Private Letter Rulings - Gift of Remainder Interest in Mortgaged Property Treated as Bargain Sale
GiftLaw Note:
Frazer Farmer paid $110,000 for a farm. Farmer purchased the farm by paying $30,000 cash and obtaining an $80,000 mortgage. Farmer wants to donate a remainder interest in the farm to the International Farm Federation (IFF), a public charity, and retain a life estate for himself while remaining fully liable for the mortgage. If he does this, may Farmer claim a deduction for the donated remainder interest in his farm?
Generally, a donor is not able to deduct a contribution of less than his or her entire interest in property. A Section 170(f)(3)(B)(i) exception to this rule permits a donor to deduct the value of a remainder interest in a personal residence or farm that is given to charity. Reg. 1.170A-7(c) provides that the amount of the deduction is the fair market value of that remainder interest. Reg. 1.1011-2(a)(3) provides that if property is transferred to charity subject to indebtedness, the amount of the debt must be treated as an amount realized by the donor even if the charity does not agree to assume or pay the indebtedness.
The IRS ruled that Frazer Farmer could claim a deduction for the donated remainder interest in his farm with the amount of the deduction determined as follows:
Generally, a donor is not able to deduct a contribution of less than his or her entire interest in property. A Section 170(f)(3)(B)(i) exception to this rule permits a donor to deduct the value of a remainder interest in a personal residence or farm that is given to charity. Reg. 1.170A-7(c) provides that the amount of the deduction is the fair market value of that remainder interest. Reg. 1.1011-2(a)(3) provides that if property is transferred to charity subject to indebtedness, the amount of the debt must be treated as an amount realized by the donor even if the charity does not agree to assume or pay the indebtedness.
The IRS ruled that Frazer Farmer could claim a deduction for the donated remainder interest in his farm with the amount of the deduction determined as follows:
- The value of the remainder interest is calculated using only the value of Farmer's equity in the farm. His equity is $30,000 - the difference between the farm's $110,000 fair market value and $80,000 debt.
Any subsequent mortgage payment made by Farmer will be regarded as an additional donation of a remainder interest and the remainder value of that mortgage payment will be deductible as such. - Farmer is deemed to have sold a portion of the property to IFF for $80,000 - the amount of the outstanding mortgage. He must apportion his basis between the mortgaged portion of the property and the equity. In this case, since Farmer's basis is $110,000, he will apportion $80,000 basis to the mortgaged portion and $30,000 basis to the equity portion. He therefore recognizes no gain when the deemed sale of the mortgaged portion occurs because his basis is equal to the value of the mortgage.
DATE: April 26, 1993
REFER REPLY TO: CC:IT&A:03/TR-31-2181-92
This is in response to your November 4, 1992 letter, as amended by a letter dated February 16, 1993, requesting a ruling concerning the income tax consequences of a proposed transfer of a remainder interest to a charity.
FACTS
The facts are represented as follows:
Taxpayer paid $ 110,000 for real property that is a farm. He financed the farm by paying $ 30,000 in cash and obtaining a mortgage for $ 80,000 from a financial institution. Taxpayer intends to renovate the farm.
Taxpayer proposes to donate a remainder interest in the farm to X. Under the proposed transaction, he will remain liable for payment of the mortgage.
X is a nonprofit corporation described in section 501(c)(3) of the Internal Revenue Code that provides technical assistance and financing to housing and economic development projects benefiting low-income communities throughout the United States. X raises funds for low-income housing by various programs. One program is to solicit donations of remainder interests in personal residences and farms. X warrants to its donors that the residences and farms it acquires under this program and any proceeds from their sale will be dedicated permanently to low income housing or other community needs.
ISSUES
Taxpayer requests the following rulings:
1. Taxpayer's contribution to X of a remainder interest in the farm is a charitable contribution within the meaning of section 170(c) of the Internal Revenue Code, to the extent of the remainder interest in his equity in the farm.
2. A remainder interest in Taxpayer's principal payments on the mortgage secured by the farm is a charitable contribution within the meaning of section 170(c).
3. A remainder interest in Taxpayer's improvements to the farm is a charitable contribution within the meaning of section 170(c), if the improvements constitute real property.
CONCLUSION
We agree with Taxpayer on all three issues, but we caution that Taxpayer is required to take the full amount of the mortgage into consideration as an amount realized under section 1011.
