• Restrictions in contract of sale render gift incomplete; income tax charitable deduction denied—In George Fakiris v. Commissioner (T.C. Memo. 2017-126, (June 28, 2017), George Fakiris, a real estate developer who owned a 60 percent interest in a real estate development company (the Company), deducted on his personal income tax returns for several years the value of a property that the Company had donated to a charity. The Internal Revenue Service issued a notice of deficiency denying the initial deduction and carryforwards.
The Company purchased an old theater in Staten Island, N.Y., in 2001, planning to build a highrise development on the property. The community surrounding the historical theater opposed the plan, and ultimately a local community dance ensemble expressed interest in the property. The Company decided to make a charitable donation of the theater. However, the dance ensemble hadn’t obtained its tax-exempt status yet. So, the Company made a bargain sale to a different charitable organization (the Charity), which already had tax-exempt status. As part of the deal, the Charity agreed to transfer the theater to the dance ensemble once it received tax-exempt status from the IRS.
In the summer of 2004, the Company and the Charity signed a contract of sale. Two provisions of the contract were particularly important to the IRS. First, the Charity was prohibited from transferring the theater property for five years after the conveyance, other than to the dance ensemble. Second, the Company was permitted to transfer the premises to the dance ensemble once the dance ensemble received its tax-exempt status. This second provision was inconsistent with the rest of the contract because the Company no longer had title to the premises after conveyance, but the court interpreted it to mean that the Company retained the right to direct the Charity to transfer the property to the dance ensemble.
On the same date that the contract was signed, the theater property was conveyed by deed to the Charity. In addition, the individual who established the dance ensemble and orchestrated the transfer paid the Company $470,000 for the property. The Charity didn’t pay anything to the Company for the theater. An appraisal of the theater property completed at the time of transfer estimated its value to be about $5 million.
The Company’s income tax return for 2004 shows a sale for $470,000 and a related capital gain. George, however, claimed a noncash charitable contribution of $3 million, which was 60 percent of the $5 million appraised value of the theater (as he owned 60 percent of the Company). The appraised value wasn’t reduced by the consideration paid of $470,000. In 2004 and for the next four years, George claimed charitable deductions related to the contribution and its carryforwards.
The IRS disallowed the income tax deductions for three years and issued a notice of deficiency. The Tax Court interpreted the contract of sale and held that under New York law, the Company had retained the right to direct the Charity to transfer the theater to the dance ensemble. The court held that the Company, therefore, retained “dominion and control” over the property, causing the transfer to be an incomplete gift. A critical part of the opinion analyzed New York state law and concluded that the problematic provisions of the contract of sale didn’t merge with the deed because the contract specifically stated that those provisions survived the transfer of title. As a result, the restrictions were still operative and prevented completion of the gift.
Because the gift was incomplete, the value of the contributed property was zero. Due to the disparity between the value of the property claimed on the return and as determined by the court, the court then applied accuracy-related penalties, noting that accuracy-related penalties don’t distinguish between a valuation misstatement due to legal error versus a valuation error.
• IRS simplifies extension procedures for portability extensions—The IRS issued Revenue Procedure 2017-34, which provides a simpler method for extending the time to file for portability elections.
In 2010, the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act amended Section 2010 of the Internal Revenue Code to allow a portability election for the estates of persons who died leaving a surviving spouse. The election permits the decedent’s unused exclusion amount, defined in the IRC as the deceased spousal unused exclusion amount (DSUE), to be used by his spouse, subject to certain rules. To take advantage of portability, the executor of the first spouse to die must make an election on a timely filed estate-tax return.
In 2012, the IRS finalized regulations regarding portability, providing that estates under the federal filing threshold could obtain an extension of time to file the portability election. An estate could initially file for the extension by requesting a private letter ruling under Treasury Regulations Section 301.9100-3 and showing that: (1) the estate acted reasonably and in good faith, and (2) the extension would not prejudice the interests of the government.
In 2014, the IRS published Rev. Proc. 2014-18, which provided a method for obtaining an extension to make a portability election, but it was only available until Dec. 31, 2014.
Since the end of December 2014, due to the numerous PLRs issued under Treas. Regs. Section 301.9100-3 granting extensions, the IRS determined that it needed to implement a simplified extension process again. Rev. Proc. 2017-34 provides that process for the 2-year period after the decedent’s death, or prior to Jan. 2, 2018 (for those decedents who died more than 2 years ago).
Under the revenue procedure, estates may make the portability election by filing Form 706 within the necessary time frame (that is, before the later of two years after the decedent’s date of death or Jan. 2, 2018) by making a special note that it’s filed pursuant to Rev. Proc. 2017-34 on the top of the form. To be eligible, the decedent must have died after Dec. 31, 2010, be survived by a spouse and be a citizen or resident of the United States. The estate must be under the filing threshold and not have filed any prior estate tax return.
Form 706 will be considered complete if it’s prepared according to the portability regulations under IRC Section 2010 (these regulations allow exceptions for valuing certain property eligible for the marital and/or charitable deduction). If the filing is made properly, the DSUE will be available for the surviving spouse’s transfers during lifetime or at death. However, the surviving spouse may not use the DSUE obtained through the extension process to claim a credit or refund of gift or estate tax if the statute of limitations for the claim has expired. (However, the spouse could make a protective credit or refund claim within the statute of limitations period, pending the filing of the portability return.)
If a PLR is pending on June 9, 2017, the IRS will close its file and refund the fee paid. The estate should follow Rev. Proc. 2017-34 to obtain an extension.
• Treasury identifies tax regulations subject to reform—On April 21, 2017, President Trump issued Executive Order 13789, which directed the Secretary of the Treasury to review “significant tax regulations” that were issued after Jan. 1, 2016 and report back identifying those that impose an undue financial burden on U.S. taxpayers, add undue complexity to federal tax laws or exceed the statutory authority of the IRS. The Executive Order then required the Treasury to issue a second report by Sept. 18, 2017 recommending specific actions to mitigate the burdens imposed by the regulations identified.
Of the 105 temporary, proposed and final regulations issued after Jan. 1, 2016, the Treasury determined that 52 were “significant” and thus merited review. After examining those regulations, the Treasury issued Notice 2017-38, which identifies eight regulations that meet the first two criteria (either imposing an undue burden on U.S. taxpayers or adding undue complexity to federal tax laws).
The regulations subject to reform include the proposed regulations under IRC Section 2704 on restrictions on liquidation of an interest for estate, gift and generation-skipping transfer taxes.
The Treasury is requesting comments on whether the identified regulations should be rescinded or modified and how so. We already expected the proposed 2704 regulations to be revised by the IRS, but this may impact the revisions they’re contemplating.