Tax Treatment of Appreciated Property Donations Cameron L

Tax Treatment of Appreciated Property Donations Cameron L. Hess Nonprofit Director Wagner Kirkman Blaine Klomparens & Youmans LLP

Overview �Appreciated Property: Donation Incentives �Bigger Contribution Impact �Avoid Capital Gain Recognition �Satisfy Multi-Year Pledge Faster �Estate/Wealth Planning 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 2

Overview - Limits on Donations � 50% (60%) Charities Limit – 170(b)(1)(A) �Church, convention, church association �Educational organization engaged in teaching �Publicly supported college or university �Medical institution (hospital/research) �Public charity (public support) �Governmental unit �Private operating foundation �Certain agriculture research college affiliated entities 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 3

Overview - Limits on Donations � 30% Charities Limit (2 nd Tier) �Private foundations �Limit is the lesser of: � 30% of the contribution base � Unused portion of the 50% limit 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 4

Overview - Limits on Donations �Capital Gain Properties General Limit �Limits if 170(e)(1)(B) Inapplicable � 30% of Contribution Base (for donations to 50% (60%) charities. � 20% of Contribution Base �Donations to private foundations. �Limited to lesser of (i) 20% or (ii) unused portion of 30% base. 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 5

Impact of 2017 Tax Cut & Job Act �Increases Standard Deduction �Itemized Deductions �HELOC Eliminated (non-acquisition) �>12/15 – Acquisition/Improvement Loan Limit Lower �Casualty loss (Non-disaster) + Misc. Suspended (‘ 18 -’ 25) �Limit Tax Deduction - $10, 000 (‘ 18 -’ 25) �Increase in Public Charities Limit – 60% �Phase-Out Suspended (18 -25) - BOTTOM LINE: �Appreciated Property – Larger Donors Helped 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 6

Additional Appreciated Properties Limits �Donation if Appreciation NOT Long-Term Capital Gain (170(e)(1)(A)): �Built-in Short-term Capital Gain �Built-in Ordinary Income = any amount that would be ordinary income (including 1245 depreciation recapture, etc. ) if the asset was sold at fair market value. �Limit on Deduction: Tax Basis 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 7

Additional Appreciated Properties Limits �Deductions Reduced By Built-In Long Term Capital Gain �(1) Tangible Personal Property � If charity will not “use” property received; � Or charity sells property prior to end of donation year and will not certify its use became impossible or infeasible (and charity had intended to or did use. ) �Deduction limited to basis � Deduction reduced by capital gain amount. � Recapture under 1245(a), 1250(a), 1252(a), 1254(a) – all treated as capital gain assets. 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 8

Additional Appreciated Properties Limits �(2) Tangible Personal Property �Related Use Exception �If personal property is related to function or use (i. e. , use the property for operations) – then deduction allowed at fair market value. �Problem – Early Disposition. �Charity dispose that year. Must get Certification. �No certification = no Deduction. [They don’t care, you are too unimportant. ] 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 9

Additional Appreciated Properties Limits �Deductions Reduced By Built-In Long Term Capital Gain: �(2) Donation to or for use by a Private Foundation �Effect: Roughly Tax Basis Only Deduction �Does not matter if use related or not. �(Exception: Private Operating Foundation) – hint – organization “stuck” as private foundation, even though it meets public charity requirements currently. 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 10

Additional Appreciated Property Limits �Deductions Reduced By Built-In Long Term Capital Gain: �(3) Donate Intellectual Property. �(4) Donate Taxidermy Property (stuffed animals) �“Capital Gains Property” – Includes 1231(b) – trade/business property �Depreciable Property �Real Property (including land) 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 11

Additional Appreciated Property Limits �(3) Intellectual Property. �What is Intellectual Property? �Patents. �Copyrights (not under 1221(a)(3) or 1231(b)(1)(C)). �Trademarks, Trade names, Trade secrets. �Know-how. �Software (not under 197(e)(3)(A)(i)). �Similar property. 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 12

Intellectual Property. Tax Deductible year percentage 1 100% 2 100% 3 90% 4 80% 5 70% 6 60% 7 50% 8 40% 9 30% 10 20% 11 10% 12 10% 2/23/2018 �Exception: “Additional deductions” - (i) year of the contribution and years following = “% x income” to charity from donated property. �Deduction ends earlier of (i) legal life or (ii) 10 th anniversary. �No deduction if donated to private foundations. (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 13

Intellectual Property. �Royalty Income (e. g. music rights): �Ordinary Income Asset – Limited to Basis. �Must Contribute Underlying Asset �Mere assignment if cash stream = No Deduction �Must assign underlying rights. 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 14

