Land donations may not result in desired tax benefit

Editor: Howard Wagner, CPA

Is there a hidden agenda with contributing parcels of land to the government, or is it always out of the kindness of someone’s heart? To facilitate a large development, developers often donate land to a state or municipality. A charitable contribution deduction is available if there is no quid pro quo. If the donor’s benefit from a contribution is only incidental to the benefit the general public receives, a deduction may be allowed.

Thus, for example, the IRS has allowed a deduction for the cost of a highway interchange a taxpayer constructed and contributed to a public highway system, even though the interchange would provide easier access to property the donor developed. The IRS found that the value of the donor’s remaining property would not be increased substantially in relation to the value of the gift, and that any benefit the donor realized would be small in comparison to the benefit that would accrue to the public from making traffic conditions less dangerous (see IRS Letter Ruling 8421018). If the developer benefits in some way, such as by obtaining a change in zoning or receiving project approval or through an increase in the property’s value, no charitable deduction is available.

Triumph case

A recent Tax Court case, Triumph Mixed Use Investments III, LLC, T.C. Memo. 2018-65, determined that a real estate development company was not entitled to claim a charitable contribution deduction for its transfer of certain open land to a city. The court found that the transfer was in exchange for the city’s approval of the company’s development plan, and that the city’s approval constituted a substantial benefit that the taxpayer neither reported nor valued when it claimed the charitable contribution deduction.

Triumph Mixed Use Investments III LLC (Triumph) was one of a group of entities (the Traverse entities) that were developing a master planned community on real property they owned (the Traverse property) in Lehi, Utah. In an agreement with the city of Lehi in 2000, the Traverse entities received approval for a development plan that allowed the entities to place a specified number of units on the Traverse property. Later, the Traverse entities received additional development credits (rights to develop units) from the local authorities, which doubled the number of units that they could develop. However, to develop these additional units, these entities were required to follow the city of Lehi’s development procedures and receive specific development approvals from the city council. To comply with these development procedures, the entities were required to create another development plan, which was approved by the city council.

However, the city council’s approval for the plan was contingent on the transfer by the Traverse entities of certain real property to the city and reducing the density of units in the development. In December 2011, Triumph agreed to transfer approximately 747 acres and almost 2,000 development credits to the city of Lehi. The agreement for the transfer of the property and the credits stated that the donation was voluntary and that none of the related Triumph entities were receiving any compensation, development benefits, or approvals from the city as consideration. On its return for 2011, Triumph claimed an $11,040,000 charitable contribution deduction on its tax return for the transfer, based on a valuation report that used the “before and after” approach.

The law

Sec. 170(a)(1) provides that a taxpayer may deduct any charitable contribution made during the tax year. If a taxpayer makes a charitable contribution of property other than money, the amount of the contribution is the fair market value (FMV) of the property at the time of the contribution. A contribution of property generally will not “constitute a charitable contribution if the contributor expects a substantial benefit in return.” However, a taxpayer may still deduct a contribution of property if (1) the value of the property transferred to charity exceeds the FMV of any goods or services received in the exchange and (2) the excess payment is made “with the intention of making a gift.”

The parties’ positions

The IRS challenged Triumph’s deduction on several grounds, asserting:

1.The transfer was not a charitable contribution in that it was part of a quid pro quo arrangement in which the Traverse entities received development approvals;

2.The transfer was not valid because Triumph did not own the property or development credits;

3.The contemporaneous written acknowledgment was not valid because it did not value the consideration received;

4.The appraisal was not a qualified appraisal; and

5.The value of the charitable contribution was overstated.

According to the IRS, the benefits of obtaining development approval had substantial value that was not reported on the tax return; therefore, no charitable contribution deduction should be allowed. Triumph argued that the plan approvals had no value and that the transfer reduced the value of the property, so a charitable deduction was warranted.

Tax Court disallows deduction

The Tax Court determined that the transfer to the city of Lehi was part of a quid pro quo arrangement and that Triumph had not proved the value of the benefit it received; thus, Triumph could not take a charitable deduction for the transfer.

In determining whether a payment is a contribution or gift, the Tax Court found that the relevant inquiry is whether the transaction in which the payment is involved is structured as a quid pro quo exchange. In ascertaining whether a given payment was made with the expectation of any quid pro quo, courts examine the external features of the transaction to determine whether the taxpayer expected a benefit in return for its contribution. The benefit does not have to be financial. The Tax Court noted that in previous cases, it had found that a transfer of real property in exchange for development approvals or the expectation of future development approvals is a benefit and precludes a finding of the requisite donative intent for a charitable gift.

As the Tax court further explained, it has also found that if a taxpayer has received a benefit in exchange for a property transfer, it looks at the value of the property transferred and the value of the benefit received to determine if any portion of the transfer qualifies as a charitable deduction. Under Regs. Sec. 1.170A-1(h), only the excess of the value of the property transferred over the value of the benefit can be deducted as a charitable deduction, and if the value of the benefit exceeds the value of the transferred property, no deduction is allowed. Moreover, if a taxpayer fails to specify the value of any benefit received, then the taxpayer fails to comply with the substantiation requirements of the Sec. 170 regulations, and no charitable deduction is allowed.

The Tax Court held that the Traverse entities’ dealings with the city of Lehi demonstrated that Triumph received a development plan approval and the expectation of a future development plan approval in exchange for transferring the real property and development credits. Because these approvals allowed the Traverse entities to proceed with their plans to continue with their development of the Traverse properties, they had received a substantial benefit that was not incidental their transfer of real property to the city of Lehi. Because Triumph had received a benefit, and it had not reported or established at trial the value of the benefit it received, the Tax Court found that Triumph was not entitled to a charitable deduction for the transfer.

Proving incidental effect

Land developers often donate land back to a city or state, so it is important to be prepared to make sure taxpayers get the full benefit for the donation. The lesson from this case is that land owners must be able to prove that the increase in value to their land was only incidental as a result of their charitable contribution. If the donor received more than an incidental value from the donation, then that value needs to be properly established and reported on the tax return. This case also shows the importance of having no quid pro quo intent for making the donation and obtaining a valid and timely appraisal from a qualified appraiser. Failure to comply with these rules could result in not only a lost deduction, but also accuracy-related penalties under Sec. 6662.

EditorNotes

Howard Wagner is a partner with Crowe LLP in Louisville, Ky.

For additional information about these items, contact Mr. Wagner at 502-420-4567 or howard.wagner@crowe.com.

Unless otherwise noted, contributors are members of or associated with Crowe LLP.