The IRS has proposed regulations that would classify some charitable remainder annuity trusts (CRATs) as listed transactions. If finalized, the regulations would bar taxpayers from pairing CRATs with single-premium immediate annuities (SPIAs) to avoid recognizing all or a portion of the annuity payments as taxable income or capital gains.

A tax strategy is designated as a listed transaction when the IRS determines it to be the same or substantially similar to types of transactions it considers to be tax avoidance. Taxpayers participating in a listed transaction must disclose additional information to the IRS in the manner described in the regulations classifying the transaction as listed. Additionally, material advisors may be required to disclose information about the transaction to the IRS and keep a list of clients they have advised with respect to it.

What is a CRAT?

CRATs are a type of charitable remainder trust that must satisfy strict requirements under §664. Most CRATs provide annual payments to one or more “private” beneficiaries for either their lifetime or a specified time period. Any funds remaining in the trust when the beneficiary dies or at the end of the specified period are paid to the tax-exempt entity that is the CRAT’s remainderman.

CRATs can offer significant tax benefits to the grantor, who is entitled to a charitable contribution deduction in the year the contribution was made for the present value of the remainder interest to be passed to the tax-exempt entity. Additionally, the grantor does not recognize capital gains on appreciated property transferred into the CRAT. The CRAT itself is usually a tax-exempt entity.

Distributions from the CRAT to private beneficiaries are usually taxed as ordinary income or capital gains under the rules laid out in §664(b). It is these tax obligations that some taxpayers seek to avoid by pairing the CRAT with an SPIA.

What transactions are the IRS targeting?

According to the IRS, the transactions the agency is targeting are those where the grantor creates a trust that purports to qualify as a CRAT under §664. The grantor usually funds the trust with property with a fair market value in excess of its basis, which often includes interests in a closely held business, or assets used or produced in a trade or business. The trust sells the appreciated property and uses some or all of the proceeds to purchase an annuity.

On their federal income tax return, the trust’s beneficiary treats the annuity amount as payable from the trust as an annuity payment under §72, not ordinary income or capital gains, as required under §664(b). Under §72, only the portion of the annuity payment attributed to interest is subject to income tax, with the portion attributed to the principal passing to the recipient tax-free.

The IRS claims that the transaction should not generate any tax benefits for the beneficiary. Instead, the annuity payments should be included in the ordinary income under §664(b)(1) with a one-time amount added to the capital gain under §664(b)(2) when the CRAT sells the property. While promoters of the transaction claim the CRAT received a stepped-up basis in the appreciated property the grantor transferred into the trust, IRS guidance states that it should be characterized as a gift subject to the transferred-basis rules in §1015.

Elements of the listed transaction

According to the proposed regulations, a transaction would be characterized as listed if the participants take the following steps:

1. A trust purported to qualify as a CRAT under §664 is created by a grantor
2. The grantor funds the CRAT with contributed property
3. The contributed property is sold by the trustee
4. Some or all of the proceeds from the sale are used by the trustee to purchase an annuity
5. The beneficiary’s federal tax return treats the amounts distributed by the trust, in whole or in part, as annuity payments subject to §72, instead of treating the amounts received by the beneficiary as ordinary income or capital gain under §664.

The tax-exempt organization that is the CRAT’s remainderman would not be treated as a participant in the listed transaction if its only tie to the transaction is its remainder interest.

A recent memo issued by the IRS Chief Counsel’s Office makes it clear that the agency will reject claimed deductions for a non-cash donation to a charitable organization if there was no clear intent on the part of the taxpayer to donate the property. The memo (20233201F), stated that a taxpayer could not claim a deduction for the difference between the fair market value (FMV) of a property and the amount the taxpayer received in a bargain sale to an unnamed qualified nonprofit organization.

Field attorney advice memorandums issued by the Office of Chief Counsel can’t be relied upon by taxpayers as precedent, but they do lay out the agency’s position on an issue and the reasoning behind it. In the case of the taxpayer who was attempting to deduct the difference between the FMV of a property and the amount received in a bargain sale to a charitable organization, the IRS found there was no intent to make a gift and nothing of value to donate after the property was sold.