LAW
Section 170(a)(1) of the Code allows as a deduction any charitable contribution (as defined in section 170(c)) payment of which is made within the taxable year. Section 170(a)(3) of the Code and section 1.170A-5 of the Income Tax Regulations disallow a deduction for contributions of future interests in tangible personal property. Section 1.170A-5(a)(3) of the regulations, however, makes it clear that this rule does not apply to transfers of future interests in real property.
Section 170(c) of the Code generally defines the term "charitable contribution" as a contribution or gift to or for the use of a corporation, trust, or community chest, fund or foundation organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes.
Section 170(f)(3)(A) of the Code denies a charitable contribution deduction for the donation of an interest in property that consists of less than the taxpayer's entire interest in the property. However, section 170(f)(3)(B)(i) excepts contributions of remainder interests in farms from the application of section 170(f)(3)(A). Section 1.170A-7(b)(4) of the regulations defines the term "farm" as any land used by the taxpayer or his tenant for the production of crops, fruits, or other agricultural products or for the sustenance of livestock. A farm includes the improvements thereon.
Section 1.170A-7(c) of the regulations provides that the amount of the deduction allowable under section 170 of the Code in the case of a charitable contribution of a partial interest in property is the fair market value of the partial interest at the time of the contribution.
Section 1.170A-4(c)(2)(i) of the regulations provides that section 1011(b) of the Code and section 1.1011-2 of the regulations apply to bargain sales of property to charitable organizations. The term "bargain sale" is defined by section 1.170A-4(c)(2)(ii) of the regulations as a transfer of property that is in part a sale or exchange of property and in part a charitable contribution of the property.
Section 1011(b) of the Code provides that if a deduction is allowable under section 170 by reason of a sale, then the adjusted basis for determining the gain from the sale is that portion of the adjusted basis that bears the same ratio to the adjusted basis as the amount realized bears to the fair market value of the property.
Section 1.1011-2(a)(3) of the regulations provides that if property is transferred to a charitable organization subject to an indebtedness, the amount of the indebtedness must be treated as an amount realized for purposes of determining whether there is a sale or exchange to which section 1011(b) of the Code applies, even though the transferee does not agree to assume or pay the indebtedness.
ANALYSIS
Because the property will be transferred subject to a mortgage, the transfer must be considered a bargain sale between Taxpayer and X. Under section 1.170A-4(c)(2)(ii) of the regulations, there are two aspects to a bargain sale transaction--part of the transaction is a charitable contribution to X and part of the transaction is a sale of the property by Taxpayer to X.
First, Taxpayer will have made a contribution of the remainder interest of the difference between the fair market value of the property and the amount of the mortgage. Thus, if the property has a fair market value of $ 110,000 and the outstanding mortgage is $ 80,000, a charitable contribution for the remainder interest in $ 30,000 is allowable to Taxpayer. Similarly, and subsequent payment of the principal of the mortgage by Taxpayer will be regarded as an additional donation of a remainder interest in real property by Taxpayer to X. The contribution will be measured by the value of the remainder interest in each payment of principal.
Second, Taxpayer will be deemed to have sold a portion of the property to X for the amount of the outstanding mortgage. Taxpayer is required to take the full amount of the mortgage into consideration as an amount realized in determining whether he had any gain or loss under sections 1.170A-4(c)(2)(ii) and 1.1011-2 of the regulations when he conveys the remainder interest to X. The gain or loss to Taxpayer is determined under the formula in section 1.1011-2 of the regulations.
If Taxpayer makes improvements to the farm and the improvements constitute real property under the applicable local law, the remainder interest in the improvements are charitable contributions within the meaning of section 170(c). To the extent that the improvements in question constitute tangible personal property described in section 1.170A-5 of the regulations, the contribution is a partial interest and may not be deducted. We express no opinion about whether any particular improvements are real or personal property in light of the fact that no specific improvements have been proposed. See section 7.02 of Rev. Proc. 93-1, 1993-1 I.R.B. 10, 22, which states that the Service will not rule on hypothetical situations.
This ruling is directed only to the taxpayer that requested it. Section 6110(j)(3) of the Code provides that it may not be used or cited as precedent. A copy of this ruling should be attached to Taxpayer's income tax return for the year of the transaction.
A copy of this letter is being sent to the taxpayer pursuant to the Power of Attorney and Declaration on file with this office.
Sincerely yours,
Assistant Chief Counsel
(Income Tax & Accounting)
Karin G. Gross
Senior Technician Reviewer
Branch 3
Enclosure:
Copy of this letter
Copy for section 6110 purposes