Ltr. Rul. 8144052

Ltr. Rul. 8144052

Story posted in Letter Rulings on 30 July 1999
audience: PGDC Network | last updated: 15 June 2011
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CHARITABLE CONTRIBUTION OF PATENT RIGHTS IS DEDUCTIBLE

Reference:

Section 170 -- Charitable Deduction

Full Text:

August 6, 1981

Refer Reply to: T:I:I:3:2

A = ***
X = ***
Y = ***
Z = ***

Dear ***

This is in reply to a ruling request submitted on your behalf by your attorney concerning a planned charitable donation of an undivided interest in a right to patent royalties.

X is a private foundation (as defined in section 509(a) of the Internal Revenue Code) other than a private foundation described in section 170(b)(1)(D). X is also a charitable organization referred to in section 170(c)(2).

A is a professor of biophysics at Y, a state university. A, along with two other persons, discovered a drug that has proved effective in the treatment and cure of cancers. In 1970, A (as he was required to do by Y's regulations) assigned his patent rights to Z, a corporation that handles inventions and patents made by Y's faculty. In exchange for the assignment of A's patent rights, Z become contractually obligated to pay royalties to A in the amount of 5 percent of the income Z derived from the patent. A represents within the transaction qualified as a sale or exchange of patent rights within the purview of section 1235 of the Code. Section 1235 provides, in part, that such a transfer shall be considered the sale or exchange of a capital asset held for more than one year.

As Y had born all costs related to the development of the drug, A had a zero basis in his patent rights. Similarly, A has a zero basis in contract rights to royalties that he received in exchange for his patent rights. The entire amount of any royalty payment that A receives is capital gain to A.

A intends to donate to X, by absolute assignment, an undivided portion of his entire interest in the right to receive royalty payments from Z.

Section 170(a) of the Code allows as a deduction any charitable contribution payment of which is made within the taxable year. Section 170(c) defines a charitable contribution to include a contribution or gift to or for the use of an organization described in section 170(c)(2).

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.

Generally, section 170(f)(3) of the Code provides for the denial of a deduction in the case of certain contributions of partial interests in property. Section 170(f)(3)(A) provides, in part, that a contribution of less than the taxpayer's entire interest in property (not made by a transfer in trust), is not allowed as a charitable contribution deduction unless such contribution would have been allowed had it been transferred in trust. However, section 170(f)(3)(B)(ii) provides an exception to the rule in section 170(f)(3)(A) for the contribution of an undivided portion of the taxpayer's entire interest in property.

Section 1.170A - 7(b)(1)(i) of the regulations provides, in part, that an undivided portion of a donor's entire interest in property must consist of a fraction or percentage of each and every substantial interest or right owned by the donor in such property and must extend over the entire term of the donor's interest in such property and in other property into which such property is converted.

Rev. Rul. 58-260, 1958 - 1 C.B. 126, concerns the donation, by an inventor and owner of a patent, of an undivided one-fourth present interest in the patent to an organization described in section 170(c) of the Code. The owner of the patent had, prior to the donation, granted a nonexclusive license under the patent to a corporation controlled by the patent owner and his wife. The revenue ruling holds that a deduction will be allowed for the fair market value of the undivided present interest in the patent donated to the 170(c) organization, in the taxable year in which such property is contributed. The ruling states that the fair market value of the donated interest is a question of fact to be determined upon the examination of the donor's income tax return for the year in which the contribution is claimed as a deduction.

Because A will assign to X an undivided portion of A's entire royalty interest, section 170(f)(3) of the Code will not operate to deny a deduction for the contribution.

Section 170(e)(1)(B)(ii) of the Code provides, in part, that the amount of any charitable contribution of property otherwise taken into account under section 170 shall be reduced by the sum of 40 percent of the amount of gain which would have been long-term capital gain, if the property contributed had been sold by the taxpayer at its fair market value (determined at the time of such contribution), where this contribution is made to or for the use of a private foundation (as defined in section 509(a)) other than a private foundation described in section 170(b)(1)(D). Thus, because X is a private foundation to which 170(e)(B)(ii) applies, the amount of the charitable contribution of the undivided interest must be reduced by 40 percent of the amount of gain which would have been long-term capital gain if the property contributed had been sold by the taxpayer at its fair market value (determined at the time of contribution).

