Ordinarily, the trust is not taxed on its income.¹ Under prior law, the trust lost its tax-exempt status for any year in which it had unrelated business taxable income (UBTI). The old rule caused the loss of the CRT’s exemption for even one dollar of UBTI. TRHCA 2006 modified the excise tax on unrelated business taxable income of charitable remainder trusts and changed the loss-of-exemption rule. The current law imposes a 100 percent excise tax, but leaves the CRT’s exempt status intact.² The excise tax is allocated to corpus and does not reduce the taxable income of the trust.³ See Q 8086 regarding how distributions from a charitable remainder trust are taxed to a beneficiary.

An unrelated trade or business means any trade or business that is not substantially related to the charitable purpose of the trust.¹ In general, UBTI means the gross income derived by the trust from an unrelated trade or business regularly carried on by the trust, reduced by certain modified deductions directly connected to the unrelated trade or business.² For example, there is a specific deduction for up to $1,000 of UBTI.³ Certain unrelated debt-financed income is also treated as UBTI.⁴

Unrelated business taxable income includes income from debt-financed property.⁵ Securities purchased on margin have been held to be debt-financed property.⁶ An exempt trust that is a limited partner may receive unrelated business income to the same extent as if it were a general partner.⁷ A charitable remainder trust that received unrelated business taxable income from its investments in three limited partnerships was held to be taxable as a complex trust under IRC Section 664(c) to the full extent of its income.⁸

Yes, if certain requirements are met. A charitable lead trust is essentially the reverse of a charitable remainder trust; the donor grants a right to payment to the charity, with the remainder reverting to the donor (or his named beneficiaries). Such trusts are commonly called charitable “lead” trusts because the first or leading interest is in the charitable donee. Even though a gift of such an interest in property is less than the entire interest of the donor, its value will be deductible if the interest is in the form of a “guaranteed annuity interest” or a “unitrust interest.”¹

A guaranteed annuity interest is an irrevocable right to receive payment of a determinable amount at least annually. A unitrust interest is an irrevocable right to receive payment at least annually of a fixed percentage of the fair market value of the trust assets, determined annually. In either case, payments may be made to the charity for a term of years or over the life of an individual (or lives of more than one individual) living at the date of the transfer to the trust.

Only one (or more) of the following individuals may be used as measuring lives: (1) the donor; (2) the donor’s spouse; (3) a lineal ancestor of all the remainder beneficiaries; or (4) the spouse of a lineal ancestor of all the remainder beneficiaries. A trust will satisfy the requirement that all noncharitable remainder beneficiaries be lineal descendants of the individual who is the measuring life (or that individual’s spouse) if there is less than a 15 percent probability that individuals who are not lineal descendants will receive any trust corpus. This probability must be computed at the time property is transferred to the trust taking into account the interests of all primary and contingent remainder beneficiaries who are living at that time. The computation must be based on the current applicable Life Table in Treasury Regulation Section 20.2031-7.²

A guaranteed annuity may be made to continue for the shorter of a term of years or lives in being plus a term of years.³ The IRS determined that an annuity met the requirements for a “guaranteed annuity” even though neither the term nor the amount was specifically stated; the term was ascertainable as of the death of the grantor, based on a formula described in the trust instrument.⁴ The annuity cannot be for the lesser of a designated amount or a fixed percentage of the fair market value of trust assets, determined annually.⁵ After termination of the charity’s right to payment, the remainder interest in the property is returned to the donor or his designated beneficiaries.

Example: Walter gives $1,000,000 to a charitable lead trust. The trust’s term is twenty-one years paying 5 percent each year to his favorite charity. At the end of the twenty-one year period, the assets in the trust will be distributed to Walter’s three children. The gift tax charitable deduction is $741,870 assuming annual trust payments and a 3.4 percent 7520 rate. Over the course of twenty-one years, the charity will receive $1,050,000. The children will receive the trust assets free of any further estate or gift taxes.

