p. 872):
The right to use the air space superjacent to the ground is one of the rights in land. These air rights are frequently the most valuable rights connected with the ownership of land since the value of commercial property consists almost exclusively of the right of the owner to erect business and industrial structures thereon. Cf. Piper v. Ekern, 180 Wis. 586, 194 N. W. 159, 161 (1923). The sale or lease of superjacent air space is not at all uncommon in large cities. Attempts to subdivide the superjacent air space into horizontal strata or air lots poses difficult questions. But there does not seem to be
any policy of the law prohibiting these transactions and their validity has been recognized.
See special ruling letter dated April 10, 1964 (C.C.H. par. 6636, P.-H. par. 54, 951), and Rev. Rul. 64-205, promulgated July 27, 1964 (I.R.B. 1964- 30), wherein it was held that the gratuitous conveyance to the United States of a restrictive or 'scenic' easement in real property is a charitable contribution and entitled the taxpayer to a deduction under section 170 of the 1954 Code to the extent of the fair market value of the restrictive easement. The restrictions in question included limitations on the height of buildings which might be constructed on such real property. In effect these rulings recognize a property right in the airspace superadjacent to real property which is subject to separate evaluation and conveyance. The rulings further provide for the adjustment of the taxpayer's basis in the real property by eliminating that part of the total basis which is properly allocable to the restrictive easement granted.
The State of Illinois, by statute, specifically allows railroads to subdivide, improve, and sell the superadjacent airspace. Ill. Ann. Stat., ch. 114, sec. 174(a)(Smith-hurd).
42 T.C. 1094, 42 T.C. 1094,
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