Forgiveness of loan to charity - cash or non cash?

Technical topics regarding tax preparation.
#41
Nilodop  
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If a landlord rents a house to a charity and later decides to transfer the title to the charity, they can take a donation for the fair market value of the house (as opposed to the rental agreement) even though the charity had physical possession of the property both before and after the transfer.

But that's not comparable to the loan. What would be comparable would be if the lender "transfers" his right to collect rent (the lease) to the charity, but does not transfer the deed to the house. And if the charity had fallen on hard times and was unable to pay the rent, that lease would have a reduced FMV. (For discussion purposes only, I am disregarding the other complication - that free rent to a charity is not even deductible).

At the maturity of the note, the lender might have been paid in full (if the charity had recovered financially), but at the time of the transfer/forgiveness, that's not the likely situation, so only the reduced value gets deducted. That note represented the right to collect the principal as well as the interest. The principal will not get repaid, not just because the note was forgiven, but because some major part of it was more than the charity could pay. The right to both has a reduced value at the time of forgiveness.

At the end of the lease, the owner might have been paid all the back rent, but at the time of the forgiveness of the lease, that's not the likely situation, so again only the reduced value gets deducted. That lease represented the right to get back the house as well as to collect the rent. Landlord will, in fact, get back the house, the whole house, despite the charity's financial problems. The house's value did not decrease.

Statd more simply, donating the lease only gives up the right to collect rent, but donating the note gives up the right to collect interest and principal.
 

#42
Chay  
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Nilodop wrote:Statd more simply, donating the lease only gives up the right to collect rent, but donating the note gives up the right to collect interest and principal.

You started out saying that donating a house is not comparable to canceling a note receivable, but then you concluded with this, which shows the exact opposite. Giving a house to its tenant and canceling a note receivable are in fact analogous because each act relinquishes the property that was previously lent.

Perhaps what you meant to say is that the situations are distinct because the likelihood of a creditor recovering cash is significantly lower than the likelihood of a landlord recovering a house. With that there can be no argument. Yes, the risks involved in the two types of arrangements are very different. However, I don't see that fact as relevant to the argument. My property is not any less my property no matter how greatly I subject it to a risk of loss.

To your point about the reduction in fair market value: if a tenant lays waste to my property, the property loses value. If a tenant misses payments on a lease, the lease loses value. If a borrower suffers from financial problems, then the associated note receivable loses value. All of these things are non-cash property whose value is measured in cash. But cash itself cannot lose value in an accounting or tax sense, nor can a lender's interest in borrowed cash be extinguished through the depletion of that cash. Due to fungibility, an interest in future income is just as good as an interest in present cash accounts, so that's the type of interest the lender will have. Sure, the interest is subject to an extreme risk of uncollectibility. This risk will be reflected in the cash value of the note receivable, but it cannot alter the value of the cash itself, and that's the value that matters.
 

#43
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Jeff-Ohio wrote:$6k is left on the note, which the donor cancels. Under your theory – and correct me if I’m wrong - that $6k must be a valid deduction because the donor has relinquished his right to $6k of the $10k he previously lent.

If there is truly no hope of recovering the $6k, then I'd say the lender has sustained a $6k capital loss. Once that line is crossed, I don't see a way to go back and characterize the transaction as a gratuitous transfer. But that has more to do with tax rules related to loss recognition than with the argument I'm making.

If the note cannot yet be determined to be uncollectible, then the lender has the option of forgiving the balance of the note and claiming a charitable cash contribution. But the forgiveness should actually be done with charitable intent and not simply because the lender doesn't feel he'll be able to collect much more on the note.
 

#44
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In my mind, the money is not lent in the sense that a property is rented, it is transferred to the borrower in exchange for a note - a different kind of asset from the liquid, fungible cash. It is more akin to a seller financed sale of property - property exchanged for a note. The lender cannot convert the note back to cash by choosing not to collect it.
 