The memo is heavily redacted, so it is impossible to know who the parties to the transaction were, the amounts at issue and when the events described took place. Thus, the descriptions of the taxpayer’s situation are only outlined in general terms. While not specifically stated in the memorandum, it seems likely the taxpayer was trying to claim a donation to the local governmental unit where the property was located.

Sale price agreed upon to end litigation

The charitable organization made an offer to purchase property owned by the taxpayer that was accompanied by a substantial payment. However, after multiple appraisals conducted by the taxpayer and the organization, they could not agree on a purchase price.

The taxpayer then documented their intent to decline the organization’s offer and sell to another party, and the matter ended up in court. The case was resolved by a stipulation that stated the parties could not agree on the property’s FMV, but that the taxpayer was selling it to the organization for the amount it initially offered. A stipulation is a written agreement between parties that resolves all of the matters addressed in the document.

The taxpayer’s returns claimed a deduction for a charitable contribution as a result of the bargain sale of the property to the charitable organization. The amount of the deduction was the difference between the property’s appraised value and the sale price.

Attempted third-party sale shows no charitable intent

The Office of Chief Counsel determined that the taxpayer’s intent to sell the property to a third party for a higher amount than was offered by the charitable organization and their failure to accept the organization’s lower offer indicates that the taxpayer did not intend to make a gift. The taxpayer accepted the organization’s lower offer as a stipulation to settle litigation. After the parties signed the stipulation, the taxpayer lacked any rights in the property at issue, so it could no longer attribute any value to the property in excess of what was paid.

The memo also noted that the taxpayer did not properly substantiate the claimed deduction because they did not prove its FMV. While the charitable organization provided a Form 8283, Donee Acknowledgement, for the property, it did not provide an FMV for the property and never stated that the property had value in excess of the sale price.

After years of fighting to prevent taxpayers from using syndicated conservation easements (SCEs) to claim outsized tax deductions, the IRS has finally gotten help from Congress. That help came in the form of a provision in the $1.7 trillion omnibus spending bill President Biden signed into law in December that limited partnership deductions for conservation easements to 2.5 times their investment. While the new law is expected to curb the use of SCEs as tax scams, it should have little impact on taxpayers who donate legitimate conservation easements.

Taxpayers are allowed to claim a charitable deduction when they give up development rights to property through a conservation easement that is equal to the property’s development value. However, aggressive promoters have taken advantage of the deduction by pitching “syndication” deals that allow investors to claim deductions of many times the value of the property donated.

SCE promoters form partnerships to purchase idle land and find an appraiser willing to give it a development value that is far larger than the purchase price. The promoters then sell interests in the partnership to investors who use it to claim an inflated charitable contribution deduction based on the inflated value when the partnership donates a conservation easement on the land.

As part of its efforts to tamp down on the abusive use of the easements, the IRS added certain SCEs to its listed transactions through Notice 2017-10. But recent rulings by the U.S. Court of Appeals for the 6th Circuit and the U.S. Tax Court found that the IRS lacked the authority to identify its listed transactions through notices unless it followed the notice and public comment procedures that apply to regulations. While the IRS has continued defending Notice 2017-10 in courts not located in the 6th Circuit, and has proposed new SCE regulations, the new legislation should drastically reduce the need for these actions.

New cap based on partners’ relevant basis
The Consolidated Appropriations Act, 2023, amends §170(h) to limit the deduction available for qualified conservation easements made by pass-through entities, including partnerships and S-corporations (collectively referred to as “partnerships”). It says that contributions by partnerships must not be treated as qualified conservation contributions if the amount of the contribution exceeds 2.5 times the sum of each partner’s basis in the partnership. The act defines “relevant basis” as the portion of a partner’s modified basis in the partnership that can be allocated to the portion of the donated property.