According to regulations, an income tax charitable deduction is allowable for a charitable annuity or unitrust interest that is preceded by a noncharitable annuity or unitrust interest. In other words, the regulations eliminate the requirement that the charitable interest start no later than the commencement of a noncharitable interest in the form of a guaranteed annuity or unitrust interest. However, the regulations continue to require that any amounts payable for a private purpose before the expiration of the charitable annuity or unitrust interest must be in the form of a guaranteed annuity or unitrust interest, or must be payable from a separate group of assets devoted exclusively to private purposes. The regulations conform the income tax regulations to the Tax Court’s decision in Estate of Boeshore.⁶

The IRS determined that the requirements for a charitable lead annuity trust were met even though the trust authorized the trustee, who was the grantor’s son, to choose among various charities to receive the annuity interest and apportion the payouts among them.⁷ The IRS has also found that the requirements for a CLAT were met when the taxpayer first established a revocable trust that would make payments to cover certain debts and expenses after his death, and then make payments to individual and trust beneficiaries, before eventually funding the CLAT.  The IRS found that it would eventually be possible to calculate the payout term based upon the fair market value of the CLAT assets after the original revocable trust made the other payments.⁸

The Service ruled that so long as a donor was treated as the owner of a guaranteed annuity interest for purposes of the grantor trust rules, the income interest transferred in trust to a private foundation qualified as a “guaranteed annuity interest” under IRC Section 170(f)(2)(B). Even though the present value on the date of the transfer exceeded 60 percent of the aggregate fair market value of all the amounts in trust, the Service reasoned that this did not prevent the income interest from being a “guaranteed annuity interest” because the trust agreement provided that the acquisition and retention of assets that would give rise to an excise tax if the trustee had acquired the assets was prohibited, in accordance with Treasury Regulation Section 1.170A-6(c)(2)(i)(D).⁹

The partition of a charitable lead annuity trust into three separate trusts to address differences of opinion among trustees as to the choice of charitable beneficiaries and the investment of trust assets did not cause the original trust, the new trusts, or any of the trusts’ beneficiaries to realize income or gain.¹⁰

The Service has privately ruled that the sale of assets, which were pledged as collateral for a promissory note to the family’s charitable lead annuity trust, to a limited liability company would not constitute self-dealing so long as the value of the collateral remained as required under the terms of the note, and would not give rise to tax liability under IRC Section 4941 to the CLATs, related family members, the estate, or the marital trusts.¹¹

Sample Trusts. The IRS has released sample forms, annotations, and alternate provisions for inter vivos and testamentary charitable lead annuity trusts and unitrusts.¹²

An immediate deduction of the present value of all the annual payments to be made over the period may be taken if the trust is structured so that the donor is taxable on the income of the trust each year (under the “grantor trust rules”). If the trust is structured so that he is not taxable on trust income, he will not get an income tax deduction for the gift.¹ The IRS has determined that a donor was to be treated as the owner of a charitable lead trust where the donor retained the power to substitute trust property. The donor was entitled to a current deduction in an amount equal to the present value of the unitrust interest.²

In general, the amount of the charitable contribution deduction allowable for the transfer of property to a charitable lead annuity trust is equal to the present value of the annuity payable to the charity (see Appendix A).

Example 1. In September, Mr. Smith (age eighty-five) transferred property worth $100,000 to a charitable lead annuity trust that is a grantor trust. The trust is to make biannual payments (at the end of each six-month period) of $2,500 to the charity during his lifetime. Assume the IRC Section 7520 interest rates for September and the two preceding months, July and August, were 3.4 percent, 3.2 percent, and 3.0 percent. Mr. Smith elected to use the 3.0 percent rate because the lowest 7520 in the three-month period produces the highest charitable deduction for charitable lead trusts.

The value of the annuity payable to charity is calculated as follows:

(1) Find the single life annuity factor for a person age eighty-five at a 3.0 percent interest rate – 5.3605 (from Single Life Annuity Factors Table in Appendix A).