Additional Appreciated Properties Limits �Special Limits �Partial Limit – Inventory/Depreciable Property � Not to a private foundation � Use to care for ill, needy or infants � No consideration received � Written acknowledgement of qualified use � If FDA regulated – must meet regulations. �Deduction = greater of � ½ Section 170 Deduction or 200% of property Basis 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 15

Warning: Surprise Disposition Gain �Section 1256 – Mark to Market Rule �OID Bond Issuances �Options �Commodity Futures �Installment Sale Notes 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 16

Pass-Through Entities Appreciated Property Concerns �Overview �S Corporations �Basis Adjustment �Timing of Deduction �Partnerships �Rev. Rul. 96 -11 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 17

Substantiation �Gift Tax Returns �IRC § 6501(c)(9) – Disclosure-Statute of Limitations �Disclosure Requirements � Describe Method � Identify Financial Data � Identify restrictions on property � Describe Discounts �Appraisal Report may meet disclosure required, if: � Qualified Appraiser. (Does appraisals, qualified in area, not donor, related or employee) � Appraisal Report detail satisfactory (several requirements. ) 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 18

Substantiation �Gift Tax Returns �Appraisal Report elements � Date of Transfer � Description of Property � Description of Appraisal process � State assumptions, limitations, conditions affecting appraisal � Information considered (financial, etc. ) � Procedures followed, reasoning, analysis, conclusions � Valuation method used – why used. � Approach & source methods used. 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 19

Substantiation �Estate Tax Returns �Not subject to IRC § 6501(c)(9) �Good idea to follow anyway. 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 20

Substantiation �Income Tax Returns �Small donations. Some nominal documentation. Canceled check, receipt or other reliable record. �$250 (Or More) Item. A “contemporaneous written acknowledgment” before the due date the donor files. � § 170(f)(8) – Each item separate for $250 test; no lumping together. 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 21

Substantiation �Income Tax Returns �$250 (Or More) Item - written acknowledgment (§ 170(f)(8)) �$ Cash + Description of Property �Whether Goods/Services Received “in consideration” �Plus, if yes, description & good faith value estimate 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 22

Substantiation �> $500. �Contemp. Written Acknowledgement PLUS �Written Records (§ 1. 170 A-13(b)(3)(ii)) – Req’d �Form 8283 – Page 1 Required � Manner & Date Acquired � Adjusted Basis in Property & value �Omission = No Deduction, Unless �Reasonable Cause: State reason for omission on return (if IRS accepts)-else $0 Deduction. 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 23

Substantiation �Income Tax Returns �> $5, 000 item �Qualified Appraisal required. �Form 8382 Appraisal Summary (Page 2) �Completed/signed by qualified appraiser �Attached to return �$500, 000 �Qualified Appraisal attached to return. 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 24

Substantiation �Income Tax Returns �$500, $5, 000, $500, 000 �§ 170(f)(11) – Similar Items “Grouped” for Dollar Testing �Similar Items = same generic category or type �Coin collections �Paintings �Nonpublicly traded stock �Land or Buildings 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 25

Substantiation Ite m 1. (Estate &) Gift Tax (Regs. § 301. 6501(c)-1(f)(3)) Income Tax (IRC § 170(f)(11)(E)(i)) The dates of the transfer and the appraisal. The date on which the property was appraised. The date (or expected date) of its contribution. A statement that the appraisal was prepared for income tax purposes. A description of the property and its physical condition. The terms of any agreement that relates to the property. 2. The purpose of the appraisal. 3. Descriptions of the property, the appraisal process, the assumptions made and any restrictions that affect the analyses, opinions and conclusions. The information considered, including in the case of a business interest, all financial data that was used. The appraisal procedures followed and the reasoning that support s that analyses, opinions and conclusions. The valuation method 1 utilized and the rationale for using that method. The specific basis 2 for the valuation. 4. 5. 6. 7. The method 1 of valuation used. The basis 2 for the valuation. 8. The appraised FMV of the property on the date of contribution 9. The name, address and identifying number of the appraiser and the appraiser’s employer. 10. The appraiser’s qualifications. _____________________________________ 1 Method 2 Basis – Income v. Market Data v. Replacement Cost – Comparable Sales v. Statistical Sampling 26

Substantiation �Qualified Appraisal Requirements �Overview � Qualified Appraiser � No Prohibited Appraisal Fee � Qualified Appraisal � Notice 2006 -96 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 27

Substantiation �Qualified Appraiser (Notice 2006 -96) >8/17/2006 �Has an earned appraisal designation (ASA, MAI, etc. ) or meets verifiable education/experience; �Regularly performs appraisals for compensation; and �Not prohibited from practice before IRS > 3 years ago. �Meets other requirements under regulations �Real Property: licensed/certified for type of property, within state. �Declaration complies with statutory statement relating to substantial gross valuation misstatement (>2/16/17. ) 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 28

