CCA 1042023: Trust's charitable deduction for appreciated property is limited to adjusted basis

Plain-English summary

Chief Counsel Advice considered whether a complex trust could deduct the fair market value of appreciated property purchased with accumulated gross income and later donated to charity. It concluded that the deduction under IRC § 642(c)(1) should be limited to the property's adjusted basis. The memorandum reasoned that the appreciation had not been realized as gross income and that the deduction must be traced to gross income. It distinguished authority involving cash contributions and relied on decisions concerning property contributions and unrealized appreciation. The memorandum acknowledged that the Service had not previously imposed this limitation in a case it identified and that contrary authority existed. It nevertheless stated that the majority view and the Service's analysis supported limiting the deduction to basis.

Ruling snapshot

• Question: May a complex trust deduct the fair market value, rather than adjusted basis, of appreciated property bought with accumulated gross income and donated to charity?
• Outcome: Advice given
• Key authorities: IRC §§ 61(a)(3), 1001, 1011, and 642(c)(1); Treas. Reg. § 1.42-5; Old Colony Trust Co. v. Commissioner, 301 U.S. 379 (1937); W. K. Frank Trust of 1931 v. Commissioner, 145 F.2d 411 (3d Cir. 1944)

Full text (IRS public release)

       Office of Chief Counsel
       Internal Revenue Service
       Memorandum
       Number: 201042023
       Release Date: 10/22/2010
       CC:PSI:B02:JKeeney                                 Third Party Communication: None
       POSTU-127829-09                                    Date of Communication: Not Applicable

UILC: 642.03-01

date: May 10, 2010

 to:   Manager, Special Enforcement Program, Gulf States Area
       (Examination, Small Business/Self-Employed)

from: Senior Counsel, Branch 2
(Passthroughs & Special Industries)

subject: Request for Chief Counsel Advice

       This Chief Counsel Advice may not be used or cited as precedent.

       LEGEND

       Trust    =   -------------------------------------------------------------
       Date 1   =   -----------------------
       Date 2   =   -------------------
       Date 3   =   --------------------
       Date 4   =   -----------------
       a        =   ---------------
       b        =   -----------------
       c        =   -----------------
       d        =   -----------------
       e        =   -----------------
       f        =   -------------
       g        =   -------------
       h        =   -------------
       i        =   -------------
       Year 1   =   -------

       ISSUE

POSTU-127829-09 2

May Trust take a charitable contribution deduction under § 642(c)(1) based on the fair
market value of appreciated property purchased from accumulated gross income of the
trust; or, should the charitable contribution deduction be limited to the adjusted basis of
the contributed properties?

CONCLUSION

Trust’s charitable contribution deduction should be limited to the adjusted basis of the
properties purchased from accumulated gross income.

FACTS

On Date 1, the Trust filed an amended return requesting a refund of $a on its Year 1
return. The refund was based on charitable contributions made by the Trust that
increased from $b, as originally reported, to $c. The Trust represents this increase was
due to an error in calculation of the unrelated business taxable income (UBTI)
limitations on their Year 1 charitable contribution. This refund case is currently in
Examination and is not a docketed Tax Court case.

Trust is a complex trust subject to the provisions of §§ 661-663 of the Internal Revenue
Code (“Code”). Trust’s agreement provides that “[t]he Trustee may also distribute to
charity such amounts from the gross income of the trust as the Trustee determines
appropriate to help carry out [its charitable] mission....” Trust represents that all of the
properties contributed to charity during Year 1 were purchased with prior years’ gross
income and can be traced to that gross income.

The charitable contribution deduction was based on the donation of three properties to
three different charities and a flow-through deduction from a partnership (which is not
at issue in the present case). One of the three properties was a building purchased on
Date 2 for $d and donated in Year 1 for the appraised fair market value of $e. Another
property was purchased on Date 3 for $f and donated in Year 1 for the appraised fair
market value of $g. The third property was purchased on Date 4 for $h and donated in
Year 1 for the appraised fair market value of $i. The materials which you have
submitted neither explain nor challenge the rapid appreciation of the properties.

LAW AND ANALYSIS

Section 61(a)(3) provides that gross income includes gains derived from dealings in
property.

Section 1001(a) provides that the gain from the sale or other disposition of property
shall be the excess of the amount realized therefrom over the adjusted basis provided in
§ 1011 for determining gain, and the loss shall be the excess of the adjusted basis
provided in § 1011 for determining loss over the amount realized.

POSTU-127829-09 3

Section 1001(c) provides that, except as otherwise provided in subtitle A of the Code,
the entire amount of gain or loss, determined under § 1001, on the sale or exchange of
property must be recognized.

