Friday, March 29, 2024
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GiftLaw Note: A taxpayer transferred an assignable option to purchase real property to a charitable remainder trust (CRT) and then sold it to a third party for its fair market value. When the third party purchaser exercised the option, the taxpayer was permitted to take a deduction for the difference between the option price and the fair market value paid by the third party purchaser to the CRT.

The IRS withdrew this letter ruling in PLR 9417005 stating that "[n]o inference should be made from this withdrawal as to the proper tax treatment of the transfer to a charitable remainder trust of an option to purchase property." The IRS indicated at this time that it was reconsidering whether the use of an option grant was permissible.

PRIVATE RULING 9240017

DATE: July 2, 1992


We received your letter dated July 19, 1991, requesting several rulings, on behalf of the Taxpayer. For purposes of your requested rulings, you asked us to assume that Trust is a valid charitable remainder unitrust within the meaning of section 664(d)(2) of the Internal Revenue Code. Specifically, your requested rulings are: (1) If the taxpayer transfers what is purported to be an assignable option to purchase unencumbered real property to the Trust, the purported option will not be considered an asset of the Trust, or alternatively has no fair market value, for purposes of section 664(d)(2); (2) the taxpayer will be entitled to a deduction under section 170, not in the year the purported option is transferred to the Trust, but in the year in which the Trust assigns the purported option to any third party; and (3) if the Trust assigns the purported option to an unrelated third party for consideration, the taxpayer will not recognize gain or loss. This letter is in reply to your request.

On July 19, 1991, Taxpayer, as trustor, and Trustee executed an irrevocable declaration of trust establishing the Trust and funded it with a small amount of cash. The Trust document provides for the Taxpayer to deliver to the Trustee property that is selected by the Taxpayer and is acceptable by the Trustee. The Trust estate will be comprised of the acceptable property delivered to the Trustee by the Taxpayer.

The terms of the Trust require the Trustee to pay to Taxpayer, as beneficiary, an annual unitrust amount equal to 9-percent of the net fair market value of the Trust estate. For each taxable year of the Trust, the unitrust amount is required to be paid first from income. To the extent income is not sufficient to pay the annual unitrust amount, the balance is to be paid from principal. If the Trust income exceeds the annual unitrust amount in any year, the excess is required to be accumulated and added to the principal of the Trust. On the death of Taxpayer, the remainder of the Trust estate must be distributed to the charitable remaindermen named in the trust document. The Trust is intended to qualify as a charitable remainder unitrust within the meaning of section 664(d)(2) of the Code.

The terms of the Trust provide the Trustee with broad investment powers in the management of the Trust estate. In addition, the terms of the Trust grant the Trustee broad powers to dispose of any real or personal property held in the Trust estate. The Trustee, however, is prohibited from engaging in any self-dealing, as defined in section 4941(d) of the Code, and from making any investments subjecting the Trust to tax under section 4944 of the Code.

Most of Taxpayer's assets consist of rental real property that, if donated to the Trust, would not generate sufficient income to pay the annual unitrust amount as required under the terms of the Trust document. Therefore, the Taxpayer proposes to enter into an agreement with the Trustee under which the Trust will possess the right (but not the obligation) to acquire a fee interest in certain unencumbered real property (a capital asset in the hands of Taxpayer) by tendering to Taxpayer the sum of $ x. The agreement that Taxpayer proposes to enter into will cover a period beginning with the date the agreement is signed and ending three years after that date. The Trust's rights under the agreement will be assignable by the Trust and by any third-party assignee. It is contemplated that if the Trust assigns its rights under the agreement to an unrelated third party, the Trust will receive as consideration for the assignment an amount approximately the difference between the fair market value of the real property at the time of assignment (currently estimated to be about $ y) and $ x.

Section 664(d)(2) of the Code provides that a charitable remainder unitrust is: (1) a trust from which a fixed percentage (which is not less than 5-percent) of the net fair market value of its assets, valued annually, is to be paid, not less often than annually, to one or more persons (at least one or which is not an organization described in section 170(c) and, in the case of individuals, only to an individual who is living at the time of the creation of the trust) for a term of years (not in excess of 20 years) or for the life or lives of such individual or individuals, and (2) a trust from which no amount other than the payments just described may be paid to or for the use of any person other than an organization described in section 170(c). In addition, to qualify as a charitable remainder unitrust a trust must be one in which after the termination of the payments described in the above sentence, the remainder interest in the trust is to be transferred to, or for the use of, an organization described in section 170(c) or is to be retained by the trust for such a use.

Under section 664(d)(2) of the Code, a fixed percentage of the fair market value of the Trust's assets, valued annually, must be paid annually to the recipient. For purposes of the requirements of section 664(d)(2), the term "assets" has a broad meaning. In the present case, the Trust's assets consist of the small amount of cash initially contributed to the Trust and the contract rights acquired by the Trustee from Taxpayer.

Thus, we conclude that the Trustee's right to acquire a fee interest in real property for an amount below the fair market value of the property is an asset of the Trust for purposes of the requirements of section 664(d)(2) of the Code. In addition, we conclude that the Trustee's contract right to acquire a fee interest in real property with substantial value ($ y) for a significantly lower amount ($ x) has substantial fair market value for purposes of section 664(d)(2). This substantial fair market value must be included each year in determining the net fair market value of the Trust's assets and the resulting unitrust amount payable to Taxpayer.