(2) Find the adjustment factor at a 3.0 percent interest rate for semi-annual annuity payments at the end of each period – 1.0074 (from Annuity Adjustment Factors Table A in Appendix A).

(3) Multiply the aggregate payments received during a year by the factors in (1) and (2) – $5,000 × 5.3605 × 1.0074 = $27,001.

The amount of the charitable contribution deduction is equal to $27,001.

Example 2. If in Example 1, payments were to be made to charity at the beginning of each six-month period (instead of at the end of each period), one payment is added to the value of the annuity payable at the end of each period. The value of the annuity payable at the beginning of each period would be $29,501 ($27,001 + $2,500). The amount of the charitable contribution deduction would be equal to $29,501.

Example 3. If payments in Example 1 were to be made for twenty years rather than for Mr. Smith’s life, the value of the annuity payable to charity (at the end of each 6-month period) is calculated as follows:

(1) Find the term certain annuity factor for twenty years at a 3.0 percent interest rate – 14.8775 (from Term Certain Annuity Factors Table in Appendix A).

(2) Find the adjustment factor at a 3.0 percent interest rate for semi-annual annuity payments at the end of each period – 1.0074 (from Annuity Adjustment Factors Table A in Appendix A).

(3) Multiply the aggregate payments received during a year by the factors in (1) and (2) – $5,000 × 14.8775 × 1.0074 = $74,938.

The amount of the charitable contribution deduction is equal to $74,938.

Example 4. If payments in Example 2 were to be made for twenty years rather than for Mr. Smith’s life, the value of the annuity payable to charity (at the beginning of each period) is calculated as follows:

(1) Find the term certain annuity factor for twenty years at a 3.0 percent interest rate – 14.8775 (from Term Certain Annuity Factors Table in Appendix A).

(2) Find the adjustment factor at a 3.0 percent interest rate for a term certain annuity payable at the beginning of each semi-annual period – 1.0224 (from Annuity Adjustment Factors Table B in Appendix A).

(3) Multiply the aggregate payments received during a year by the factors in (1) and (2) – $5,000 × 14.8775 × 1.0224 = $76,054.

The amount of the charitable contribution deduction is equal to $76,054.

An immediate deduction of the present value of all the annual payments to be made over the period may be taken if the trust is structured so that the donor is taxable on the income of the trust each year (under the “grantor trust rules”). If the trust is structured so that he is not taxable on trust income, he will not get an income tax deduction for the gift.¹ The IRS has determined that a donor was to be treated as the owner of a charitable lead trust where the donor retained the power to substitute trust property. The donor was entitled to a current deduction in an amount equal to the present value of the unitrust interest.²

In general, the amount of the charitable contribution deduction allowable for the transfer of property to a charitable lead unitrust is equal to the present value of the unitrust interest. If the unitrust payments are made annually at the beginning of each year and the annual payout rate is equal to an adjusted payout rate for which factors are given, the present value of the unitrust interest can be calculated simply by multiplying the value of the property transferred to the charitable lead unitrust by the appropriate unitrust factor (see Appendix A). If the unitrust payments are made other than annually at the beginning of each year or the annual payout rate falls between adjusted payout rates for which factors are given, the calculation of the deduction for a contribution to a charitable lead unitrust is more complex.

Example 5. In September, Mr. Smith (age eighty-five) transferred property worth $100,000 to a charitable lead unitrust that is a grantor trust. The trust is to make annual payments (at the beginning of each year) of 5 percent of the value of the trust corpus (valued annually) to charity during his lifetime (i.e., a 5 percent annual payout rate).

The value of the unitrust payable to charity is calculated as follows:

(1) Find the single life unitrust remainder factor for a person age eighty-five at a 5.0 percent adjusted payout rate: .74516 (from Single Life Unitrust Remainder Factors Table in Appendix A).