Provided the initial assignment of the patent right was a sale of a patent for purposes of section 1235 of the Code, the contract right to royalty payments is a capital asset, the sale of which would result in long-term capital gain.

As A has a zero basis in the royalty interest, all of the proceeds of any sale of part or all of the interest would be capital gain. Thus, the deduction for the charitable contribution of the partial royalty interest will equal fair market value of the partial interest reduced by forty percent (that is, the deduction will equal 60 percent of the fair market value of the donated partial interest).

Section 170(b)(1)(A) of the Code provides that in the case of any charitable contribution made by an individual to certain specified organizations the deduction provided in section 170 shall be allowed to the extent that the aggregate of such contributions does not exceed 50 percent of the individual's contribution base. "Contribution base" is defined as adjusted gross income (computed without regard to any net operating loss carryback to the taxable year under section 172 of the Code).

Section 170(b)(1)(B) of the Code provides that deductions for any charitable contributions, other than charitable contributions to which section 170(b)(1)(A) applies, shall be allowed only to the extent that the aggregate of such contributions does not exceed the lesser of (1) 20 percent of the taxpayer's contribution base for the taxable year, or (2) the excess of 50 percent of the taxpayer's contribution base for the taxable year over the amount of charitable contributions allowable under section 170(b)(1)(A). Section 170(b)(1)(A) does not apply to contributions to foundations, such as X, that are not described in section 170(b)(1)(D).

Thus, any deduction for contribution of the partial interest will be subject to the 20 percent limit of section 170(b)(1)(B) of the Code because a contribution to X is not a contribution described in section 170(b)(1)(A). In addition, as the carryover provisions of section 170(d) of the Code apply only to charitable contributions described in section 170(b)(1)(A) of the Code, when A makes a charitable contribution to X or makes any other contribution to which section 170(b)(1)(B) applies and the aggregate of such charitable contributions exceeds the limitations imposed by section 170(b)(1)(B), such excess charitable contributions may not be carried over and claimed as a deduction in any subsequent taxable year.

Accordingly, based on the facts submitted, we conclude as follows:

(1) The contribution by A to X of an undivided portion of A's entire royalty interest is a charitable contribution within the meaning of section 170(c) of the Code.

(2) Provided the initial assignment of the patent right was a sale of a patent for purposes of section 1235 of the Code, the contract right is a capital asset, the sale of which would result in long-term capital gain, and the amount of the deduction allowable under section 170(a) will be 60 percent of the fair market value of the property under section 170(e)(1)(B)(ii). The fair market value of the donated interest is a question of fact to be determined upon the examination of the donor's income tax return for the year in which the contribution is made.

(3) Once A has transferred an undivided interest in the contract right received in exchange for his patent rights, the income allocable to that transferred portion will not constitute income to him.

You have requested a ruling that the contribution of the undivided fractional interest in the royalty right is not a taxable disposition of an installment obligation under section 453B of the Code. However, that ruling request is based on the contention that the exchange of patent rights for royalty rights in 1970 was an open transaction under the doctrine of Burnet v. Logan, 283 U.S. 404 (1931), and that, therefore, the contractual interest in royalty payments is not an installment obligation. We are not in a position to address the fundamental question of whether the open transaction doctrine would apply to the 1970 exchange because such a determination would involve a prior year's tax return. See section 5.01 Rev. Proc. 80-20, 1980 - 1 C.B. 633. Because the determination of whether the contractual interest in the royalty payments is an installment obligation is under the jurisdiction of the District Director, we are unable to rule on whether section 453B of the Code applies to the planned contribution.

Except as specifically ruled upon above, no opinion is expressed as to the federal income tax consequences of the transaction described above under any other provision of the Internal Revenue Code.

You should attach a copy of this ruling to your tax return for the taxable year in which the transaction covered by this ruling is consummated. We are enclosing a copy for that purpose.

In accordance with the power of attorney submitted we are sending a copy of this ruling to your authorized representative.

This ruling is directed only to the taxpayer who requested it. Section 6110(j)(3) of the Internal Revenue Code provides that it may not be used or cited as precedent.

Sincerely yours,

Anthony Manzanares, Jr.
Chief, Individual Income Tax Branch

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