Tuesday January 25, 2022
Case of the Week
Give Peace A Chance
Case:Several years ago, Martha and Frank built a very unique home on 45 acres of beautiful rolling hills and woods. Frank passed away three years ago and now Martha solely owns the 45-acre parcel and home.
She enjoys the peaceful country view out her front window. However, the university adjacent to the property is very interested in acquiring the property for future growth. Not surprisingly, Martha is concerned. She does not want a new dormitory filled with college students in her front yard. In fact, she enjoys the peace and protection of her lovely home in the wooded countryside. However, at age 80, she recognizes that eventually some planning will have to be accomplished.
After obtaining a thorough understanding of Martha's needs and desires, Martha's attorney, Paul, crafted a wonderful four-part solution which incorporated an outright sale, a unitrust, a gift annuity and a gift of a remainder interest in a home. (See Case Study "Peace in the Countryside" from last week for a full explanation.) This solution seemed like the perfect fit until Paul discovered that Martha had discussed selling the 45-acre family lot to Billy Jackson, an adjacent landowner, for $2.5 million several months ago.
Question:If the discussions between Martha and Billy are deemed a prearranged sale, Paul stated that Martha's four-part solution would surely crumble. What are the tax consequences if a prearranged sale is found? What are the rules governing prearranged sales?
Solution:The principle that income is taxed to the person who earned it leads to the IRS prohibition on the assignment of income from one party to another. In general, in order to bypass capital gain, there cannot be a binding obligation to sell when appreciated property is transferred either outright to charity or to a charitable trust. See Ferguson v. Commissioner. Therefore, any contributed property must be transferred to the charity or to the trust with no legally binding obligation to sell in existence. If there were such a legally binding obligation in existence, then the donor would not avoid the capital gain on the sale of the property. For instance, in Revenue Ruling 78-197, the Service treated the proceeds of a company's redemption of stock as income to the donor when the donee was legally bound or could have been compelled by the corporation to surrender the shares for redemption.
In this case, Martha and Billy entered into discussions about the possible sale of the 45 acres for $2.5 million. At first blush, these facts do not sound promising. However, after further investigation, Paul discovered that Martha and Billy did not enter into an oral or written contract for the sale of land. Further, Martha took no actions and made no statements under state law that would legally obligate her to sell the land to Billy. Apparently, Martha was merely "testing the waters" of interested buyers. Paul determines that so long as there is no signed or oral binding agreement to sell, there may be prospective purchasers "waiting in the wings."
As a result of Paul's favorable findings, Martha proceeds safely ahead with her four-part solution. With her newfound liquidity, steady lifetime income and beautiful hillside views, Martha finds peace in the countryside (and her annual six-figure income stream) very agreeable.
Published August 20, 2021