Friday April 26, 2024

5.5.4 Risk Disclosure

Risk Disclosure

Real Estate Transfers:  The four potential real estate sale strategies involve the no-negotiation gift, the buyer waiting in the wings gift, the contingent sale agreement and the contingent escrow agreement.

C Corporation Sale Risk:  There are four areas of potential concern with respect to sale of a corporation.
Counsel is responsible for attempting to quantify and disclose the risk presented by a potential prearranged sale.

With a prearranged sale, the "no binding agreement" standard of Rev. Rul. 78-197 is a fine bright line. However, there may be some discussion of the state law of contracts as to whether or not a binding agreement has been created. Counsel should be able to give some general guidance in this area.

There are always issues concerning the actual binding nature of contracts. Many real estate transactions fail to close due to a multitude of factors - clouds on title, financing, zoning and environmental issues. Sales of business interests are similarly subject to a plethora of variables, and a sale may be close when the transaction is cancelled by one party. Therefore, the determination of a "binding contract" does involve a risk estimate by donors' counsel.

Real Estate Transfers
The four potential real estate sale strategies involve the no-negotiation gift, the buyer waiting in the wings gift, the contingent sale agreement and the contingent escrow agreement. While each specific sale must be analyzed on its own unique merits, it is helpful to estimate risk for each strategy.

With the no-negotiation circumstance, the prearranged sale risk is near zero. The charity can list the property for sale, negotiate with many buyers and document the independent status of the sale.

With a buyer waiting in the wings, the risk can be extremely low if there is more than one potential buyer. If there are two or more buyers waiting in the wings and the property is advertised for public sale, once again the risk is near zero.

With a contingent sale agreement, the risk also may be low. If the charity has been in negotiations with the potential buyer, there is no specific basis for the IRS to claim a binding agreement between the donor and the potential buyer. In addition, the donor may change his or her mind and not complete the gift. In this case, there would be no sale.

With the contingent escrow agreement, the risk may be reasonably low. The charity and the potential buyer have entered into negotiations. They have signed a contingent sale agreement and opened the escrow process. The normal procedures for reviewing property title, obtaining financing or securing funds for payment for the property and preparations for final closing are completed. Prior to closing, the donor must decide whether or not to complete the gift. Once again, there is no obligation for the donor to complete the agreement and the donor has no binding agreement with buyer.

C Corporation Sale Risk
There are four areas of potential concern with respect to sale of a corporation. Counsel should attempt to quantify the risk based upon these general principles and the specific characteristics of a particular C corporation sale.

In the negotiation phase, there is virtually no risk with the bypass of gain on a charitable gift. C corporation sales regularly fail to close after initial negotiations. Counsel should document that there have been efforts to offer the company in public venues appropriate for the type of business. With this level of documentation, the prearranged sale risk is near zero.

Similarly, a letter of intent is not legally binding. As the Rauenhorst court noted, the letter of intent "does not demonstrate that the warrant holders were legally bound, or could be compelled, to sell their stock warrants at the time of the assignments." Therefore, with the typical nonbinding letter of intent, the charitable gift may be completed and the prearranged sale risk again is very low.

If the stock is widely held and the board of directors holds a small percentage of the stock, then a vote by the board of directors will permit a gift of stock to charity. In the Rauenhorst case, there was a letter of intent on September 28, a resolution by the board on October 22, the charitable gifts on November 9, the recording of the gifts on November 12, the warrant purchase and sale on November 19, a final agreement for sale on November 22, and actual closing on December 22. Even though the vote by the board of directors preceded the charitable gifts, the IRS did not contend that this created a binding obligation.

Therefore, in most cases, the risk of a prearranged sale with a charitable gift of appreciated property will be fairly low after the board of directors vote. As noted above, this risk increases substantially if the board of directors owns over 50% of the stock in the corporation. The IRS may take the position that a vote by the board of directors who own over 50% of the stock is equivalent to the vote by the shareholders, since it is very likely that the sale will be completed after approval by the directors who own over 50% of the stock.

Finally, if over 50% of the shareholders vote in favor of the transaction, then a Rev. Rul. 78-197 binding agreement clearly exists. A transfer of appreciated stock to charity, as was the case in Ferguson, will be treated as a redemption of stock and gift of cash proceeds to the charity.

Case Studies on Risk Disclosure

Give Peace a Chance:   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.

Sam Storeowner and the Tax-Free Buyout:   Sam Storeowner was having coffee at Small Town Café when his friend Bob Banker walked into the café. Bob motioned Sam to a booth in the back and said that he wanted to talk to Sam. It turns out that Bob and several friends were in the process of obtaining a charter for a new bank. They were contacting a number of business owners in town and offering them the opportunity to invest.

Pecos Bill and the Silver Saddle:   Pecos Bill hailed from West Texas and loved the open range. Bill learned to ride horses almost as soon as he could walk. While still in his teens, Bill started to build saddles. By age 25, Bill was one of the premier builders of silver and leather saddles.

Private Letter Rulings

PLR 200321010 Transfer of Restricted Stock to CRUT Neither Taxable to Donor nor Prearranged Sale:   Edward Executive is a retired officer of Big Corp. However, Edward continues to serve on Big Corp's Board of Directors and continues to hold a substantial amount of Big Corp's stock. In fact, in connection with Big Corp's executive stock purchase plan, Edward entered into 14 stock purchase plans during his time at Big Corp.

Related Topics on Risk Disclosure

2.3.1  Gift of Appreciated Property:    For donors who own appreciated real property, a gift can maximize tax savings. The selected parcel of land may be transferred by deed to a charity. Normally, the charity then sells the real property. The donor bypasses gain on the gift and uses the charitable income tax savings to offset other taxable income.

4.2.3  Stock Sale with Unitrust:    A C corporation may be subject to a double tax. There is potential tax at corporate tax rates on the gain inside the corporation and at the shareholder capital gain rate on the sale of stock by the shareholder.

4.7.1  Value of Real Estate Gifts:    Under state law, a gift of real estate is generally accomplished by transferring a properly executed and notarized deed to charity. While it is important that charity record the deed as soon as possible, the gift date is usually the date the deed is delivered to charity. If the delivery and recording of the deed can occur in the same tax year, there should be little dispute regarding the timing of the charitable deduction.

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