Monday, September 22, 2014
Puzzler: Respecting and Valuing an Interest in a Disregarded SMLLC for Charitable Deduction Purposes?
I thank Professor Cassady Brewer of Georgia State University College of Law for bringing this interesting case to our attention. Please read on...
In RERI Holdings I, LLC v. Comm’r, 143 T.C. No. 3 (2014), the Tax Court determined that a disregarded, single-member LLC interest should not be ignored for purposes of determining whether a taxpayer is entitled to a charitable contribution deduction. This decision has not received much attention, but it potentially has significant implications for charities and donors.
The taxpayer in RERI Holdings I, LLC contributed an interest in a disregarded SMLLC holding real property to the University of Michigan. The taxpayer claimed a charitable deduction of approximately $33 million in connection with the donation of the SMLLC interest. As required for tax purposes, the taxpayer obtained an appraisal substantiating the amount of its claimed deduction; however, the taxpayer’s appraisal was of the underlying real property held by the disregarded SMLLC, not the membership interest in the SMLLC itself. Because the interest in the SMLLC, not the underlying real property, was donated to the University of Michigan, the IRS argued in a motion for summary judgment that the taxpayer’s charitable deduction should be disallowed. In particular, the IRS argued that the deduction must be disallowed because the appraisal was of the wrong property and therefore failed the “qualified appraisal” requirements for charitable contributions of property.
Without much fanfare, Judge Halpern accepted the argument of the IRS that a charitable contribution of an interest in a disregarded SMLLC should be viewed differently than a charitable contribution of the underlying asset. Judge Halpern so held notwithstanding the fact that the SMLLC is otherwise ignored for federal income tax purposes. Judge Halpern’s opinion relies heavily on the Tax Court’s earlier decision in Pierre v. Comm’r, 133 T.C. 24 (2009), supplemented by 99 T.C.M. (CCH) 1436 (2010), that, for gift tax valuation purposes, a taxpayer’s gifts of membership interests in the taxpayer’s SMLLC are distinct from gifts of partial interests in the underlying property. Pierre arguably is distinguishable, though, from RERI Holdings I, LLC, because (i) Pierre is a gift (not income) tax case and (ii) the gifts in Pierre transformed the SMLLC into a multi-member LLC held by four trusts. This latter point of distinction, though, may not be significant as it appears the trusts were grantor trusts such that the taxpayer in Pierre remained the income tax owner of the SMLLC.
Despite the fact, however, that Judge Halpern agreed with the IRS’s view that an interest in a disregarded SMLLC should be respected for charitable contribution deduction purposes, all was not lost for the taxpayer in RERI Holdings I, LLC. Rather, perhaps to avoid so-easily granting summary judgment against the taxpayer and in favor of the IRS, Judge Halpern reasoned that there was an unresolved issue of material fact whether a valuation of the property held by the SMLLC rather than a valuation of the SMLLC interest itself nevertheless could “stand proxy” for the otherwise required qualified appraisal. The ultimate outcome of the case, therefore, remains to be seen.
The lesson for charities and donors: RERI Holdings I, LLC creates uncertainty with regard to the proper treatment of disregarded SMLLC interests for both charitable deduction and substantiation requirements. Given that uncertainty, donors to charitable organizations should transfer the underlying property itself to charity rather than transferring an interest in an SMLLC holding the property. If the property must be wrapped inside a disregarded LLC for liability protection or other reasons, then the donee charity should form the disregarded SMLLC to receive the contribution rather than receiving an interest in the property-holding SMLLC formed by the donor. Otherwise, due to the quirky way in which SMLLC membership interests apparently are valued for federal tax purposes, the donor inadvertently may be reducing the amount of his or her expected charitable contribution deduction. On the other hand, for estate and gift tax purposes, a donor presumably would rather transfer a membership interest in a disregarded SMLLC to a non-charitable donee in order to minimize the value of the transfer and thereby reducing potential estate and gift taxes.
My thanks again to Professor Brewer.