The recent case, Graev v. Comr., 140 T.C. No. 17 (6/24/13), illustrates that a donor is not allowed a charitable deduction when at the time of the donor's gift, the possibility that the contribution would be returned to the donor is "not so remote as to be negligible."

In Graev, the donor made charitable contributions to a historic architecture preservation organization of cash and a conservation easement attached to donor's historic property. The donor was informed of the organization's standard policy regarding contributions from donors, which was to return the contribution for any amounts for which the IRS disallowed a deduction to the donor. Before making the contributions, the donor's accountants advised him of Notice 2004-41, 2004-28 I.R.B. 31, that advised taxpayers of increased IRS scrutiny of conservation easement contribution deductions. The donor ignored the warnings and made the contributions.  At the time of making the contributions, the donor requested a "side letter" from the organization stating that it would return the contributions should their respective deductions be disallowed by the IRS.   

Before the filing of the donor's tax return, the organization contacted the donor on two occasions.  First, the organization informed the donor of the U.S. Senate's recent press release that it intends to increase and create additional fines and penalties for those involved in abusive easement donations. Second, the organization informed the donor that its attorney advised it that the organization's offer to refund the contributions may adversely affect their deductibility. For that reason, the organization offered to withdraw the side letter, hoping to restore the deductibility of the contributions for the donor.  However, the donor declined to do so.  The donor subsequently filed his tax return claiming charitable contribution deductions.  The IRS disallowed the deductions and the donor filed a petition with the Tax Court.

The Tax Court held that the donor's charitable contribution deduction is not allowable under Regs. §1.170A-1(e) because the possibility that the organization's interests in the contributions would be defeated was not "so remote as to be negligible." The court reasoned that the possibility of the IRS disallowing the deduction was not negligible since a substantial risk clearly arose when the IRS announced its intention to scrutinize charitable contribution deductions for conservation easement contributions in Notice 2004-41. The donor knew of the substantial risk involved in making the contribution when he received words of caution from his accountants, and requested the side letter confirming the availability of a refund.

Also of interest to the court was the fact that under §170(f)(3), a deduction is only allowed when a charitable contribution is made for the entire interest of the property. By its definition, an easement is a partial interest, but a qualified conservation contribution granted in perpetuity is generally exempt from the partial interest rule under §170(f)(3)(B)(iii).  However, the court found that the conservation easement contribution in this case is not exempt since there was a possibility that the organization would return the easement to the donor.

The donor made the argument that because the side letter was unenforceable under state law, the contributions were not actually conditional.  The court did not agree with the donor, stating that the possibility that the organization would nonetheless abandon its rights to honor the side letter was "more than negligible."

Donors wanting deductions for their charitable contributions should be especially careful in making such gifts.  If there is a possibility that the contribution could revert back to the donor in the future, the deduction may be disallowed by the IRS.

Michelle Vesole, J.D., LL.M.

Bloomberg BNA Legal Editor,

 Estates, Gifts & Trust Group