(2) Calculate the single life unitrust factor for a person age eighty-five at a 5.0 percent adjusted payout rate by subtracting the factor in (1) from one – 1 – .74516 = .25484.

(3) Multiply the value of the property transferred to the charitable lead unitrust ($100,000) by the single life unitrust factor for a person age eighty-five at a 5 percent payout rate (.25484) – $100,000 × .25484 = $25,484.

The amount of the charitable contribution deduction is $25,484.

Example 6. If the unitrust payments in Example 5 were to be made for twenty years (at the beginning of each year) rather than for Mr. Smith’s life, the present value of the unitrust remainder interest is calculated as follows:

(1) Find the term certain unitrust remainder factor for twenty years at a 5.0 percent adjusted payout rate: .358486 (from Term Certain Unitrust Remainder Factors Table in Appendix A).

(2) Calculate the term certain unitrust factor for twenty years at a 5.0 percent adjusted payout rate by subtracting the factor in (1) from one – 1 – .358486 = .641514.

(3) Multiply the value of the property transferred to the charitable lead unitrust ($100,000) by the term certain unitrust factor for twenty years at a 5 percent payout rate (.641514) – $100,000 × .641514 = $64,151.

The amount of the charitable contribution deduction is $64,151.

Example 7. Assume the same facts as in Example 5, except that payments are to be made at the end of each year. Assume the valuation table interest rates for September and the two preceding months, July and August, were 3.4 percent, 3.2 percent, and 3.0 percent. Mr. Smith elected to use the 3.0 percent rate.

The value of the unitrust payable to charity is calculated as follows:

(1) Find the unitrust payout adjustment factor for annual payments to start 12 months after the valuation date at a 3.0 percent interest rate: .970874 (from Unitrust Payout Adjustment Factors Table in Appendix A).

(2) Multiply the factor in (1) by the annual payout rate to obtain the adjusted payout rate: .970874 × 5 percent = 4.854 percent.

(3) Find the single life unitrust remainder factor for a person age eighty-five at a 4.8 percent adjusted payout rate: .75352 (from Single Life Unitrust Remainder Factors Table in Appendix A).

(4) Find the single life unitrust remainder factor for a person age eighty-five at a 5.0 percent adjusted payout rate: .74516 (from Single Life Unitrust Remainder Factors Table in Appendix A).

(5) Subtract the factor in (4) from the factor in (3): .75352 – .74516 = .00836.

(6)

(7) Subtract X in (6) from the factor at 4.8 percent from (3): .75352 – .00226 = .75126.

(8) Subtract the interpolated unitrust remainder factor in (7) from one – 1 – .75126 = .24874.

(9) Multiply the value of the property transferred to the charitable lead unitrust ($100,000) by the interpolated unitrust factor in (8) (.24874). The amount of the charitable contribution deduction is $24,874. [The same procedure applies to calculating a unitrust interest for a term certain. However, Term Certain Unitrust Remainder Factors are used instead of Single Life Unitrust Remainder Factors.]

If the donor of a right to payment ceases to be taxable on the trust income before the termination of the interest, he must “recapture,” that is, include in his income, an amount equal to the deduction less the discounted value of all amounts required to be, and which actually were, paid before the time he ceased to be taxable on trust income.³

A conservation easement is a restriction on the owner’s use of the property. A popular form is the open space or scenic easement, wherein the owner of land agrees to set the land aside to preserve natural, scenic, historic, scientific and recreational areas, for public enjoyment.¹

The Tax Court held that taxpayers’ contributions of conservation easements (encumbered shoreline) were qualified conservation contributions because: (1) they protected a relatively natural habitat of wildlife and plants (in accordance with Treasury Regulation Section 1.170A-14(d)(3)); and (2) were exclusively for conservation purposes.²