#45
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OK, let's cut through it this way. It's all quite comparable.
Lending money on a note involves getting interest for use of the money, and getting back the amount of the loan.
Lending property on a lease involves getting rent for use of the property, and getting back the property.
If the charity gets into financial problems while the note is outstanding, we deduct the reduced value of the note when it is forgiven as a charitable gift, taking into account the significant reduction in its value because of inability to repay the principal.
If the charity gets into financial problems while the lease is in effect, we deduct the reduced value of the lease when it is forgiven as a charitable gift, (again for now disregarding the rule that free rent is not a deduction), taking into account the the value of the property, which has not gone down just because the charity can't pay the rent.
So it's all quite comparable.
And the capital loss on the note is personal unless the lender is in the lending business.
 

#46
Chay  
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Nilodop wrote:If the charity gets into financial problems while the note is outstanding, we deduct the reduced value of the note when it is forgiven as a charitable gift, taking into account the significant reduction in its value because of inability to repay the principal.

I've already made my case as to why the lender can claim a deduction for the borrowed cash itself as opposed to the note. That argument is my answer to this claim, which itself is a restatement of ideas you've already expressed.

And the capital loss on the note is personal unless the lender is in the lending business.

I'm not sure why you believe that. See section 165(c):

    (c)Limitation on losses of individuals In the case of an individual, the deduction under subsection (a) shall be limited to—

      (1)losses incurred in a trade or business;

      (2)losses incurred in any transaction entered into for profit, though not connected with a trade or business; and

      (3)except as provided in subsection (h), losses of property not connected with a trade or business or a transaction entered into for profit, if such losses arise from fire, storm, shipwreck, or other casualty, or from theft.
 

#47
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I'm not sure why you believe that.. Yeah, I realized that. I retract that, because once we establish that the gift was not intended when the loan was made, and it's a real note with market rate interest, yes, it's an investment.

But that's all I retract.
 

#48
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Story v. Commissioner, 38 T.C. 936 (1962)

Synopsis by the Court:

Petitioners advanced $45,194.68 to a charitable organization in 1955 to build a chapel and received a promissory note from the organization in the amount of the funds advanced. After consulting their tax advisor at the end of each year, petitioners forgave a portion of the principal amount of the note each year by endorsing on the back thereof the amount canceled by gift. Held, petitioners did not make a gift of the entire amount advanced in 1955. Held, further, petitioners are entitled to deduct as a charitable contribution, to the extent allowed under section 170, I.R.C. 1954, the amount of the indebtedness canceled in each of the years 1955-1958 by endorsements on the back of the note.
 

#49
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Yeah, but Chay doesn’t want to say he has a Receivable. The Receivable is not a distinct asset under Chay’s theory. It is just the mechanism that determines the timing of the deduction. He is also using it to peg the value of the deductible portion of his contribution. But remember: Chay says his current year deduction is in the nature of Cash…cash he gave a long while ago. But he’s saying he really didn’t give it a long time ago, given that he wants to take a current year Cash deduction for it. Thus, what Nilidop and I are calling a Receivable Asset, Chay is calling it a “Cash I gave awhile ago, but I Haven’t Given It Yet” Asset. When Chay pulls the string, the cash is given, even though it was already given. No bad debt deduction for the worthless piece under Chay’s theory. There is no Receivable Asset under Chay’s theory, and hence, there cannot be a loss deduction. What Chay’s asset sounds like, under Chay’s theory, is a prepaid expense, but it isn’t that under any valid theory.

If the contributed amount was $10k, and Chay’s saying it was all cash, and any deduction flowing from the transaction would be a cash deduction, you cannot parse things apart at any point and say, “This much is deductible Cash and this much is non-deductible Cash.” You can’t do that with cash (unless some benefit was received in return). Or unless you have some misguided theory that ignores a Receivable as a separate asset, but uses its existence to determine the timing and value of the tax deduction associated with a long-ago cash advance.
 

#50
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Pitch solved it! All hail Pitch!
 

#51
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Jeff-Ohio wrote:Yeah, but Chay doesn’t want to say he has a Receivable.

Not true. The cash, currently in someone else's possession, is attached to a note receivable and classified under that heading. It's like creating separate accounts for office real estate and rental real estate; one you can use freely in your operations, the other you have devoted to the production of income.

The Receivable is not a distinct asset under Chay’s theory. It is just the mechanism that determines the timing of the deduction.