The act provides an exception for contributions that are made outside of a three-year holding period. The three-year period begins on the latest of:

• The last date on which the partnership making the contribution acquired any portion of the real property that was donated
• The last date on which any partner in the partnership making the contribution acquired any interest in the partnership
• When one or more partnerships hold an interest in the partnership making the contribution, the date is the last date on which any of the partnerships acquired an interest in the partnership making the contribution, or the last date in which any partner in the partnership with an interest in the donating partnership acquired an interest in it

The legislation also provides an exception for partnerships where “substantially all” of the partnership interests are held directly or indirectly by an individual and their family members. Additionally, there is an exception for contributions to preserve certified historic structures.

Finally, the act adds more reporting requirements for partnerships claiming a deduction for the donation of conservation easements by partnerships.

As 2022 wraps up, many individuals and businesses are considering charitable donations to help reduce their federal tax bills for the year. This makes it an excellent time for tax preparers to remind their clients they must properly document their charitable contributions to claim a deduction, especially when it comes to donated property.

Four recent court rulings provide excellent examples of how the IRS enforces the rules regarding property donations and how the failure to follow the rules can lead to the loss of valuable deductions.

Home donation not properly appraised

In the first decision, the U.S. Court of Appeals for the 4th Circuit denied a $675,000 charitable deduction to a couple that donated a house they were going to have demolished so they could build a new home on the property. The house was donated to a charity that removed salvageable materials from the house before demolishing it and provided job training to disadvantaged members of the community.

The taxpayer in the case, Mann v. United States, No. 19-1793, (4th Cir. 2021), provided the IRS with an appraisal for the property that valued the house as if it was to be moved to another lot. The IRS rejected the deduction because the appraisal did not reflect what they actually donated and because the entire ownership interest in the house was not conveyed to the charity. The court found the IRS correctly disallowed the deduction because some portions of the home were demolished and not removed by the charity, and the entire interest in the property was not conveyed under state law. The court also found that an alternate appraisal valuing the house’s components at $313,353 overstated the value of the donation.

Deed did not include necessary information

The U.S. Tax Court’s decision in Albrecht v. Comm’r, T.C. Memo. 2022-53 (2022), addressed the IRS’s disallowance of a deduction for a donation of 120 pieces of Native American Jewelry to a museum through a five-page deed of gift, which can serve as contemporaneous written acknowledgement. A copy of the deed was provided to the IRS, but a deduction for the donation was disallowed under §170(f)(8)(B) because the deed did not specify whether the museum provided any goods or services in exchange for the donation or state that it was the entire agreement between the taxpayer and the museum. That Tax Court found that the taxpayer made a good faith attempt to comply with the rules regarding the charitable contribution of property but failed to satisfy the strict requirements of §170(f)(8)(B).

Letter did not meet statutory requirements

In its ruling on Izen v. Comm’r, No. 21-60679 (5th Cir., 2022) the U.S. Court of Appeals for the 5th Circuit upheld the IRS’s disallowance of a deduction for the charitable donation of 50% ownership in an aircraft because the letter he provided from the recipient did not satisfy §170(f)(12)(B)’s rules for the donation of qualifying vehicles. Specifically, the IRS found that for donations that exceed $500 in value, the taxpayer must provide contemporaneous written acknowledgement from the organization receiving the gift, which includes the donor’s name and taxpayer identification number (TIN). Additionally, it found his Form 8283 lacked the taxpayer’s TIN. While the taxpayer argued that he substantially complied with the requirements for claiming the deduction, the 5th Circuit said it could not accept the argument that “substantial compliance satisfies statutory requirements.”

Qualified appraisal not attached

Finally, in October, the Tax Court issued Schweizer v. Comm’r, T.C. Memo. 2022-102 (2022), which disallowed an art dealer’s claim of a $600,000 deduction for a donation to the Minneapolis Institute of Art because he failed to fully complete a Form 8283 or attach a qualified appraisal of the donated property. While the taxpayer claimed he had reasonable cause for the failure because he relied on the advice of an enrolled agent who said the completed form and the appraisal were unnecessary, the court found that the defects in the return should have been obvious.

