Can Charitable Remainder Trust Assets be Sold Under a Prearranged Plan Without Triggering Capital Gains Tax to the Donor?

Yes.  An example of a qualified prearranged plan would be the so-called Letter of Intent.  Unlike a Purchase and Sale Contract, a qualified prearranged plan is not contractually binding.  There is no legal obligation included in the plan.

Therefore, a Donor who donates assets to a Charitable Remainder Trust (CRT) and, pursuant to a prearranged plan, sells the assets from the CRT, does not realize income as a result of the redemption.  The IRS will treat the sale proceeds as capital gains income to the Donor only if the CRT Trustee is legally bound or can be compelled by the Donor to sell the CRT assets.

The IRS has issued many favorable Private Letter Rulings to CRTs concerning this question.  All of these PLRs incorporate references to Revenue Ruling 78-197 (that involved a Private Foundation).  This Revenue Ruling is reproduced in its entity.

Rev. Rul. 78-197, 1978-1 C.B. 83

IRS Headnote Redemption; charitable contribution followed by a prearranged redemption.  A taxpayer with voting control of a corporation and an exempt private foundation who donates shares of the corporation's stock to the foundation and, pursuant to a prearranged plan, causes the corporation to redeem the shares from the foundation does not realize income as a result of the redemption.  The Service will treat the proceeds as income to the donor under facts similar to those in the Palmer decision only if the donee is legally bound, or can be compelled by the corporation to surrender the shares for redemption.

Full Text of Rev. Rul. 78-197 In Palmer v. Commissioner, 62 T.C. 684 (1974), aff'd on another issue, 523 F.2d 1308 (8th Cir. 1975), the United States Tax Court held that the IRS incorrectly treated a gift of stock to an organization exempt from income taxation pursuant to section 511(c)(3) of the Internal Revenue Code of 1954, followed by a prearranged redemption of the stock, as a redemption of the stock from the donor followed by a gift of the redemption proceeds to the donee.  The Service will follow Palmer on this issue, acq., page 6, this Bulletin.

In Palmer, the taxpayer had voting control of both a corporation and a tax-exempt private foundation.  Pursuant to a single plan, the taxpayer donated shares of the corporation's stock to the foundation and then caused the corporation to redeem the stock from the foundation.  It was the position of the Service that the substance of the transaction was a redemption of the stock from the taxpayer, taxable under section 301 of the Code, followed by a gift of the redemption proceeds by the taxpayer to the foundation.  The United States Tax Court rejected this argument and treated the transaction according to its form because the foundation was not a sham, the transfer of stock to the foundation was a valid gift, and the foundation was not bound to go through with the redemption at the time it received title to the shares. 

Also see, Grove v. Commissioner, 490 F.2d 241 (2nd Cir. 1973); Behrend v. United States, No. 72-1153, 72-1156 (4th Cir. 1972); and Carrington v. Commissioner, 467 F.2d 704 (5th Cir. 1973).

The service will treat the proceeds of a redemption of stock under facts similar to those in Palmer as income to the donor only if the donee is legally bound, or can be compelled by the corporation, to surrender the shares for redemption. 

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