A Solution To A Pre-Arranged Sale Dilemma

by Chase V. Magnuson, CCIM & Allen Thomas, JD, CAP

Charitable Planning.com (January 30, 2014)

SUMMARY

All too often a pre-arranged sale arises with donors, and there does not seem to be an easy solution. Chase and Allen provide a solution in the form of a like-kind exchange.

STUDY

A donor recently offered to donate to a university a condominium she was holding as rental property. She told the development officer the condo was already under a written contract to be sold for half a million dollars, with closing to take place in ten days. She thought the pre-arranged sale was a “plus” because it spared the university the difficulty of finding a buyer. She was eager to apply the sale proceeds toward her commitment to endow a scholarship in the amount of one million dollars. She planned to donate a second condo to meet this endowment goal, and to provide for any shortfall through a bequest in her will.

After consulting with colleagues, the development officer explained to the donor that where the sale was pre-arranged, the IRS would apply the “step transaction” doctrine to treat her as having received the sale proceeds and then contributing cash to the university. Because her basis in the condo was only fifty thousand dollars, the donor would pay a substantial capital gains tax, which would not be fully offset by the deduction for her gift to the university.

The university did not want to disappoint the donor, nor did it want to forgo the potential for the endowed scholarship. But the university wanted to be certain the donor was fully informed as to the implications of what she had proposed to do. The university does not provide tax or legal advice to donors. However, it does encourage donors to review with their advisors all the implications of complete gifts, including potentially adverse consequences.

Working with the development officer, the donor’s tax accountant and her attorney came up with a solution. The existing sale contract was amended to allow the donor to assign her rights to a “qualified intermediary” for purposes of a “like-kind exchange” under section 1031 of the Internal Revenue Code. That section allows a taxpayer to defer recognition of gain on the sale of investment property if instead of cash, she receives “replacement property” that she then puts to the same use–here, as rental property.

The difficulty here was that at the moment, the donor had not yet identified any “replacement property.” However, since 1984 there has been clear statutory and regulatory authority for a “reverse” or “delayed” 1031 exchange, sometimes called a “Starker” exchange, after the name of the taxpayer in a 1979 decision of the 9th Circuit federal appeals court that laid the groundwork for this device.

In order to complete the “Starker” exchange, the donor would have to find a “replacement property” within 45 days and the “qualified intermediary” would have to acquire the property within 180 days of the closing on the pending sale. As it happened, everything went smoothly. The pending sale closed, the proceeds were placed in the hands of the “qualified intermediary,” and a “replacement property” was identified and bought. The donor rented that property to a tenant for some length of time and later sold it to the university in a “bargain sale,” in which the university paid her a small amount, roughly equivalent to the additional expense she had incurred in setting up the 1031 exchange.

It is important to note that the donor held the “replacement property” for at lease a year, and that the later “bargain sale” to the university was not itself the subject of a formal pre-arrangement. Section 1031 does require that the “replacement property” itself be held for investment and put to a similar use as the property exchanged, and if it were clear that the donor intended only to give the “replacement property” to the university, the “like-kind exchange” would have failed and she would have been taxed on the gain.

The end results are a:

    1. Happy donor
    1. Happy university
    1. Happy purchasers for both properties

The professionals who play a role in this type of arrangement are:

    1. Attorney
    1. CPA
    1. Title company officer
    1. The charity’s general counsel
    1. A facilitating agent
    1. Realtor with section 1031 exchange experience

COMMENTARY

The views, opinions and conclusions expressed in this Case Study are those of the authors and do not necessarily reflect the views, opinions, or conclusions of CharitablePlanning.com

BIOGRAPHY

Chase is in the Office of Planned Giving – Real Estate at The George Washington University; and Allen is Vice President, Advancement & Alumni Relations at The American College.

For more information on this subject, please contact:

Chase V. Magnuson, President
Real Estate for Charities
Phone: (714) 815-8889
Email: info@realestateforcharities.com