The IRS seems to be stuck in its conservation easement attack mode even in the recent bargain sale case, Davis v. Commissioner, T.C. Memo 2015-88, which was issued by Judge Paris last week. Davis involves the bargain sale of property made by a generous real estate developer in Waco, Texas who over time had assembled desirable property in Waco and considered the possibility of selling the property to a charitable organization (the “Foundation”), which wanted to build a needed retirement home.
Because the Foundation did not have the resources to pay fair market value for the property (which had an appraised value of $4,100,000), and at the suggestion of the head of the Foundation, Davis made a bargain sale of the property to the Foundation for $2,000,000 cash. Of interest to the IRS were the additional goodies that the Foundation had talked about providing to Mr. Davis (in addition to the $2,000,000 in cash). Such additional goodies included (1) the right to name one of the buildings on the property, (2) the right to require the Foundation to construct its first single family model home on the property using a contractor designated by Mr. Davis, (3) the right to allow Davis family members to have free or discounted use of the retirement home and (4) the right to terminate such rights in exchange for a payment. While such additional goodies were discussed and actually found their way into a nonbinding preclosing agreement between Mr. Davis and the Foundation, these additional benefits were never provided to Mr. Davis and, in fact, the sale of the property for a purchase price of $2,000,000 closed without any additional benefits being paid or provided to Mr. Davis.
Consequently, Davis treated the transaction as a bargain sale to the Foundation and claimed a charitable deduction of $2,100,000. He deducted $566,960 of that amount in 2005, $416,290 in 2006 and $170,981 in 2007 (presumably carrying the balance to future years).
The IRS subsequently issued a notice of deficiency with respect to the charitable contribution deductions claimed in 2005, 2006 and 2007, claiming (1) that the taxpayer’s gift lacked a charitable intent, (2) that the taxpayer did not satisfy the contemporaneous written acknowledgement requirement of section 170(f)(8) and (3) that the fair market value of the gift was….wait for it…. zero!
The IRS argument that Davis lacked charitable intent in selling the property in a bargain sale is something we see regularly in conservation easement related audits and tax litigation. In this case, the IRS argued that Davis lacked charitable intent based on several factors. First, the IRS noted that Davis negotiated with the Foundation over the price (imagine that!) and that Davis structured the transaction as a contribution in part only after the Foundation’s president “schooled” Davis about the concept of a bargain sale. Second, the IRS argued that Davis lacked charitable intent because he desired tax benefits from the charitable contribution. Third, the IRS argued Davis lacked charitable intent because he received consideration in the form of $2,000,000 plus the other goodies that Davis and the Foundation discussed but which never were put into place. Fortunately for Mr. Davis, the court disagreed with the IRS’ arguments, finding that charitable intent existed.
Specifically, the court found that as of the time of the sale, Davis believed that he was selling the land for less than fair market value and that he intended to transfer the excess value as a charitable contribution. The court also noted that Davis completed the transaction even after learning that certain other benefits (the aforementioned goodies), which he had hoped to receive, were not to be provided to him. The court also found that the retention of a minor easement and the cooperation between Davis and the Foundation for the building of a minor road were both incidental benefits to Davis and did not have an impact on Davis’ charitable intent.
The IRS attack on charitable intent is characteristic of a disturbing new tactic we have been seeing in our cases defending conservation easements and flies in the face of established case law, including Skripak v. CIR, 84 T. C. 285 (1985).
Strangely, the IRS even argued that Davis’ deduction should be denied because the bargain sale of the land would make nearby land also owned by Davis more valuable as a result of the gift. This “enhancement” type argument is certainly borrowed from the conservation easement arena; Judge Paris disposed of that IRS misstep by stating that any speculative increase in the value of Mr. Davis’ nearby property fails to vitiate or otherwise erode his charitable intent and that he could not compel the construction of the retirement community and that any future increase in the value of Davis’ nearby property would not be a direct product of the contribution. It is interesting to see the IRS try to apply special valuation rules found in the conservation easement area to other charitable gifts.
As to the contemporaneous written acknowledgement issue under code section 170(f)(8), which is a “foot fault” attack often seen in conservation easement cases, the IRS argued that the Foundation’s statement in the written acknowledgement that the property was received in exchange for $2,000,000 in cash (the statement specifically stated: “The certified appraised value of the above described property was $4.1 Million, and the bargain sale price was $2 Million. Therefore your gift to the Foundation was $2.1 Million.”) was found to satisfy the contemporaneous written acknowledgement requirement. The Tax Court noted in the opinion that the IRS conceded in post-trial briefs that the petitioner would have met the contemporaneous written acknowledgement requirement if goods and services were not received or expected to be received. In this case, the court found that there was no such expectation.
The last portion in the decision involves the valuation of the property, which, as it often does, relies on the specifics of the property. While the analysis of how the property should have been appraised is not particularly noteworthy, the recognition by the court of how the assembly of property can make property more valuable is welcome and was argued by us in one of our recent cases. Ultimately, the court agreed with the taxpayer’s valuation, making only minor adjustments to sales price for certain variables that are relevant to that particular property.
While the valuation discussion is of interest generally, Davis is instructive of how the IRS seems stuck in how it attacks gifts of appreciated real estate, be it in the form of a conservation easement, a bargain sale or otherwise. We will likely see additional specious attacks on such transactions based on lack of donative intent and technical foot faults, followed by a draconian attack on value.