The Tax Court held that a taxpayer did not make a contribution of a qualified conservation easement because the attempted grant did not satisfy the conservation purposes required under IRC Section 170(h)(4)(A. Specifically, the deed did not preserve open space, an historically important land area, or a certified historical structure.³

The IRS approved a contribution of a conservation easement in which the taxpayer retained limited water rights; the conditions of the use of those rights were sufficiently restricted that the Service determined their exercise would not adversely affect the purposes for which the easement was established.⁴ The IRS also determined that the proposed inconsistent use of some of a farm (i.e., construction of eight single-family homes) to be burdened by a conservation easement was not significant enough to cancel the conservation purpose of the easement because the conservation easement would still maintain over 80 percent of the entire tract in its presently undeveloped state, thereby preserving the habitat.⁵

Open space easements have been approved by the Service in several instances.⁶ (Although some of these rulings were made under prior law, they remain valid under the current IRC Section.)

The deductible value of the easement is generally determined using a “before and after” approach. That is, the value of the total property owned by the taxpayer (including adjacent property that is not encumbered by the easement) before granting the easement is determined. Then, the value of the property after granting the easement is subtracted to determine the value of the easement.⁷ For purposes of determining the value of the property before granting of the easement, the Tax Court determined that the highest and best use of the property had to be taken into account.⁸

General guidelines for valuing property can be found in Revenue Procedure 66-49.⁹ If there is a substantial record of sales of easements comparable to the one donated, the fair market value of the donation can be based on the sale prices of the comparable easements. However, where previous sellers of easements to the county had generally intended to make gifts to the county by way of bargain sales, the Tax Court determined that the comparable sales approach was inappropriate in a bargain sale of a conservation easement.¹⁰ Increases in the value of any property owned by the donor or a related person that result from the donation, whether or not the other property is contiguous to the donated property, reduce the amount of the deduction by the amount of the increase in the value of the other property.¹¹

The Service privately ruled that an estate could properly claim an estate tax deduction for the value of a conservation easement attributable to a 68.8 percent tenancy in common interest includible in the decedent’s gross estate notwithstanding the fact that the co-tenants would claim an income tax deduction for the conservation easement granted with respect to the interests in the property they owned.¹²

The Service determined that a taxpayer’s exchange of a conservation easement in real property under IRC Section 1031(a) would qualify as a tax-deferred exchange of like-kind property, provided that the properties would be held for productive use in a trade or business, or for investment.¹³

In a legal memorandum, the Service analyzed the issues regarding the Colorado conservation easement credit, including: (1) to the extent a taxpayer is effectively reimbursed for the transfer of the easement through the use, refund, or transfer of the credit, whether that benefit is a quid pro quo that either reduces or eliminates a charitable contribution deduction under IRC Section 170; and (2) whether the benefit of the state conservation easement credit is, in substance, an amount realized from the transfer of the easement under IRS Section 1001, generally resulting in capital gain.¹⁴

Improper deductions for conservation easements. The Service has determined that some taxpayers have been claiming inappropriate contribution deductions for cash payments or easement transfers to charitable organizations in connection with purchases of real property. In some of these questionable cases, the charity purchases the property and places a conservation easement on the property. Then, the charity sells the property subject to the easement to a buyer for a price that is substantially less than the price paid by the charity for the property. As part of the sale, the buyer makes a second payment – designated as a “charitable contribution” – to the charity. The total of the payments from the buyer to the charity fully reimburses the charity for the cost of the property. The Service warned that in appropriate cases, it will treat these transactions in accordance with their substance rather than their form. Accordingly, the Service may treat the total of the buyer’s payments to the charity as the purchase price paid by the buyer for the property. Taxpayers are advised that the Service intends to disallow all or part of any improper deductions and may impose penalties, and also intends to assess excise taxes (under IRC Section 4958) against any disqualified person who receives an excess benefit from a conservation transaction, and against any organization manager who knowingly participates in the transaction. In appropriate cases, the Service may challenge the tax-exempt status of the organization based on the organization’s operation for a substantial nonexempt purpose or impermissible private benefit.¹⁵ Taxpayers must maintain written records of the property’s fair market value before and after the donation, and the conservation purpose involved.¹⁶