A note receivable embodies the interest that the lender maintains in the cash they've lent. It's like a title to a property. The note also serves the function of a rental agreement. In an accounting sense, we don't typically create separate asset accounts for rental agreements or titles because assets only show up in the books if there is a dollar figure attached to them. There are plenty of meaningful assets that don't show up in the books, and in this way the note receivable and the cash are two different things even though they don't show up that way in the books.

Chay says his current year deduction is in the nature of Cash…cash he gave a long while ago. But he’s saying he really didn’t give it a long time ago, given that he wants to take a current year Cash deduction for it.

My current year deduction is for cash that I lent a long while ago.

Chay is calling it a “Cash I gave awhile ago, but I Haven’t Given It Yet” Asset.

It's a “Cash I lent awhile ago, but I Haven’t Given It Yet” Asset.

There is no Receivable Asset under Chay’s theory, and hence, there cannot be a loss deduction.

The "receivable asset" is there, and it consists of the cash that's been lent plus the note receivable. There is no problem with a loss deduction for cash.

What Chay’s asset sounds like, under Chay’s theory, is a prepaid expense

A prepaid expense arises when cash is actually paid, not when it's lent. Thus, your theory more closely resembles a prepaid expense than mine.

If the contributed amount was $10k, and Chay’s saying it was all cash, and any deduction flowing from the transaction would be a cash deduction, you cannot parse things apart at any point and say, “This much is deductible Cash and this much is non-deductible Cash.” You can’t do that with cash (unless some benefit was received in return).

You can if you incrementally forgive portions of a loan balance, e.g. Story v. Commissioner (see #48).

Or unless you have some misguided theory that ignores a Receivable as a separate asset, but uses its existence to determine the timing and value of the tax deduction associated with a long-ago cash advance.

My theory actually depends on the note receivable being a separate asset from the cash. Because the note is not the cash, but rather controls the terms of the loan of the cash, it doesn't prevent me from doing as I choose with the cash assuming I do so within the terms of the loan.

jerem200 wrote:Pitch solved it! All hail Pitch!

Indeed. Thanks for your contribution, Pitch.
 

#52
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Code: Select all
Furthermore, the question here is not whether petitioners intended to collect the debt, but whether they intended to make a gift of the amount advanced when it was advanced, or to create an obligation portions of which could be forgiven from time to time as gifts in the future. We think the latter was the case here.
. (From Story).

In our facts, we are working anote where the intent was to collect.
 

#53
Chay  
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Under your theory, creating an obligation results in a loss of ownership of the cash and the cash can no longer be donated, although the obligation itself can be. If true, it shouldn't matter why the lender created the obligation or what they were planning on doing with it; they lose ownership of the cash all the same. Thus, the Story case conflicts with your theory.

I'd also like to point out that your quote doesn't imply that the petitioners did not intend to collect. It only implies that such question was not relevant to the case.
 

#54
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Pitch solved it! All hail Pitch!


It was solved before it started, quite frankly. Chay is merely presenting an alternative argument as to the “type” of deduction we get – cash vs. non-cash.

Indeed. Thanks for your contribution, Pitch.


LOL. LOL to your theory too.

So, the $10k in cash you “lent” to charity 5-years ago, which is now insolvent, magically becomes cash you gave in the current year by virtue of your current year forgiveness of a worthless Receivable. Seems you have a little valuation problem with your theory, as has been previously stated, given that cash donations are fully allowable. Add the valuation problem to all the other problems of your theory. Here is what the acknowledgement might say:

“Thank you kindly for your current year cash donation of $10k. The fair market value of your cash donation is $10k. Please consult your tax adviser about how much you can deduct. No good or services were received in exchange for the cash you gave to us in the current year many years ago.”

You should definitely claim a $10k deduction on your return, Chay, since that’s what the rules for cash donations provides.
 

#55
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Jeff-Ohio wrote:Chay is merely presenting an alternative argument as to the “type” of deduction we get – cash vs. non-cash.

That's not an "alternative" argument, that's the central question of this thread.