Section 170(a)(1) of the Code allows a deduction for a charitable contribution to or for the use of organizations described in section 170(c), payment of which is made within the taxable year.

Section 1.170-2(a)(1) of the regulations provides that a deduction is allowable to an individual under section 170 of the Code only for charitable contributions actually paid during the taxable year, regardless of when pledged and regardless of the method of accounting employed by the taxpayer in keeping his books and records.

Rev. Rul. 82-197, 1982-2 C.B. 72, considers a situation in which an individual granted a charitable organization an assignable written option to purchase real property owned by the taxpayer. The price of the option was less than the fair market value at the time the option was granted. Under the law of the state in question, an option does not, before exercise, vest in the optionee any interest, estate, or title in the land. Rev. Rul. 82-197 states that:

"Under section 170 of the Code and the Income Tax Regulations thereunder, a charitable contribution may be in the form of money or other property. The transfer to a charitable organization of an option by the option writer is similar to the transfer of a note or pledge by the maker. In the note situation there is a promise to pay money at a future date in the pledge situation there is a promise to pay money or transfer other property, or do both, at a future date; and in the option situation there is a promise to sell property at a future date. Although the promise may be enforceable, a promise to pay money or to sell property in the future is not itself a "payment" for purposes of deducting a contribution under section 170 of the Code. Thus, the grant of the option to [the charitable organization] in this case is not a contribution for which a deduction is allowable under section 170."

Rev. Rul. 82-197 holds that the taxpayer is not entitled to a charitable contribution deduction in the year the option is granted but is allowed a charitable contribution deduction in the year in which the charitable organization exercised the option. The amount of the contribution is the excess of the fair market value of the property on the date the option is exercised over the exercise price.

Section 170(f)(2)(A) of the Code provides that in the case of property transferred in trust, no deduction shall be allowed for the value of a contribution of a remainder interest unless the trust is a charitable remainder annuity trust or a charitable remainder unitrust (described in section 664), or a pooled income fund (described in section 642(c)(5)).

Assuming the proposed agreement to be entered into by Taxpayer and Trustee concerning the transfer of a right to acquire a fee interest in real property for $ x is an option, this case is similar to the facts in Rev. Rul. 82-197 except that the purported option is granted to a trust purporting to be a charitable remainder trust rather than to the charity itself. Under the law of State, as under the state law described in Rev. Rul. 82-197, an option does not convey an interest in the land.

Thus, we conclude that Taxpayer is not entitled to a deduction for the remainder interest either when the purported option is granted or when the charitable remainder trust sells the purported option. We conclude that Taxpayer would be entitled to a deduction for the remainder interest only if and when he sells the property to the Trust or to another charitable organization exercising the purported option. This conclusion, however, is limited by the requirement that the Trust qualify as a charitable remainder trust when it exercises the purported option or sells it to another charitable organization, as well as when the Trust is created. If the Trust does not qualify at both times, section 170(f)(2)(A) would prevent Taxpayer from deducting the remainder interest as a charitable contribution under section 170(a).

The value of any charitable deduction allowed will be measured by the remainder interest of the difference between the fair market value of the property and the amount received by Taxpayer, including the amount of the purported option. The fair market value will be determined as of the date Taxpayer sells the property to the Trust or to another charitable organization that holds the purported option.

If a taxpayer makes a "bargain sale" to or for the use of a charitable organization, the taxpayer must recognize gain or loss on the sale of that portion of the property not being donated. In this case, if Taxpayer is entitled to a deduction under section 170(a) of the Code, Taxpayer must recognize gain based on receipt of the purported option price under the formula in section 1.1011-2 of the regulations. The gain would be recognized in the year Taxpayer is entitled to a deduction under section 170(a).

Finally, the incidence of taxation depends on the substance of a transaction and not mere form. Commissioner v. Court Holding Co., 324 U.S. 331, 334 (1945). In the present case, the Trust will obtain rights under the agreement that will enable it to acquire property from Taxpayer for an amount significantly below the property's fair market value. In the hands of the Trust, these rights have substantial value. Although the agreement contemplates that the Trust may assign these rights, Taxpayer cannot compel the Trust to assign the rights and cannot choose the party to whom the rights will be assigned. Taxpayer will not participate in any negotiations relating to the assignment. Upon assignment by the Trust, the rights may be assigned further by the assignee.

Accordingly, we conclude that Taxpayer will not recognize gain or loss solely by reason of the assignment by the Trust of the Trust's rights under the agreement.

No opinion is expressed as to the federal tax consequences of the formation or operation of the Trust under the provisions of any other section of the Code. Specifically, no opinion is expressed as to whether the Trust qualifies as a charitable remainder unitrust as defined in section 664(d)(2) of the Code and no opinion is expressed as to whether the Trust's rights to acquire a fee interest in real property qualifies as an option.

A copy of this letter should be attached to the federal tax return for the taxable year in which the Trust is established. A copy is enclosed for that purpose.

This ruling letter is directed only to the taxpayer who requested it. Section 6110(j)(3) of the Code provides that the letter may not be used or cited as precedent.

Sincerely yours,

Frances D. Schafer
Senior Technician Reviewer
Branch 3
Office of the Assistant
Chief Counsel
(Passthroughs and Special Industries)




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