Substantiation �Qualified Appraiser (Notice 2006 -96) �Business Appraisers � Issue – no state licensing, even if in connection with real estate entity. �Credentials � ASA – Am. Society of Appraisers-Accredited Senior Appraiser � CVA/AVA – Nat’l Association of Certified Valuation Analysts � CBA – Institute of Business Appraisers � Accredited in Business Valuation – AICPA �Caveat Emptor – review an appraisers credentials/experience before hiring – assume the IRS will challenge the appraiser. 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 29

Substantiation �Qualified Appraisal �Meets the standards of 170(f)(11) �Declaration complies with statutory statement relating to substantial gross valuation misstatement 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 30

Substantiation - Appraisals �Mohamed v. Commissioner �TC Memo 2012 -152 (Substantial Compliance) � 2003 -2004 years pre-date Notice 2006 -96 �Taxpayer followed “form instructions” without practitioner assistance. �Taxpayer donated to charitable remainder trust; Summary appraisal was attached (taxpayer signed as “appraiser”) �Contribution was stated at $18. 5 million (actual higher) 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 31

Substantiation - Appraisals �Other Cases: �Boltar LLC v. Com’r, 136 T. C. No. 14 (2011). Appraisal excluded on conservation easement. “Unreliable & irrelevant. ” $42, 400 of $3. 245 million allowed. �Bond v. Com’r, 10 TC. No 4. (1993) Substantial compliance is sufficient. Treas. Reg. 1. 170 A-13 is to facilitate processing and audit; 1. 170 A-13 is directory, not mandatory. �Hewitt v. Com’r 166 F 3 d. 332 (1998) Providing practically none of information by statute/regs is not substantial compliance. 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 32

Substantiation - Appraisals �Other Cases: �Consolidated Investors Group v. Com’r, T. C. Memo 2009 -290 (2009). Bargain sale. Appraisal done > 60 days before donation, and was missing some items, but was otherwise complete. Substantial compliance met. � 310 Retail, LLC, v. Com’r , TC Memo 2017 -164. (2017) Historic façade. The court could not get to the appraisal due to summary judgment actions as to the contemporaneous written acknowledgement on contributions over $250. 00 Court ruled that the deed’s face is sufficient proof that no goods or service were received. 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 33

Substantiation - Appraisals �Other Cases: �RERI Holdings I, LLC et al. v. Commissioner, 149 T. C. No. 1 (2017). Remainder interest purchased for $3 million and gifted following year, claiming a substantially larger deduction. Substantial compliance not met. Form 8283 failed to include the donor’s cost or other adjusted basis of the contributed property. The large disparity between the appraisal and the basis meant the absence of basis was substantial. 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 34

Carryover & Errata �C Corporation Limit �Carryover Rule – Individuals & Nonprofits � 5 -year Rule �Special Rules � 15 -years Conservation Easements 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 35

Examples & Issues �Stock �Publicly Traded Securities � No Deduction on Appreciation if < 1 year held � Deduction = lower of FMV or basis � Hold > 1 year to get FMV Deduction. � No capital gain recognition on donation � Donation Limit � 30% Public Charity � 20% Private Foundation � Examples: stocks, open-end mutual funds, US government bonds, exchange traded corporate bonds. 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 36

Examples & Issues �Stock �Publicly Traded Securities � Treasury Reg. § 1. 170 A-13(c). No Qualified Appraisal. � If not restricted. � Hi-Low Average Trading Value at Date of Donation � Restricted Stock � Rule 144 Stock � Other Restrictions � Valuation - Rev. Rul. 77 -287 � Note – Rule 144 – Restricted Stock CAN be donated. 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 37

Examples & Issues �Stock �Non-Publicly Traded Stock � Example: Closely held corporation � Qualified Appraisal Required. � Warnings: � Private Foundations – Lots of Issues! � Deduction limits � Prohibited Transactions � Self Dealing � Excess Business Holding 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 38

Examples & Issues �Real Estate �Bargain Sale Rules � Sale for less-than fair market value to a sale results in part- sale, part gift � Gain is recognized on the sale portion � Only a portion of tax basis is deductible against the sale portion � Basis is pro-rated. � A charitable contribution is allowed on the “gift” portion. �Inadvertent bargain sale � Charity’s taking property subject to debt involves a sale 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 39

Examples & Issues �Real Estate �Fractional Interests � Generally No Charitable Deduction: � Fractional Use � Future Use (until current use ceases) �Exception � % of entirety of rights (i. e. , 1/4 th interest in whole. ) � Charitable Lead Trusts � Charitable Remainder Trusts � Certain Easements 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 40

