Welcome to CPA at Law, helping individuals and small businesses plan for the future and keep what they have.

This is the personal blog of Sterling Olander, a Certified Public Accountant and Utah-licensed attorney. For over thirteen years, I have assisted clients with estate planning and administration, tax mitigation, tax controversies, small business planning, asset protection, and nonprofit law.

I write about any legal, tax, or technological information that I find interesting or useful in serving my clients. All ideas expressed herein are my own and don't constitute legal or tax advice.

Donations of Closely-Held Business Interests

A charitable donation of long-term capital gain property is a useful tax-planning technique for charitably-inclined individuals. The reason this works is because the donor (1) receives a deduction for the fair market value of the donated asset and (2) avoids paying tax on the built-in gain of the asset. However, in the case of a donation of an interest in a closely-held business taxed as a partnership, two issues often arise which impact this strategy: Business liabilities and ordinary-income property.

Because relief of debt is considered taxable income, a donor who has been allocated a share of a partnership's liabilities and who transfers the interest to a charity is deemed to have engaged in two separate transactions. First, a sale transaction has occurred, whereby the donor realizes income equal to the amount of debt relief. Second, a donation has occurred, whereby the donor makes a contribution equal to the fair market value of the interest less the amount of debt relief. The donor's basis is allocated pro-rata between the two transactions, meaning the donor will recognize and pay tax on the gain arising from the "bargain sale."

The donation is further complicated if the partnership owns ordinary-income property. This is because I.R.C. § 170 requires the amount of a charitable deduction to be reduced to the extent that a sale or exchange of the contributed property would generate ordinary income.

Chapter 7 of the IRS's Partnership Audit Technique Guide contains an example addressing the impact of the debt-relief issue, which I've modified below so that it also illustrates the impact of ordinary-income property, or "hot assets." In this example, an individual donor contributes a partnership interest valued at $50,000 to a public charity. The donor's basis in the interest is $40,000 and the donor is allocated $30,000 of partnership liabilities. In addition, the partnership owns a fully-depreciated piece of equipment which, if sold, would result in $2,000 of ordinary income allocated to the donor. The consequences of this donation on the donor should be as follows:

 Bargain Sale: Footnotes:
 Deemed Proceeds:
 Allocated Basis (pro-rata):
 Gain on Bargain Sale:
 Ordinary Income Portion:
 Capital Gain Portion:
 Gross Donation:
 Ordinary Income:
 Allowable Deduction: 

1. Rev. Rul. 75-194, 1975-1, C.B. 80.
2. Treas. Reg. § 1.1011-2(c).
3. The proper allocation of the gain on the bargain sale between ordinary income and capital gain is not clear. See Jonathan G. Tidd, Charitable Gifts of Limited Partnership and Limited Liability Company Interests, Trusts & Estates, October 2015.
4. I.R.C. § 170(e)(1)(A).