Green v. U.S., No. 16-6371 (10th Cir., Jan. 12, 2018)
Practitioners and donors often forget a pesky donation limitation that applies only to irrevocable trusts: the deduction for a real property donation is limited to the trust’s adjusted basis in the real property and is only permitted if the real property was acquired using the trust’s gross income. Internal Revenue Code section 642(c)(1) permits an irrevocable trust to claim a charitable deduction for “any amount of the gross income” of the trust which is donated to a qualified donee. Traditionally, most conservative tax practitioners have interpreted Section 642(c)(1) to mean that an irrevocable trust may donate an interest in real property, so long as (1) the interest was acquired with gross income and (2) the trust’s claimed deduction excludes unrealized appreciation. Unlike Internal Revenue Code section 170, which applies to individuals and corporations and clearly permits claiming unrealized appreciation as part of a charitable deduction, trusts and estates must rely on section 642 to claim charitable deductions and that section does not contain a similar provision.
As any donor of a conservation easement over long-held family land can attest, the owner’s adjusted basis in the land (approximately how much they paid for the land when they bought it) is often much lower than the current fair market value of the land. Section 642(c)(1)’s limitation to adjusted basis means that conservation easement donors that are irrevocable trusts cannot enjoy the full benefit of the enhanced tax incentives available to other donors of conservation easements under section 170(b)(1)(E) and section 170(b)(2)(B). Even worse, if the trust’s assets include the real property from inception (i.e., the property was contributed on formation and the real property was not acquired with the trust’s gross income), then the trust cannot claim a deduction at all. See Rev. Rul. 2003-123; Thomas B. Goldsby, Jr. v. Commissioner, TC Memo 2006-274.
Perhaps because this position seems to be the most logical plain language interpretation of section 642(c)(1), prior to last month there was little judicial authority interpreting the breadth of the term “gross income” used in that section, beyond the U.S. Supreme Court’s venerable opinion in Old Colony Trust Co. v. Comm’r, 301 U.S. 379 (1937). Old Colony Trust provided limited guidance that “gross income” includes income made in prior years and not just the donation year, thus extending the charitable deduction to donations of prior year gross income. See also 26 C.F.R. § 1.642(c)-1(a)(1). Applying that reasoning to real property acquired with gross income, this means that an irrevocable trust should be able to donate real property that was acquired with gross income prior to the year of the donation.
Further judicial guidance is now available in the form of Green v. U.S., No. 16-6371 (10th Cir., Jan. 12, 2018) and the message is clear and unsurprising: irrevocable trusts can claim a deduction for real property interests purchased out of gross income from prior years but only to the extent of the property’s adjusted basis.
The plaintiff in Green vs. U.S., a family trust that is the upstream owner of most of the Hobby Lobby stores in the U.S., proffered a different interpretation of the statute and attempted to deduct the appreciated value of various parcels of real property that the trust acquired and then donated for the use of churches in Oklahoma, Texas, and Virginia. Green’s interpretation would have permitted a charitable deduction of $30.3 million, while the traditional interpretation of the statute, limiting the deduction to the trust’s adjusted basis, would have only generated a charitable deduction of $10.7 million.
Although the court acknowledged Green’s argument that individuals and other (non-irrevocable trust) taxpayers are permitted to deduct the appreciated value of property under section 170, the court pointed to the plain language of section 642(c) and stated that “unless and until Congress acts to make clear that it intended for the Section 642(c)(1) deduction to extend to unrealized gains associated with real property … (similar to what Congress did in Section 170…), we conclude we cannot construe the deduction in that manner.”
This case is an excellent reminder that taxpayers who are planning to donate a conservation easement or any other real property interest where any portion of the ownership of the underlying property is held by an irrevocable trust, must be sure to consult qualified legal counsel to determine an appropriate donation strategy, such as a distribution of the real property interest to the trust beneficiaries (if permitted by the trust terms).