Examples & Issues �Real Estate �Examples of Permitted Donations � Fee simple � Entire lease interest held (if fee simple equivalent) � Oil rights - operating interest (the land owner interest) � Future gift, with life estate retained. �Problem Areas � “Dealer” property – e. g. , home lots by builder � Debt encumbered property (disguised bargain sale) � Pass-through real estate entities (debt encumbrances) 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 41

Charitable Lead Trusts �§ 170(f)(2) �Annually pays 501(c)(3): guaranteed annuity or unitrust interest. �Charitable Deduction = NPV - “Present Interest” �Funding: Real estate, stock securities. �Features: � Irrevocable Trust – Complex Trust (NOT Tax Exempt) � Doesn’t Avoid Gain on Sale of Appreciated Propety � Remainder reverts/paid to noncharitable beneficiary. 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 42

Charitable Remainder Trusts �§ 170(f)(2) – Deduction allowed if annuity or unitrust. �Irrevocable Trust - tax exempt (except UBTI. ) � (Treas. Regs. §§ 1. 664 -1(a)(1)(i)) � Avoids Gain on Sale of Appreciated Property �Deduction = NPV of future gift �Funding: real estate, stock, other investments �Current beneficiaries get (at least one not a charity) � Stated Benefit for (i) life or for (ii) term of years; � Either (i) an fixed annuity (=/> 5% initial FMV) or (ii) a % of annual value (=/> 5% of annual net FMV). 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 43

Conservation Easements � 3 Basic Elements - § 170(h) �(1) Qualified Real Property Interest � Note – 170(e)(3)(B) – Exempt from denial of deduction for fractional interests. � i) Entire, ii)remainder, or iii) use restricted (common) �(2) Qualified Conservation Organization � 501(c)(3) – land conservation or government entity � Resource Test – resources/commitment to perpetually protect 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 44

Conservation Easements � 3 Basic Elements �(3) Conservation Purpose � Recreation/education � Natural habitat � Open space (farmland or forestland okay) – scenic � Historical preservation – land or structure �Exclusively = in perpetuity + no surface mining 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 45

Conservation Easements � 3 Problems �Mining �Mortgage �Valuation �Deduction Limit � 50% Individuals (10% - C Corporation) � 15 -year carry-forward �Estate Tax Planning �Can bequest to get estate tax deduction. 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 46

Examples & Issues �Artwork, Jewelry, Collectibles �General Deduction Limit – Tax Basis! (Tangible Personal Property Limit). Doesn’t matter if appreciation = � Ordinary Income � Capital Gain �Exception: � Held > 1 -year � “Type” Normally held by Nonprofit (Check with Charity!) �Limits – 50(60)/30% limit reduced to 30/20% limit – capital gain property. 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 47

Applicable Penalties �Section 6662 Accuracy Related Penalties (20%) �Negligence or disregard of rules or regulations �Any substantial understatement of income tax �Any substantial valuation misstatement �Types �Basis overstated by 150% or more �Gift/bequest 65% or less than correct amount � 40 % Penalty if “gross valuation misstatement” �– substitute – 150%200% and 65%40%. 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 48

Applicable Penalties �Section 6694 Understatement by Tax Return Preparer �Unreasonable position ($1, 000 or 50% of fee) �Willful Misconduct ($5, 000 or 50% of fee) �Section 6701. Aiding and Abetting Aids or assists in preparation; knows position causes understatement � Penalty: $1, 000 ($10, 000 for Corporation) � �Section 6695 A Appraiser Penalty Knows or should now appraisal is for return/refund � Substantial valuation penalty imposed on taxpayer � Penalty: > 10% of underpayment or $1, 000; NTE 125% gross income from appraisal. � 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 49

Penalty Avoidance/Defenses �Defenses to Penalty � 1. 6662 -3(c). Adequate Disclosure � Form 8275 R (position contrary to regulation) � 1. 6662 -4(d). Substantial authority � 1. 6664 -4 Reasonable Cause � Acted in good faith �Valuation misstatement � Relied on qualified appraisal by qualified appraiser; and � Made good faith investigation of value 2/23/2018 (c) Wagner Kirkman Blaine Klomparens & Youmans LLP 50

Penalty Avoidance/Defenses �Defenses to Penalty �Esgar Corp. v. Com’r, T. C. Memo 2012 -35 (2013). No penalty where advisor was competent, taxpayer provided information to advisor; taxpayer relied in good faith. �Thompson v. Com’r, 370 Fed. App 141 (2010. ) No penalty where valuation of asset was particularly difficult. �Mc. Grady v. Com’r, T. C. Memo 2016 -233 (2016) Conservation easement. No penalty for adjustment to donation deduction. The court questioned some analysis, but Taxpayer had qualified appraiser, qualified (c) Wagner Kirkman Blaine Klomparens & appraisal and made a good faith investigation. 2/23/2018 Youmans LLP 51