Underlying this matter was a dispute as to the location of a boundary line between a state park and property owned by the corporation. The first survey of the property had placed the line at one location; a subsequent survey had placed it elsewhere. A more contemporary survey confirmed that the first survey was correct. This line-shifting created a strip of property that was the parcel of land involved in the case. Eventually, to settle earlier disputes, the corporation executed a quitclaim deed to the state—and claimed a charitable deduction for the fair market value of the property. Applying the doctrine of collateral estoppel, the court found that the true property line had been established in prior litigation, seemingly adding the land to the corporation's assets. Indeed, the government vigorously argued against application of the collateral estoppel rule.
Over the years, however, the state and the corporation had acted as though the property line were at the place established by the second survey. The state maintained the park property, including the disputed parcel, and placed signs around the park (and the property at issue) identifying all of it as park land. Based on these and other facts, the court concluded that the state had acquired title to the property in dispute by virtue of the doctrine of adverse possession. Thus, although the corporation thought it owned this land at the time of the intended gift, the title, unknown to the corporation, had already shifted to the state by operation of law. Therefore, the charitable deduction was denied, on the basis of the fundamental principle that there cannot be a charitable contribution deduction for a “gift” of property that the “donor” did not own at the time of the transaction.
Likewise, the IRS challenged a charitable contribution promotion program that involved gifts of grave sites to charitable organizations; one of the bases of the challenge was that the “donors” never owned the contributed items. The ground for this contention was that the “donors” did not receive a formal deed to the property. This issue arose twice in 1993 in the U.S. Tax Court, with the court observing that state law controls on this issue163 and that the states' law on the point did not require a deed for the legal transfer of a grave site or cemetery lot. The court held that it was adequate, as a matter of “administrative efficiency,” to use a deed only for the transfer of the grave sites from the original owners to the charitable donees.164
In another instance, an individual contributed a conservation easement on several acres of undeveloped land; access to the property was by means of neighboring land, pursuant to easements granted by the landowners. The individual lacked a permit to divert water from a creek traversing the property. The property was subject to use and development restrictions imposed by state law. At trial, the donor's expert witnesses testified that the highest and best use of the land before placement of the easement was residential development and as a vineyard. The court, however, held that the donor failed to establish that these uses were “reasonably probable,” “physically possible,” or “economically feasible,” and concluded that the donor “failed to show that the conservation easement had any value,” thus allowing the claimed charitable contribution deduction.165
This aspect of the law is further illustrated from a different perspective. Forgiveness by the lender of a debt owed by a charitable organization can give rise to a charitable contribution deduction for that lender. For that to occur, however, there must be, in the eyes of the law, a valid, enforceable indebtedness to forgive. This principle was demonstrated in a court case in which the charitable deduction was denied because the underlying obligation was legally deficient.166
In this case, a married couple placed their two children with learning disabilities in a private school, rather than a public one, because of the inability of the public school to adequately serve the children's academic needs. The couple relied on the Individuals with Disabilities Education Act (IDEA) for the assertion that they were entitled to reimbursement from the public school system for the tuition and other expenses incurred in connection with their children's attendance at the private school. They endeavored, nonetheless, to forgive the system's obligation to reimburse them for the expenses and claimed a charitable contribution deduction for the amount forgiven.
The IDEA prescribes a multistage administrative procedure by which individuals in these circumstances establish their right to reimbursement. The parents of these children, however, did not avail themselves of that procedure. Once before the court, they submitted an affidavit concerning their consultations with educational, psychological, and legal professionals, who agreed with the parents that they had a valid claim for reimbursement. They also submitted a letter from an educational consultant they had consulted, who expressed the view that the parents were entitled to reimbursement. The court rejected these submissions as inadequate to support an “unequivalent obligation” on the part of the public school system to provide the reimbursement.167
A statutory path was open to this couple to attempt to establish the requisite unconditional obligation, which could then have served as the predicate for a forgiveness.168 But, as the court stated, “they didn't elect to pursue that right.”169 The court referred to the couple's approach as a “self-proclaimed unilateral decision.”170 This was not enough to adequately obligate the school system, so the attempt to make the forgiveness the basis for a charitable deduction failed.
When situations like this are particularly egregious or are otherwise abusive, the courts have the authority to levy certain penalties.171
Another illustration of this situation is the carefully contrived circular gift. A court case illustrated the point.172 The transaction involved three related organizations. One was a business league operated in support of small business interests (BL). BL was funded by an individual (A). A also established, with BL funds, a charitable organization (CO). A third organization was a for-profit entity (FP), owned 40 percent by A and 60 percent by BL. Upon application, FP would loan money to a borrower at a 3 percent interest rate, with no principal payment due for 20 years. On the day the borrower received the loan proceeds, they would transfer the funds to CO, along with a small contribution from their own funds. The borrower would then claim a charitable contribution deduction for the entire amount transferred to CO.
The court found a “cooperative arrangement” among the three organizations, facilitated by the fact that A was the sole signatory on the bank accounts of the organizations.173 The court found the following “circular flow” of funds: (1) CO loaned money to BL on a short-term basis at a 2.5 percent interest rate; (2) BL then lent the money to FP for a 20-year term, also at a 2.5 percent rate; (3) FP then lent the funds at a 3 percent interest rate to investors; and (4) the investors would complete the flow by contributing the funds to CO.174
The consequence of this money circle scheme was that the organizations and the “contributors” improved themselves financially. With each transaction, FP received a promise of small interest payments and a repayment of principal in 20 years. CO, while breaking even on the funds “contributed” (since it was the source of the funds), received a small contribution from an investor's personal funds with each transaction. Each investor received a large tax benefit from the charitable deduction, a benefit that more than offset the present value of the interest and principal they agreed to pay to FP. Said the