So, the $10k in cash you “lent” to charity 5-years ago, which is now insolvent, magically becomes cash you gave in the current year by virtue of your current year forgiveness of a worthless Receivable.

No, it doesn't work if the charity is insolvent. See #43.

Add the valuation problem to all the other problems of your theory.

I believe I addressed the "valuation problem" in #42. I don't think there's anything relevant you or Nilodop have brought that I haven't been able to reasonably incorporate into my theory.

You and Nilodop, on the other hand, have yet to adequately address the issues in #40 and #48.
 

#56
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If true, it shouldn't matter why the lender created the obligation or what they were planning on doing with it; they lose ownership of the cash all the same. Thus, the Story case conflicts with your theory.


It matters if the “obligation” is bona fide or not. That was the seminal question in Story. If bonafide, forgive as time goes by and you get the deduction accordingly. If not bonafide, there was no debt to forgive in the first place. Therefore, the deduction all hits in Year1. That’s the gist of Story. No real mention of the type of the deduction – cash or non-cash. And back then, it might not have mattered. Story has no real relevance to OP’s situation. It doesn’t answer anything. Of course, the Code answers it. And so does the Regulation’s “actually paid” wording. But you apparently don’t like those authorities, nor the Rev Rul, instead opting for the esoteric, magical accounting theories of Post #51.

And here’s a newsflash: When you make a loan, you no longer own the cash. It’s basic. I’m pretty sure that when the charity records the entry to book up the forgiveness, there won’t be any credit to Cash.

Tons of holes in your theory – it applies to this, it doesn’t apply to that, it has to be modified for this, etc., etc., etc. Compare and contrast to a simple theory that passes muster no matter the situation.

In any case, just go tell your clients they don’t need appraisals. Not a big deal…
Last edited by Jeff-Ohio on 11-Oct-2019 7:10am, edited 1 time in total.
 

#57
Chay  
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Jeff-Ohio wrote:It matters if the “obligation” is bona fide or not. That was the seminal question in Story. If bonafide, forgive as time goes by and you get the deduction accordingly. If not bonafide, there was no debt to forgive in the first place. Therefore, the deduction all hits in Year1. That’s the gist of Story.

Correct. An obligation that isn't bona fide is no obligation at all, so it doesn't apply to our facts. The obligation in Story was bona fide, so it does apply to our facts.

No real mention of the type of the deduction – cash or non-cash.

Wrong. The mention is right here:

    And we see no reason why a taxpayer cannot advance money to a charity when it is needed and arrange the transaction in such a manner that he can take full advantage of the charitable deduction provisions of the income tax statutes over a period of years, provided he does not actually part with all dominion and control over the property contributed at the time it is advanced, and truly intends to make a contribution of the property advanced over a period of years rather than all at one time.
The contribution in Story was of "the property advanced". The petitioners did not advance a note receivable. They advanced cash.

But you apparently don’t like those authorities, nor the Rev Rul, instead opting for the esoteric, magical accounting theories of Post #51.

And here’s a newsflash: When you make a loan, you no longer own the cash. It’s basic. I’m pretty sure that when the charity records the entry to book up the forgiveness, there won’t be any credit to Cash.

Tons of holes in your theory – it applies to this, it doesn’t apply to that, it has to be modified for this, etc., etc., etc. Compare and contrast to a simple theory that passes muster no matter the situation.

Your problems with my theory all spring from the fact that you are stuck in an accounting mindset where nothing exists or has relevance unless a dollar figure is attached to it. In such a world, the complexities and nuances of actual property transactions may seem magical.

If you could clear your head of all that and approach things from a practical standpoint, you might find yourself wondering, as I did in #40, what it is exactly that prevents someone from lending money and getting it back later in the same way that any other asset may be lent and retrieved. You might reach the same conclusion I did, which is that the fungibility of cash means there is no problem with such an arrangement.

You, and anyone else who might agree with your accounting-centric theory, should broaden your perspective, read the Story case objectively, and understand that accounting systems don't control real-world transactions but only reflect them to the extent necessary to accomplish a narrow goal.
 

#58
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Wrong. The mention is right here:

You’re reading way too much into this case. The case involved one of these serial forgiveness situations, with some particularly unique facts. We don’t have any of that in the OP. This is presently a “no rule” area for the IRS and has been for a long time. And for good reason.