Section 642(c)(1) provides that a trust (other than a trust subject to §§ 651 and 652) is
allowed a deduction in computing its taxable income for any amount of gross income,
without limitation, that pursuant to the terms of the governing instrument is, during the
taxable year, paid for a purpose specified in § 170(c)(2)(A)). This deduction is in lieu of
the charitable deduction allowed by § 170.

In Old Colony Trust Co. v. Commissioner, 301 U. S. 379 (1937) the Supreme Court ,
stated that it was not necessary for a trust to prove that contributions of cash to charity
arose from gross income that was earned during the same year in which the cash was
contributed to charity. Instead, the payment of cash was still considered to have its
source in the gross income of a trust if the gross income was earned in prior taxable
years.

In W. K. Frank Trust of 1931 v. Commissioner, 145 F.2d 411 (3d Cir. 1944), the trustees
contributed securities to charity which had been received in a tax-free exchange for
securities that made up the original trust corpus. The trust had amounts of gross
income which exceeded the value of the securities that were contributed to charity. The
Circuit Court, affirming the Tax Court, held that the contribution of securities did not
arise from the gross income of the trust and disallowed the deduction.

The Tax Court pointed out in W.K Frank Trust that if the trusts had sold the shares
which they had contributed to charity and realized the fair market value of the shares at
the dates of the gifts they would have been subject to income tax upon the capital gains
made. If they had contributed money out of such capital gains, they would clearly have
been entitled to deduct the amounts contributed up to the amounts of net income of the
trusts. W.K. Frank Trust of 1931, 2 T.C.M. 1107 (1943). The present case differs from
W.K. Frank Trust in that the contributions to charity were not made from property that
was initially contributed to the corpus of the trust, but rather property purchased in a
previous year from gross income. In addition, Rev. Rul. 2003-123, 2003-2 C.B. 1200,
similarly denies a § 642(c) deduction for the contribution of a conservation easement on
property owned by the trust since its inception.

In Crestar Bank v. IRS, 47 F. Supp 2d 670 (1999), the District Court denied a § 642(c)
deduction to an estate on a contribution of stock owned by the decedent at death. The
estate argued that under Old Colony Trust Co. it did not matter whether the charitable
contribution was traceable to gross income so long as there was sufficient gross income
to cover the contribution. The District Court disagreed, stating that “[t]he Estate’s
reading of Old Colony Trust Co. . . . would destroy the tracing requirement of § 642(c).”
Crestar Bank at 677. The District Court explains that § 642(c)(1) requires that
contributions have their source in gross income; therefore, the stature requires tracing
to determine the source of the contribution.

POSTU-127829-09 4

A standard treatise on fiduciary income taxation discusses the issue of whether
unrealized appreciation should be considered as gross income under § 642(c). M. Carr
Ferguson, James J. Freeland & Mark L. Ascher, Federal Income Taxation of Estates,
Trusts, and Beneficiaries § 5.9 (Second Edition). The treatise states that the
contribution of low-basis property would yield a double tax advantage: (1) avoidance of
tax on the potential gain, and (2) the ability to deduct not only the basis, but also the
gain, from gross income. As the Circuit Court in W.K Frank Trust pointed out that
“[A]ppreciation in value, unrealized by sale or other disposition, [is] not gross income.”
(145 F.2d at 413.)

Limiting the deduction to basis (representing amount previously taken into income) on
the basis of the Court’s analysis in W.K Frank addresses a substantive question not
directly controlled by Old Colony (which concerned a cash contribution). U.S. v.
Benedict, 338 U.S. 692 (1950) offers a useful parallel. In Benedict, a contribution under
the predecessor to § 642(c) was denied for a contribution of certain capital gains
because those gains were excludable from gross income under another provision. The
Court stated, citing W.K. Frank, that “[w]e treat that percentage of capital gains which
expressly is not to be taken into account in computing taxable net income as also
excluded from statutory gross income.” (338 U.S. at 699.)

HAZARDS AND OTHER CONSIDERATIONS

We find no prior cases or other authority in which the Service has so limited a § 642(c)
deduction and there is at least one source of counter-authority. One commentator
interprets Old Colony as authority for a § 642(c) deduction up to the amount of gross
income for that year in any case where the controlling document does not specifically
designate the payment as coming from principal, whether made from “prior years’ cash
accumulations, principal, or income receipts in hand, such as stock dividends or
borrowings, as well as principal assets . . . .” Abbin, Byrle M., Income Taxation of
Fiduciaries and Beneficiaries, § 4128.3 (2006). On balance, however, the majority view
of the court’s and commentators as well as our own points to the view that Trust may
not claim a charitable contribution deduction greater than its adjusted basis of the
properties purchased from accumulated gross income under § 642(c).

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