Category: Deductions & Credits; Sales
& Exchanges; Gift & Estate; Real Estate Copyright 1998, The Tax Resource Group. All rights reserved. Telephone 800-578-3498. Internet: www.taxresourcegroup.com Taxpayer owns appreciated real estate with a gross value of $60,000. The property is encumbered to the extent of approximately $20,000. The taxpayer has negotiated with a buyer for the property and has reached an oral agreement concerning the terms of the sale. At this point, there is no binding sales agreement. The taxpayer wishes to donate the property (subject to the debt) to his church. The church will then consummate the sale the taxpayer has set up. What are the tax effects of the transaction set forth above? Part-Gift-Part-Sale Prearranged Plan Rev. Rul. 60-370 deals with a taxpayer who transferred appreciated securities in trust to a university under a plan whereby the university was legally obligated to sell the securities and invest the proceeds in tax-exempt securities. The income from the sale became part of the corpus of the trust. Subsequent income from the trust was payable to the taxpayer for his life and the life of a secondary beneficiary. The remainder of the trust went to the charity. The ruling holds that given the existence of a legal obligation on the part of the trust to dispose of the property, the donor in substance donated the proceeds of the sale, not the property itself. I think your client is nowhere close to being in the same position as the taxpayer in Rev. Rul. 60-370. In Rollins v. U.S., DC-Tex--69-2 USTC ¶9544; 302 FSupp 812, the taxpayer entered into a binding contract to sell closely-held stock. The contract was signed in May and closed in late June. About a week before closing, the taxpayer donated the stock to a charity. The court held that at the time of the gift, the taxpayer could not legally donate the stock: he no longer controlled the stock by virtue of having entered into a binding agreement to sell it. The taxpayer only controlled the proceeds from the sale. In substance, the court held, the taxpayer donated the proceeds, not the stock. Hence, the sale was taxable to the donor. The Rollins case turns on the theory of assignment of income. Once a taxpayer earns income, he cannot avoid taxation on the earnings simply by giving the income to someone else. This is a legal principle handed down by the courts in a long series of rulings deriving from Helvering v. Horst, 311 U.S. 112, 1940-2 USTC ¶9787 (Supreme Court, 1940). It seems to me the issue for your client is whether the earnings process with respect to the sale of this property has been completed. Is it not true that the sale could fail to materialize? Despite the oral arrangements, could the buyer legally back out under the laws of your client's state? This is a question for a competent attorney. I am aware, however, that in many states a real estate transaction must be in writing in order to be legally binding and valid. I suggest you check out this point before going any further. Assuming that your client's arrangement with the buyer is not legally binding under the laws of his state, I think your client is on reasonably solid ground that he does not have to recognize the entire amount of income on the property. Clearly, he is still required to report the amount of income determined under the part-gift-part-sale rules discussed above.I think this conclusion is not free from doubt, and of course nothing can prevent the IRS from challenging this position. I suggest putting the client on notice that there a risk of challenge; and if a challenge did occur, there is a risk that IRS could prevail based on the hazards of litigation. I very strongly suggest that your client do nothing to legally bind the buyer. The property should be donated immediately to the charity and the charity should complete the negotiations and consummate the sale. |