Guidance on qualified conservation contributions made in 2006 and thereafter. A charitable contribution of a qualified conservation easement is available to the extent the contribution does not exceed 50 percent of adjusted gross income (AGI). (The limit was 100 percent of AGI for certain farmers or ranchers.) A qualified conservation easement contribution disallowed because it exceeds the percentage of AGI limitation can be carried over for up to fifteen years.¹⁷ The Service has released question-and-answer guidance relating to the increased percentage limitation and increased carryover period for qualified conservation contributions (see above) made in taxable years beginning after 2005. According to the Service, if a taxpayer has made a qualified conservation contribution, which is subject to the special 50 percent limitation (under IRC Section 170(b)(1)(E)), and one or more contributions subject to the other percentage limitations (i.e., the 50 percent, 30 percent, or 20 percent limitations under IRC Sections 170(b)(1)(a), 170((b)(1)(B), 170(b)(1)(C), and 170(b)(1)(D)), the qualified conservation contribution may be taken into account only after taking into account the contributions subject to the other percentage limitations. The Service also states that the 50 percent limit applies to qualified conservation contributions only, not to all contributions of real property interests. The guidance also includes several questions and answers relating to the rules for qualified farmers and ranchers.¹⁸

The qualified easement contribution must be reduced if a rehabilitation credit was taken with respect to the property.¹⁹

Editor’s Note: Late in 2015, Congress acted to makethe tax treatment of qualified conservation easement contributions, discussed in Q 8094, permanent.

The IRC permits a deduction for a contribution of certain real property interests even though the gift is less than the donor’s entire interest if the gift is for the preservation of land for recreation or education, the protection of natural habitats, the preservation of open space, or the preservation of historically important land or buildings.¹

If a donor contributes for any of these purposes his entire interest in real property (he may retain the right to subsurface oil, gas, or other minerals), a remainder interest in the property, or a restriction on the use of the property (a conservation easement), he may be entitled to a deduction. The contribution must be made to a qualified organization (a governmental unit and certain charities), and the restriction on use of the property must be protected in perpetuity.² The Tax Court has held that in order to be protected in perpetuity, the deed of gift used to transfer the easement, once properly recorded as required by state law, must not be subordinate to a mortgage holder’s security interest.³ The mortgage subordination requirement applies even if the possibility of defaulting on the mortgage is remote. Failure to satisfy the mortgage subordination requirement at the time of donation will result in a denial of the charitable deduction even if a mortgage subordination agreement is later executed.⁴

A trust may not take a charitable deduction (under IRC Section 642(c)) or a distribution deduction (under IRC Section 661(a)(2)) with respect to a contribution to charity of trust principal that meets the requirements of a qualified conservation contribution (under IRC Section 170(h)).⁵

A variation on the conservation easement (see Q 8094) is the use of a “facade easement,” wherein the grantor agrees not to alter the facade or modify the architectural characteristics of a building.

If the building, structure, or land is listed in the National Register or is located in a registered historic district, any easement that is a restriction with respect to the exterior of the building must preserve the entire exterior and its historical character.¹ If a deduction in excess of $10,000 is claimed with respect to such an exterior easement, a $500 filing fee is required with the tax return.²

The amount of the deduction for the contribution of a facade easement is the full fair market value of the easement at the time of the contribution.³ The fair market value of the facade donation has been determined by applying the “before and after” approach.⁴ A substantial record of sales of easements comparable to the one donated results in valuation of the fair market value of the donation based on the sale prices of the comparable easements.⁵ If the donation of a facade easement increases the value of the property it would appear that the donation would be reduced by the amount of such increase.⁶

A taxpayer who claims an investment credit for the rehabilitation of a historic structure may be required to recapture a portion of the credit upon the gift of a facade easement for the rehabilitated building. The qualified easement contribution is reduced if a rehabilitation credit was taken.

