tangible personal property is put to a related use by the recipient charitable organization, the charitable reduction is based on the fair market value of the property (that is, there is no reduction for the capital gain element).
(b) Definition of Unrelated Use
The term unrelated use means a use of an item of contributed property:
By a charitable organization that is not related to the purpose or function constituting the basis of the tax exemption for the charitable organization, or
By a governmental unit that is for a purpose other than an exclusively public purpose.61
If a charitable donee sells an item of tangible personal property donated to it, this deduction reduction rule is triggered, because sale of the property is not a related use of the property. Thus, donors of tangible personal property should exercise caution when contemplating a gift of the property, particularly when the donor knows the property is going to be promptly sold (such as a gift to support an auction).
If furnishings contributed to a charitable organization are used by it in its offices and buildings in the course of carrying out its functions, the use of the property is not an unrelated use. If a set or collection of items of tangible personal property is contributed to a charitable organization or governmental unit, the use of the set or collection is not an unrelated use if the donee sells or otherwise disposes of only an insubstantial portion of the set or collection. The use by a trust of tangible personal property contributed to it for the benefit of a charitable organization is an unrelated use if the use by the trust is one that would have been unrelated if used directly by the charitable organization.62
A donor who makes a charitable contribution of tangible personal property to or for the use of a charitable organization or governmental unit may treat the property as not being put to an unrelated use by the donee if:
The donor establishes that the property is not in fact put to an unrelated use by the donee,63 or
At the time of the contribution or at the time the contribution is treated as made, it is reasonable to anticipate that the property will not be put to an unrelated use by the donee.64
In the case of a contribution of tangible personal property to or for the use of a museum, if the object donated is of a general type normally retained by the museum or other museums for museum purposes, it is considered reasonable for the donor to anticipate, unless the donor has actual knowledge to the contrary, that the object will not be put to an unrelated use by the donee, whether or not the object is later sold or exchanged by the donee.65
(c) Recapture of Deduction
The tax benefit arising from charitable contributions of tangible personal property, with respect to which a fair market value deduction is claimed and that is not used for charitable purposes, must, in general, be recovered. This recapture rule applies to applicable property, which is tangible personal property that has appreciated in value that has been identified by the donee organization as for a use related to the donee's tax-exempt purpose or function and for which a charitable deduction of more than $5,000 has been claimed.66
If a donee organization disposes of applicable property within three years of the contribution of the property (known as an applicable disposition67), the donor is subject to an adjustment of the tax benefit. If the disposition occurs in the tax year of the donor in which the contribution was made, the donor's deduction generally is confined to the basis in and not the fair market value of the property. If the disposition occurs in a subsequent year, the donor must include as ordinary income for the tax year in which the disposition occurs an amount equal to the excess (if any) of (1) the amount of the deduction previously claimed by the donor as a charitable contribution with respect to the property, over (2) the donor's basis in the property at the time of the contribution.68
There is no adjustment of the tax benefit, however, if the donee organization makes a certification to the IRS by written statement signed under penalties of perjury by an officer of the organization.69 This statement must (1) certify that the use of the property by the donee was related to the purpose or function constituting the basis for the donee's exemption and describe how the property was used and how the use furthered the exempt purpose or function, or (2) state the intended use of the property by the donee at the time of the contribution and certify that the use became impossible or infeasible to implement. The organization must furnish a copy of the certification to the donor.
A penalty of $10,000 is applicable to a person who identifies property as having a use that is related to a purpose or function constituting the basis for the donee's tax exemption while knowing that it is not intended for such a use.70
§ 3.7 STEP TRANSACTION DOCTRINE
As discussed, the general rule is that a contribution of appreciated capital gain property to a public charitable organization is deductible on the basis of the fair market value of the property, and the capital gain element is not taxable to the donor.71
If, however, the donee charitable organization sells the property soon after the contribution is made, the donor may be placed in the position of having to recognize, for federal income tax purposes, the capital gain element. This can happen when, under the facts and circumstances surrounding the gift, the donee was legally obligated to sell the gift property to a purchaser that was prearranged by the donor. In this situation, the law regards the transaction as a sale of the property by the donor to the third-party purchaser and a gift of the sales proceeds to the charitable organization.72
This is the step transaction doctrine, under which two or more ostensibly independent transactions (here, the gift and subsequent sale) are consolidated and treated as a single transaction for federal tax purposes. The key to avoiding this tax-adverse outcome is to be certain that the charitable organization was not legally bound at the time of the gift to sell the property to the prospective purchaser.73
The step transaction rule has been, and continues to be, the subject of considerable litigation. Several court opinions illustrate the nature of this controversy. In one, the court ruled that a gift to a charitable organization of the long-term capital gains in certain commodity futures contracts gave rise to a charitable contribution deduction, and that the gifts and subsequent sales of the contracts were not step transactions within a unified plan.74
The case concerned an individual who formed a private operating foundation in the early 1970s and had been president of it since the date it was established. From time to time, he contributed futures contracts to the foundation and claimed
