In McElroy v. CIR, T. C. Memo 2014-163, the Tax Court buried a promoter’s plan regarding the charitable gift of cemetery plots. Under the plan, the promoter sold to investors interests in an LLC which was formed to buy cemetery plots, hold them for a year and then make a charitable contribution of the plots to a 501(c)(3) organization. The plan was that the charitable deduction that resulted from the gift of the plots would be based on the appreciated value of the plots contributed. This would have worked because of the flow-through of the charitable contribution deductions to the investors in the LLC. However, the case makes it clear that the LLC did not follow the promoter’s plan; the LLC did not hold the cemetery plots for more than a year. Instead, the plots were purchased and then donated in less than a year’s time and, consequently, the LLC’s charitable deduction, which was flowed through to the investors, was limited under Section 170(e) to the LLC’s basis in the plots, which was much less than the claimed value of the charitable contribution. While the charitable deduction did flow through to the investors, the amount that flowed through to the investors was much lower amount than the investors expected.
Because the investors paid more for their LLC interests than the amount that flowed through to them from the LLC, the investors were left with an outside basis in interests in the LLC that had no value. To get the tax benefit of such economic loss, the LLC members tried to deduct their remaining basis in their LLC interest under Section 165 loss principles, but the Tax Court found that the Section 165 loss deduction was improper because the investments in the LLC were not made with any intent to make a profit, or in other words, without a purpose other than the flow through of the expected charitable contribution of the plots.
While the case also involved statute of limitations and penalty issues, the main point of the case was the inability of the investors to use Section 165 loss provisions to deduct the economic loss they had in this charitable contribution deduction oriented case. The case is also of interest because of the Tax Court’s displeasure with the bad actions of the promoter.