A partnership interest is a capital asset that, if sold, would be given capital gain or loss treatment except to the extent of the partner’s share of certain partnership property that, if sold by the partnership, would produce ordinary gain (i.e., his share of “unrealized receivables” and “substantially appreciated inventory”).¹ (See . See also Q 704 regarding the treatment of capital gains and losses.) Thus, if a taxpayer makes a charitable contribution of his partnership interest, and if he has held the interest for long enough to qualify for long-term capital gain treatment (i.e., more than one year, as defined in IRC Section 1222(3); see Q 8058), he may deduct the full fair market value of his interest less the amount of ordinary gain, if any, that would have been realized by the partnership for his share of “unrealized receivables” and “substantially appreciated inventory.” (His deduction is subject to the applicable limits. See Q 8058.)

If the partnership interest includes a liability (mortgage, etc.), the amount of the liability is treated as an amount realized on the disposition of the partnership interest.² Thus, the contribution is subject to the bargain sale rules, and the transfer will be treated, in part at least, as a sale (see Q 8061).³ (If the partner’s share of partnership liabilities exceeds the fair market value of his partnership interest, he may have taxable income, but no deduction under the bargain sale rules.) In Goodman v. United States,⁴ the taxpayer contributed her partnership interest to charity, subject to her share of partnership debt. The district court held that the taxpayer recognized gain on the transfer equal to the excess of the amount realized over that portion of the adjusted basis of the partnership interest (at the time of the transfer) allocable to the sale under IRC Section 1011(b).⁵

In order to determine the taxable income and the amount of charitable deduction under the bargain sale rules, the following steps must be taken:

1.Determine the taxable gain on the sale portion. Under the bargain sale rules, part of the donor’s basis is allocated to the portion sold. The basis allocated to the sold portion is the amount of basis that bears the same ratio to his entire basis as the amount realized bears to the market value of the property. Presumably, the sold portion includes the same proportionate part of his share of unrealized receivables and substantially appreciated inventory as it does basis.

Example. Mr. Jones owns a 10 percent interest in a partnership that he has held for three years. The fair market value of his interest is $100,000 and his adjusted basis is $50,000. His share of a mortgage on partnership property is $40,000, and his share of “unrealized receivables” (potential depreciation recapture on the mortgaged property) is $5,000 in which the partnership’s basis is zero. He donates his entire interest to charity. He is deemed to have received $40,000, his share of partnership liabilities, on the transfer. In effect there are two transactions–a sale for $40,000 and a contribution of $60,000.

Of Mr. Jones’ $50,000 basis in his partnership interest, $20,000 is allocated to the sale portion: $40,000 (amount realized)/$100,000 (fair market value) × $50,000 (total adjusted basis). The fair market value of the sold portion is $40,000 (amount realized). Mr. Jones must recognize a gain of $20,000 ($40,000 realized less $20,000 adjusted basis allocated to the sold portion). Of that gain, $2,000 is allocable to unrealized receivables ($5,000 unrealized receivables × $40,000/$100,000). Because the partnership has no basis in the unrealized receivables, the entire $2,000 would be ordinary income. Mr. Jones must report a taxable long-term capital gain of $18,000 and a taxable ordinary gain of $2,000.

2.Determine the charitable contribution deduction. As a general rule, the fair market value of the portion given to charity is deductible except to the extent the property would have generated ordinary income if sold. Consequently, the allowable deduction for the gift portion must be reduced to the extent the portion of the partnership interest given to the charity would produce ordinary income if sold.

Example. The fair market value of Mr. Jones’ gift to charity is $60,000. Because 60 percent of the partnership interest was given to the charity ($60,000/$100,000), 60 percent of Mr. Jones’ share of partnership “unrealized receivables,” or $3,000 ($5,000 × 60% = $3,000), is considered included in the gift. The balance of the gift would be long-term capital gain on sale. Because $3,000 would be ordinary income on a sale, Mr. Jones’ contribution is reduced by $3,000, and his charitable contribution deduction is $57,000.

