Charitable Tax Deductions & Bargain Sales

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Our tax administration operates within the framework of a zero-sum game, leaving little flexibility for taxpayers who encounter technical foot faults or minor errors. Even when taxpayers have complied with most of the tax law requirements, a single misstep can potentially result in the disallowance of a tax benefit or deduction. This zero-sum approach, while aiming for fairness and consistency, may appear unforgiving to individuals who have made genuine efforts to comply.

The recent Braen v. Commissioner, T.C. Memo. 2023-85, provides an example of this. This case involves a sizeable charitable contribution deduction that the taxpayers actually made. That was not in dispute. The taxpayers obtained valuations of the property donated, but they did not obtain a valuation of the impact of the contribution on the property they retained. The result was no charitable deduction being allowed.

This case provides an opportunity to consider the bargain-sale rules for charitable tax deductions.

Facts & Procedural History

This case involves family members who each had a trust and the trusts, in turn, invested in a family limited partnership. The partnership purchased real estate in New York to develop into a granite quarry.

From the date the property was purchased in 1998 to 2010, the taxpayers faced several obstacles in trying to get the permitting, etc. to allow it to operate the quarry. This even included litigation with a city that rezoned part of the land during this time period.

The lawsuit ended up being settled. The settlement agreement provided that the partnership would sell the property at a discount to the city and it would be treated as a bargain sale that allowed for a charitable deduction.

The taxpayers hired tax advisors and even tried to get the IRS to review its tax position on the charitable deduction prior to filing the tax return. The IRS reviewed the transaction but did not accept it before the time to file the returns. The partnership filed its return and then the taxpayers reported the charitable deduction on their individual income tax returns.

The IRS then audited the tax returns and proposed to disallow the charitable deductions. It also asserted accuracy-related penalties. The case ended up in litigation in the U.S. Tax Court.

About the Charitable Tax Deduction

The charitable tax deduction allows taxpayers to deduct donations made to qualified charitable organizations from their taxable income. It is intended to incentivize and promote philanthropy by reducing the tax burden on those who contribute to charitable causes.

The thought is that a charitable tax deduction encourages taxpayers to support charitable organizations and engage in activities that benefit society as a whole. By providing a financial incentive in the form of a tax deduction, the government hopes to stimulate charitable giving and support the work of nonprofit organizations. This in turn lessens the burden on the government. Put another way, the benefit provided to the public by the charity is one less thing that the government has to spend tax monies on.

The rules for the charitable deduction are found in Section 170. Section 170 of the tax code allows taxpayers to deduct charitable contributions made during the taxable year, subject to rules that are set out in the regulations. If the contribution is of property other than cash, the tax deduction is generally based on the fair market value of the property at the time of contribution. Valuation disputes with the IRS are common for charitable deductions. Taxpayers must meet substantiation requirements for charitable donations, including obtaining a contemporaneous written acknowledgment from the recipient for contributions exceeding $250 in value. These issues have come to a head with the IRS’s attacks on charitable conservation easements.

The party who makes the contribution can have other dealings with the charity. For example, it could give some portion of the property to the charity and, at the same time, sell a portion of the property to the charity. This does not disqualify the donor from getting a charitable tax deduction. This brings us to bargain sales and related rules.

About Bargain Sales

A bargain sale refers to a transaction where an asset is sold to a charitable organization at a price below its fair market value. In such a transaction, the seller receives payment for the property but at a reduced amount, often as a result of their philanthropic intent or desire to support a charitable cause.

By selling the property at a bargain price to a qualified charitable organization, the seller can potentially claim a charitable contribution deduction for the difference between the fair market value of the property and the sale price. This deduction allows the seller to receive a tax benefit based on the charitable component of the transaction.

Bargain sales can be advantageous for both the seller and the charitable organization. The seller receives some financial compensation for the property while also obtaining a tax deduction, and the charitable organization acquires the property at a reduced cost, enabling them to further their mission and potentially make use of the property for charitable purposes.

Naturally, to claim a charitable contribution deduction for a bargain sale, the fair market value of the donated property must exceed the value of benefits received. And as with any tax benefit that is provided by the government, there are substantiation requirements. One such requirement is that the taxpayer obtains valuation opinions from experts and a contemporaneous written acknowledgment from the recipient as to the value of the property contributed and the value of the benefit (if any) received. These requirements are similar to those that apply for tax losses and determining the amount of the losses.

This brings us to the dispute in this case. The question, well, one of the questions, was whether the taxpayer complied with the substantiation requirements.

Substantiation of Value of Property Retained

According to the court opinion, the partnership and taxpayers received two types of consideration in the bargain sale. The first was a payment of $5,250,000, which was paid by the city, and the reversion of the zoning designation over a portion of the property that the partnership retained.

The land purchase agreement and the settlement of the zoning litigation were both concluded as one agreement. The land purchase agreement explicitly stated that the zoning litigation was being settled as an integral part of the property transfer.

Based on this, the court concluded that the partnership did not obtain an appraisal and proper written acknowledgment from the city that satisfied the rules. The charitable tax deduction requires the taxpayer to obtain a contemporaneous written acknowledgment from the charity, i.e., the city in this case, that meets certain requirements. With a bargain sale, this includes a description and good-faith estimate of the value of any goods or services the taxpayer received as consideration. The court concluded that the letter that was obtained was not good enough as it did not describe or value the benefit the partnership and taxpayers received for the zoning designation change for the property that it retained. Reasonable cause may not apply in this situation.

Thus, taxpayers have to have at least two valuations or appraisals with bargain sales–i.e., the valuation for the property contributed and a valuation for the impact on the property retained.

The Takeaway

That the taxpayers made a charitable contribution was not disputed. The taxpayers contributed to the public good by entering into the bargain sale. That was not the issue in this case. The issue was whether a technical footfault in complying with the rules in the regulations could be excused.

This case highlights, even taxpayers who go to great lengths to comply with the tax rules can find their efforts to be unavailing when there is a technical footfault. Our system of tax administration is often a zero-sum game where technical foot faults are not allowed to be corrected after the fact, even when there seems to be no harm to the government in allowing a late fix.

Those entering into bargain sales should make sure to get a second appraisal and ensure that the appraisal result is included in the verification letter for the bargain sale.

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