How to Avoid a Pre-Arranged Sale: New Guidance
For many years, the rules on what constituted a pre-arranged sale have been confusing. Various sources of law offered conflicting advice, so how were we to know what to do? Fortunately, we have some new advice that gives us more solid guidance about how to avoid this situation. Before we get to that new guidance, let’s make sure we all understand the basics of pre-arranged sales.
Sometimes donors wait too long before exploring the idea of donating a non-cash asset. They put the property on the market, receive an offer and accept it. Only then does someone suggest that they could donate the asset, receive a charitable income tax deduction, and avoid the tax on the sale. They come to you proposing to donate the asset and tell you they already have a buyer lined up. That may sound like an ideal situation, but wait – it may not be.
If a donor is already obligated to sell the asset to someone else and they donate it to you instead they are in breach of their agreement to sell to that other person. Furthermore, if they donate the asset to your organization and then you sell to that buyer according to the terms of the deal they already negotiated, that’s a pre-arranged sale. It doesn’t really affect the charity, but it could negatively affect the donor.
If the IRS discovers a pre-arranged sale, the donor could very likely be required to recognize the gains on the sale of the asset even though they weren’t the ones who sold it. Your organization sold the property and received the sales proceeds. The donor would likely still be able to claim a charitable income tax deduction for a cash gift equal to the sales proceeds, but that often isn’t the most financially beneficial arrangement for the donor. After all, if it were – they wouldn’t have wanted to donate it in the first place.
The recent Tax Court case of Estate of Scott M. Hoensheid, et al. v. Commissioner, T.C. Memo 2023-34 provides new guidance to help donors and charities avoid pre-arranged sales of appreciated assets. It also gives clear guidance on the requirements for a “qualified appraisal” and “qualified appraiser“, which can make or break a non-cash gift.
For a complete and concise summary of this case, I recommend the article written by the law firm of Lathrop GPM. It outlines the many complexities of the decision as well as the details of the story to make it relatable.
Before the Hoenshied case, many donors, charities, and legal advisors have been operating under the assumption that as long as there is no legally enforceable agreement to sell the property at the time of the gift that there is no pre-arranged sale. That is no longer the case. New guidance tells us that pre-arrangement occurs when at the time of the gift, it is “virtually certain” that the asset will be sold. So, what constitutes a “virtual certainty”? The court considered all facts and circumstances of the situation – not just legal documents. It used this four-pronged test to determine “virtual certainty”.
- Any legal obligation to sell by the donee
- The actions already taken by the parties to effect the transaction
- The remaining unresolved transactional contingencies
- The status of the corporate formalities required to finalize the transaction
These items will now serve as a much clearer guide to help us avoid pre-arranged sales in the future. I encourage you to read the Lathrop GPM article to fully understand the origins of these four items and how to apply them to your own situations.
If someone comes to you and proposes a gift with a buyer all lined up or has specific terms of sale they want you to agree to – be careful! It’s best to have the donor and the buyer cancel any purchase agreement they have negotiated (written or oral) before the gift is made. After the gift is made, your organization will negotiate an arm’s-length transaction with a buyer on your own terms.
Pre-arrangement can be a very gray area. The laws aren’t in complete agreement as to exactly what constitutes pre-arrangement. You shouldn’t try to advise a donor as to whether they have engaged in pre-arrangement. That is best left to experienced legal counsel. If you suspect pre-arrangement, it’s best to bring it up with the donor and strongly encourage them to consult experienced legal counsel before proceeding with the gift.
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