Other special rules may apply under certain circumstances, for example, if the partnership owns property subject to tax credit recapture, if it has made installment sales, or (as might occur in the case of an oil and gas partnership) if it is receiving income in the form of “production payments.” See also Q 8062 with regard to prepaid interest.

Further, the IRS may examine the transaction in which a donation takes place and may disallow the charitable deduction based upon the doctrine of substance over form. In one case, a partner claimed a deduction for his donation of a partnership interest to a charitable organization. The IRS examined the transaction and found that the charity had received no membership rights in the transaction and was given only a promissory note from the partner claiming the deduction. The partner retained the right to determine when interest payments would be made on the note. The IRS found that, in substance, the partner had never transferred the interest to the charitable organization and, as such, denied the deduction.⁶

For tax years 2006 and thereafter, a taxpayer age 70½ or older is eligible to make a qualified charitable distribution from an IRA that is not includible in the gross income of the taxpayer. This provision was made permanent by the PATH Act of 2015.¹

A qualified charitable distribution is any distribution

1.not exceeding $100,000 in the aggregate during the taxable year (except that gifts for the 2012 year could be made up until January 31, 2013);

2.made directly, in a trustee-to-charity transfer;

3.from a traditional or Roth IRA (distributions from SEPs and SIMPLE IRAs do not qualify); the prohibition on making a qualified charitable distribution from a SEP IRA or a SIMPLE IRA only applies to “ongoing” SEP IRAs or SIMPLE IRAs. Such an IRA is “ongoing” if a contribution is made to it for the taxable year of the charitable distribution;²

4.to a public charity (but not a donor-advised fund or supporting organization);

5.that would otherwise qualify as a deductible charitable contribution—not including the percentage of income limits in IRC Section 170(b);

6.to the extent the distribution would otherwise be includible in gross income.³

No charitable income tax deduction is allowed for a qualified charitable distribution.⁴

If a qualified charitable distribution is made from any IRA funded with nondeductible contributions, the distribution is treated as coming first from deductible contributions and earnings.⁵ This is contrary to the general rule that distributions from an IRA with both deductible and nondeductible contributions are deemed made on a pro-rata basis.⁶

Qualified charitable distributions may count toward a taxpayer’s unsatisfied required minimum distributions for the year.⁷

For guidance on qualified charitable contributions (including questions and answers), see Notice 2007-7.⁸

The American Taxpayer Relief Act of 2012 extended the ability to make qualified charitable distributions for tax years 2012 and 2013. Because the law was not passed until January 2013, the law included special provisions for donors to make gifts in January of 2013 to qualify for the 2012 year. The provisions were that an IRA owner can treat a contribution made to a qualified charity in January of 2013 as a 2012 qualified charitable distribution if:

1.The contribution was made in cash from the donor to the qualified charity of all or a portion of an IRA distribution made to the IRA owner in December 2012 provided that the contribution would have been a 2012 qualified charitable distribution if it had been paid directly from the IRA to the qualified charity in 2012, or

2.The contribution is paid directly from the IRA to the qualified charity, provided that the contribution would have been a 2012 qualified charitable distribution if it had been paid in 2012.

A qualified charitable distribution made in January 2013 that was treated as a 2012 qualified charitable distribution is satisfied the IRA owner’s 2012 required minimum distribution if the amount of the qualified charitable distribution was equal to or greater than the 2012 required minimum distribution. However, no part of such a qualified charitable distribution could be used to satisfy the 2013 required minimum distribution, even if the 2012 required minimum distribution had already been made.  In determining the required minimum distribution for 2013, the 2012 qualified charitable distribution had to be subtracted from the December 31, 2012 IRA account balance.