Spotting A Contribution

Do you think you could spot a tax-deductible donation?

Let’s begin by acknowledging that the qualifier “tax-deductible” kicks it up a notch. Give $300 to the church on Christmas Eve service and you have made a donation. Fail to get a letter from the church acknowledging that you donated $300, receiving in return only intangible benefits, and you probably forfeited the tax deductibility.

Let’s set it up:

(1)  There was a related group of companies developing a master-planned community in Lehi, Utah.

(2)  There were issues with density. The company had rights to develop if it could receive approval from the city council.

(3)  The city council said sure – but you have to reduce the density.

a.     Rather than reduce the number of units, the developer decided to donate land to the city – 746.789 acres, to be exact.

I see couple of ways to account for this additional land. One way is to add its cost to the other costs of the development. With this accounting you have to wait until you sell the units to get a deduction, as a slice of the land cost is allocated to each unit.

That wasn’t good enough for our taxpayer, who decided to account for the additional land by …

(4) … taking a charitable donation of $11,040,000.

What do you think? Does this transaction rise to the level of a deductible contribution and why or why not?

In general, a contribution implies at least a minimal amount of altruism. If one receives value equivalent to the “donation,” it is hard to argue that there is any altruism or benevolence involved. That sounds more like a sale than a donation. Then there is the gray zone: you donate $250 and in turn receive concert tickets worth $60. In that case, one is supposed to show the contribution as $190 ($250 - $60).

Sure enough, the IRS fired back with the following:

(1)  The transfer was part of a quid pro quo arrangement to receive development approvals.

That seems a formidable argument, but this is the IRS. We still have to bayonet the mortally wounded and the dead.

(2)  The transfer was not valid because [taxpayer] did own the development credits (i.e., someone else in the related-party group did).

(3)  The contemporaneous written acknowledgement was not valid.

(4)  The appraisal was not a qualified appraisal.

(5)  The value was overstated.

Yep, that is the IRS we know. Moderation is for amateurs.

A quid pro quo reduces a charitable deduction. Quid too far and you can doom a charitable deduction. Judicial precedence in this area has the Court reviewing the form and objective features of the transaction. One can argue noble heart and best intentions, but the Court was not going to spend a lot of time with the subjectivity of the deal.

The taxpayer was loaded for bear: the written agreement with the city did not mention that taxpayer received anything in return. To be doubly careful, it also stated that – if there was something in return – it was so inconsequential as to be immeasurable.

Mike drop.

The IRS pointed out that – while the above was true – there was more to the story. The taxpayer wanted more than anything to have the development plan approved so they could improve the quality of life make a lot of money. The city council wanted a new plan before approving anything, and that plan required the taxpayer to increase green space and reduce density.

Taxpayer donated the land. City council approved the project.

Nothing to see here, argued the taxpayer.

The Court refused to be blinkered by looking at only the written agreement. When it looked around, the Court decided the deal looked, waddled and quacked like a quid pro quo.

The taxpayer had a back-up argument:

If there was a quid pro quo, the quid was so infinitesimal, so inconsequential, so Ant-Man small as to not offset the donation, or at least the lion’s share of the donation.

I get it. I would make exactly the same argument if I were representing the taxpayer.

The taxpayer trotted out the McGrady decision. The facts are a bit peculiar, as someone owned a residence, a developer owned adjoining land and a township was resolute in preserving the greenspace. To get the deal to work, that someone donated both an easement and land and then bought back an odd-shaped parcel of land to surround and shield their residence. The Court respected the donation.

Not the same, thundered the Tax Court. McGrady had no influence over his/her deal, whereas taxpayer had a ton of influence over this one. In addition, just about every conservation easement has some incidental benefit, even if the benefit is only not having a crush of people on top of you.

The quid quo pro was not incidental. It was the key to obtaining the city council’s approval. It could not have been more consequential.

And it was enough to blow up a $11,040,000 donation.

Whereas not in the decision, I can anticipate what the tax advisors will do next: capitalize the land into the development costs and then deduct the same parcel-by-parcel. Does this put the taxpayer back where it would have been anyway?

No, it does not. Why? Because the contribution would have been at the land's fair market value. Development accounting keeps the land at its cost. To the extent the land had appreciated, the contribution would have been more valuable than development accounting.

Our case for the home gamers was Triumph Mixed Use Investments II LLC, Fox Ridge Investments, LLC, Tax Matters Partner v Commissioner, T.C. Memo 2018-65.

When Is A Car Not A Car?

I had a conversation today with someone who wanted to understand the “tax side” of a series of transactions. More specifically, transactions that – to a non-tax person – would appear to have no tax side at all.

It made me think of a tax case I read while grabbing a quick dinner one night during busy season.

          COMMENT: Glamorous life, eh?

Think of your car. In the eyes of the IRS, is it one asset or is it a collection of interdependent systems that – together – form a car but which can be separately depreciated, abandoned, sold or whatnot?

This is easy: it is one asset. You start depreciation on the whole thing and you eventually sell or abandon the whole thing. You are not picking and choosing manifolds from rotors.

Except if ….

It is a race car.

There is a racing team. After each race the team strips down the car, perhaps to the nuts and bolts. They decide as they go though:

(1) Damaged parts

(2) Obsolete parts

a.    There is enough technological change in racing that a part can become obsolete almost overnight.

(3) Stress and wear parts

a.    These are not damaged or obsolete, but the team knows they have very limited life left because of the high stress and wear of racing.

                                                             i.     Some parts can be reused in a race.

                                                           ii.     Some parts cannot be raced again, but would be fine for a show car or pit car.

The team had a question for the IRS: can they deduct some of this stuff when they disassemble the car after every race?

To a tax nerd, the question is whether there has been a “disposition.” That is the trigger that allows one to remove an asset from a depreciation schedule and claim a gain or loss on the tax return – hopefully a loss.

But what does “disposition” mean to a race car?

Turns out that disassembling it after every race is the disposition. The IRS took pains to point out that the same car is never raced twice. Dale Earnhardt Jr races number 88, but you never see the same number 88 twice.

          COMMENT: There is a Zen quality to this.

That makes it easy: if you get rid of a part, you can write-off its remaining cost.

But what if you keep the part?

To phrase it another way: what if you had a disposition but did not, you know, dispose of the part?

Now you have an accounting twist. You value the part at its invoice cost (which is normal) and then adjust down for the amount of useful life already expired. Let’s say you have a $7,500 part, and the team experts say that it has 40% useful life remaining. Well, that part stays on your books at $3,000 ($7,500 times 40%). The other $4,500 gets written-off as a loss.

Heck, you can deduct a loss even if you keep the part!

Rinse and repeat for however many parts make up a race car.

COMMENT: I feel sorry for the person who has to bookkeep for all this.

I wonder if racing aficionados would recognize which racing team the IRS addressed in PLR 201710006.

A PLR is a private letter ruling, meaning that someone presents a situation to the IRS and requests the government position on tax consequences. This is generally done in advance to obtain some certainty to a transaction, especially if there is a lot of money involved.

And PLRs are published. For many years the IRS did not publish them, but there was a famous lawsuit requiring the IRS to do so. There was an issue, however, as the IRS is not allowed to release confidential information. The answer was heavy redaction of any confidential information while drafting the PLR.

Such as the name of the racing team.