Rules for properly reporting property donations

Generally, if a taxpayer wants to claim a deduction for non-cash charitable contributions, the IRS has substantiation requirements when the donated property has a value of more than $500 and the taxpayer must complete Form 8283, Noncash Charitable Contributions.

For non-cash contributions between $500 and $5,000, taxpayers need only fill out Section A of Form 8283. For contributions of personal or real property valued at more than $5,000, taxpayers must get a written qualified appraisal for the property and fill out Section B of the form. For contributions of property valued at more than $5,000, both the qualified appraiser and a representative of the organization that received the donation must sign the Form 8283.

When filling out Section B, the taxpayer must provide all of the required information, which includes an accurate description of the donated property, its fair market value on the date it was contributed, the date the property was acquired by the donor, how it was acquired and the owner’s cost or adjusted basis for the property. It is important to note that the taxpayer’s cost or adjusted basis in the donated property can be significantly less than its fair market value and the IRS will often seek to disallow a deduction when it believes that the cost or adjusted basis has not been disclosed.

For donated property valued at between $5,000 and $500,000, the appraisal is incorporated into the Form 8283 and kept by the taxpayer. However, when property has been valued at more than $500,000, the qualified appraisal must be included with the taxpayer’s Form 8283.

Charitable contributions are a great way to support organizations you care about and your local community! On top of that, depending on your client’s tax situation, donations to a qualified charitable organization could be a way for them to reduce their tax liability at the end of the year.

The Taxpayer Certainty and Disaster Relief Act of 2020 (TCDRTA) provided more tax incentives for individuals and corporations making charitable contributions on 2021 returns. It extended the suspension of the adjusted gross income (AGI) percentage limitations on the deduction of cash contributions by individuals for qualified charitable contributions. It also allows a deduction of up to $300 ($600 for married filing jointly filers) for non-itemizers for tax year 2021.

For 2021, the charitable deduction is claimed as a deduction in calculating taxable income (as opposed to an above-the-line deduction in calculating AGI for 2020).

Individual contributions

Generally speaking, only individual taxpayers who itemize their deductions qualify for a charitable contribution deduction. The itemized deduction for charitable contributions is limited to a percentage of the taxpayer’s AGI, computed without regard to the charitable deduction and any net operating loss (NOL) carrybacks.

The type of organization receiving the donation and property donated determines the percentage. For tax years beginning after Dec. 31, 2017, and before Jan. 1, 2026, the contribution base for cash contributions by individuals to 50-percent public charities increased from 50% to 60% of AGI.

The TCDTRA suspended the 60% limitation on the deduction of charitable cash contributions for 2021. The cash contribution must be made after Dec. 31, 2020, and before Jan. 1, 2022, to a qualified charity to qualify for the 100% deduction.

An individual may claim an itemized deduction for contributions to a charitable organization on Schedule A (Form 1040).

Qualified charitable organizations

The following organizations are considered qualified charitable organizations:

• Churches
• Nonprofit educational institutions
• Nonprofit medical institutions
• Public charities
• Any other organization described in §170(b)(1)(A)
  • This would be 50% charities

The following organizations are not considered qualified charitable organizations:

• §509(a)(3) supporting private foundations
• New or existing donor advised funds
• Charitable remainder trusts, unless the charitable remainder interest is paid in cash to an eligible charity during the applicable time period

The definition of qualified charity is also the same one used by a corporation when looking at qualifying corporate donations.

More information

There are of course many more steps tax preparers need to be aware of to complete a 2021 return with a charitable contribution, either for a corporation or individual.

More information on this topic was included in NATP’s 2021 Tax Season Update sessions and printed textbook or e-book. The 2022 in-person Tax Season Updates workshops details will be available soon.

The 2021 Virtual Tax Season Updates workshop is still available for free, on-demand, to NATP Premium level members.