Your problems with my theory all spring from the fact that you are stuck in an accounting mindset where nothing exists or has relevance unless a dollar figure is attached to it.


I’m really not stuck on a single fact. All I know is that with Cash, basis always equals FMV. Your theory invokes the idea that it doesn’t. Guy lends $10k in cash to charity. He forgives later, when the value of his Receivable is lower than the amount he advanced. If this is really a donation of cash, in the year of forgiveness, there is no way possible for the deduction to be different than the amount advanced. And also note, your theory wouldn’t adequately cover a situaiton when then Receivable was actually worth more than the amount advanced. Seems odd that your theory doesn’t work when value is lower, doesn’t work when the value is higher, but does work when value equals basis. Your theory also falls flat as to the Sec 170 actual payment requirement within the taxable year.

If you could clear your head of all that and approach things from a practical standpoint


My head is pretty clear. Story’s situation was this: He funded construction…hard outlays by the church. Of great importance is that he wanted to control the management and supervision of the project, so he had the charity sign a promissory note. If the charity didn’t do things his way, now he has a backup plan. If the charity did things his way, then here, keep the money I advanced. That was the purpose of the Note and the reason it was bonafide. This is not the situation with a plain old loan, where the evidence of indebtedness exists just so the charity is forced to do things the lender’s/donor’s way. I have no problem with the result and analysis in Story. But it won’t hold up in any factually dissimilar situation, such as the OP’s situation, which involves an ordinary loan from what I can see and no serial forgiveness. And it won’t hold up because it would be inapplicable. Nonetheless, we are all in agreement that when we have bonafide indebtedness – in a serial and non-serial forgiveness situation – we get a deduction upon forgiveness. We’re not debating that point.

There is this passage from Story:

Of course, a gift or contribution to a qualified organization may be made in property and be the basis for a deduction authorized by section 170, and respondent does not argue that if there was a debt from Soldiers Chapel in Nelson's favor, he could not have made gifts or contributions to the organization in 1957 and 1958 by canceling portions of the debt.3

Given that said passage references the old Rev Rul, via Footnote #3, it’s clear that the word “property” is referring to the Note. But I digress, because the whole cash vs. non-cash thing wasn’t really taken up in the case. Like I said, back then, it didn’t matter. Take a look at the 1955 Form 1040. Again, you’re reading a cash vs. non-cash element into the case, and quite frankly, it wasn’t even an issue. In other words, even if the court came right out and said that the contribution was non-cash, in the form of a Note, it wouldn’t have mattered back then. Nowadays, though, it would, given the strict substantiation rules surrounding non-cash donations. With the changed landscape, I can totally see the IRS distinguishing current cases from Story, completely relying on the old Rev Rul, and putting the taxpayer that didn’t get an appraisal in a real bind. And I think the IRS would have a good chance of winning.

In Story, the real focus was on the bonafideness of the debt. Part of that discussion involved some comments about the charity’s financial condition. But that discussion wasn’t surrounding the valuation of the Note. It surrounded the intention of creating bonafide indebtedness and the ability of the charity to repay. But even so, the court was satisfied that the Note could have been paid off. I can totally see the IRS using this idea not just to determine the validity of the Note, but to value it as well. And guess what: The burden of proof is on the taxpayer. If the IRS argues that this is a non-cash contribution, and wins, it makes little difference that the charity could easily pay off the note through non-appraisal evidence.

Further, there is nothing more practical than pointing out that that cash has a basis equal to value. Any theory premised on the fact that I advanced Cash of $10k and my deduction might be something different falls short of being able to classify the donation a cash donation.

Like I said, just tell your clients not to get an appraisal for their ordinary loans to charity…I myself wouldn’t want to chance it. The old Rev Rul is pretty clear when it comes to an ordinary loan.
 

#59
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If this amount of debate is generated from "cash or noncash?", then this is why Congress gets nothing done. ;)
 

#60
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In Story, the real focus was on the bonafideness of the debt.. Which is why I left it out of my posts. It sends some of us offtrack.
 

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