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Lower Court Reversed; Deduction for Trust's Property Donation Is Limited to Basis

(Parker Tax Publishing February 2018)

The Tenth Circuit Court reversed a district court and held that a trust's deduction for its charitable donation of real property was the trust's basis in the property and not the fair market value. The Tenth Circuit rejected the district court's interpretation of Code Sec. 642(c)(1) and concluded that the deduction thereunder was limited the trust's adjusted basis in donated properties and that the unrealized appreciation in the donated property was not part of the trust's gross income as required under Code Sec. 642(c)(1), which permits a trust to deduct a charitable contribution only if it comes from the trust's gross income. Green v. U.S., 2018 PTC 6 (10th Cir. 2018).

David and Barbara Green established a trust to provide for their children and to make charitable contributions. The trust wholly owned a single member limited liability company called GDT CGI LLC (GDT). As a disregarded entity, all of GDT's income, deductions and credits passed through to the trust. The trust was also the 99 percent limited partner in Hob-Lob Limited Partnership, which owns and operates most of the Hobby Lobby retail stores. The trust received a distributive share of Hob-Lob's ordinary business income as well as distributions from Hob-Lob.

In 2002 and 2003, GDT purchased land and buildings in Virginia, Oklahoma, and Texas for a total of approximately $10.6 million. All of the money used to purchase the properties came from distributions from Hob-Lob. The trust donated all of the Oklahoma and Texas properties, and a portion of the Virginia property, to charitable organizations. On its 2004 income tax return, the trust claimed a charitable deduction totaling approximately $20.5 million, reflecting the properties' fair market value. The trust later filed an amended return to increase the charitable deduction by around $3 million and claimed a refund for that amount. The IRS disallowed the refund claim on the grounds that the trust's deduction was limited to the basis of the contributed property. The trust sued for the refund in a district court, which found in favor of the trust. The IRS appealed to the Tenth Circuit Court of Appeals.

Under Code Sec. 642(c)(1) a trust is allowed a deduction for "any amount of the gross income, without limitation," which is paid as a charitable contribution. However, the statute does not specify whether a trust's deduction for a donation of property is the fair market value or the trust's basis in the property.

The IRS argued that allowing a trust to deduct the fair market value was contrary to the language of Code Sec. 642(c)(1) and would effectively allow a duplicative tax benefit in the form of a deduction for an amount that was never taxed. The trust countered that the charitable deduction rules are an expression of public policy and should be liberally construed in the taxpayer's favor. It also argued, for the first time on appeal, that it was entitled to a fair market value deduction under Code Sec. 512(b)(11), which applies to unrelated business income (UBI). According to the trust, Code Sec. 512(b)(11) allows a charitable deduction under Code Sec. 170 for donations made from UBI, and Code Sec. 170 permits a deduction for the fair market value of the donated property.

The Tenth Circuit reversed the district court and held that a deduction for a contribution of noncash property under Code Sec. 642(c)(1) is limited to the donor's basis in the property, rather than the property's fair market value. The court found this to be the most reasonable interpretation of the statute, particularly when considered in light of other Code provisions. The court reasoned that, under Code Sec. 61, gross income includes gains derived from "dealings" in property, and Reg. Sec. 1.61-6(a) construes "dealings" to mean gains that occur in a realization event - specifically, a sale or exchange. The Tenth Circuit noted that the trust never sold or exchanged the properties at issue, so it never realized the gains associated with their increases in market value. In other words, the appreciation in the value of the properties was not an amount of the trust's gross income as is required under Code Sec. 642(c)(1), and the trust was therefore not entitled to deduct the properties' fair market value.

The Tenth Circuit found the district court's reasoning for adopting the trust's fair market value argument unpersuasive. First, the district court relied on the phrase "without limitation" in Code Sec. 642(c)(1), but the Tenth Circuit found that to be a misconstruction because the phrase was interpreted by the Supreme Court to mean that the percentage limits in Code Sec. 170 do not apply to trusts. Next, the Tenth Circuit found that the policy of encouraging charitable donations expressed by the Supreme Court in Old Colony Trust Co. v. Comm'r, 301 U.S. 379 (1937), was not a license to construe Code Sec. 642(c)(1) to permit a fair market value deduction when other Code provisions weighed against it. Finally, the Tenth Circuit found that the district court erroneously inferred from the allowance of a fair market value deduction in Code Sec. 170 that the same rule applied in Code Sec. 642(c)(1). According to the Tenth Circuit, if Congress had intended to allow for the concept of a trust's gross income to extend to unrealized gains on property purchased with gross income, it would have said so.

The Tenth Circuit declined to consider the trust's argument that Code Sec. 512(b)(11) gave it a path to a fair market value deduction under Code Sec. 170. The court noted that under the substantial variance rule, a taxpayer may not present claims in a refund suit that were not contained in the application for a refund. As the trust's refund claim made no mention of the Code Sec. 512(b)(11) theory, that argument was barred by the substantial variance rule. The Tenth Circuit further noted that the Code Sec. 512(b)(11) theory was never clearly raised in or resolved by the district court. Therefore, even if the substantial variance rule did not apply, the argument was waived by the trust.

For a discussion of the deduction for a charitable contribution by a trust, see Parker Tax ¶53,110.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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