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Gifts with Options
In technical advice, the IRS has ruled that no charitable income tax deduction was allowed for a gift of property subject to an option exercisable by the donor until the year in which the option expired. When the option expired, a charitable income tax deduction was allowed for the fair market value of the property.
An S Corporation executed a deed granting real property to charity in 1993 but retained an option to repurchase the property for a nominal sum. The Corporation's shareholders claimed charitable deductions for their shares of the fair market value of the property on their individual income tax returns for 1993. The option to repurchase expired in 1995. The IRS states in the ruling that there was more than a remote possibility that the option would be exercised. The ruling also notes that the property was treated as transferred to charity in 1993 for state law purposes.
A charitable deduction for the contribution of the property to charity was not allowed in 1993 because the contribution was not effective at that time. In 1993, the contribution was dependent upon the expiration of the option and the possibility that the charitable transfer would be defeated was not so remote as to be negligible. Instead, the contribution became effective when the option expired in 1995 and a charitable deduction for the fair market value of the property was allowed at that time. State law was not controlling as to when the contribution took place.
Points to Ponder:
How close to fair market value does the option price have to be for the possibility that the option will be exercised to be so remote as to be negligible? What if the property subject to the option has been appreciating at a rapid pace and is likely to continue to appreciate during the option term?
Date: March 9, 1998
Control Number: TAM-122216-97 CC:DOM&IT&A:3
Taxpayer's Name: * * *
Taxpayer's Address: * * *
Taxpayer's Identification No.: * * *
Year Involved: * * *
Date of Conference: * * *
Corp = * * *
Donee = * * *
Under section 170 of the Internal Revenue Code, when is fair market value determined for property that is contributed subject to an option exercisable by the donor?
For property that is transferred to a charity and subject to such an option, fair market value under section 170 is the value of the property upon the expiration of the option.
Corp is an S Corporation. Donee is a charity described in section 170(c) of the Code. In 1993, Corp executed a deed that granted a tract of valuable land to Donee, but retained an option to repurchase the tract for a nominal amount. There was more than a remote possibility that the option would be exercised. For Tax Year 1993, Corp's shareholders each deducted as a charitable contribution their share of the fair market value of the property. On audit, a dispute arose regarding the proper year of the deduction. In a closing agreement, the Service and Corp agreed that the contribution was not deductible in 1993, but was deductible in 1995, the year that the option expired. State law treated the tract as having been transferred in 1993.
LAW AND ANALYSIS:
Section 170(a)(1) of the Code provides that there shall be allowed as a deduction any charitable contribution (as defined in section 170(c)) payment of which is made within the taxable year.
Section 1.170A-1(b) of the regulations states that, ordinarily, a contribution is made at the time delivery is effected.
Section 1.170A-1(e) of the regulations states that if as of the date of a gift a transfer for charitable purposes is dependent upon the performance of some act or the happening of a precedent event in order that it might become effective, no deduction is allowable unless the possibility that the charitable transfer will be defeated is so remote as to be negligible. If an interest in property passes to, or is vested in, charity on the date of the gift and the interest would be defeated by the subsequent performance of some act or the happening of some event, the possibility of occurrence of which appears on the date of the gift to be so remote as to be negligible, the deduction is allowable.
Section 1.170A-1(c) of the regulations states, in part, 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) and section 1.170A-4(a).
Sections 1.170A-1(b) and 1.170A-1(e) of the regulations should be read in light of section 170(a)(1) of the Code, which provides a deduction for charitable contributions "payment of which is made within the taxable year." The regulations interpret when the "payment" has been made and thus an allowable charitable contribution has occurred. Section 1.170A-1(e) provides that when a transfer is dependent on the performance of some act in order that it might become effective, no deduction is allowable unless the possibility that the charitable transfer will be defeated is so remote as to be negligible. Thus, as long as there is such a possibility, no "payment" has been made for purposes of section 170(a)(1).
Under section 1.170A-1(c) the amount of a contribution of property is the fair market value of the property at the time of the contribution. The time of the contribution is when the "payment" has been made as provided in the regulations. Thus, the time of the contribution is when the contribution has become "effective" as required by section 1.170A-1(e).
Here, Corp's shareholders could not take a charitable contribution deduction for the tract in 1993, because Corp had an option to reacquire the property. Thus, the contribution was dependent on the expiration of the option. Since the possibility of Corp exercising the option to reacquire the tract was not so remote as to be negligible, Corp's shareholders could not take a charitable contribution deduction until 1995, when the option expired. Under section 1.170A-1(c), the amount of the contribution is based on the fair market value of the tract in 1995, when the contribution became deductible under section 170(a)(1). The fact that the tract was treated under State law as the property of Donee starting in 1993 is not determinative.