Originally published on Forbes.com.
The brazenness of the charitable plan with the University of Michigan designed to benefit Wolverine Billionaire Stephen Ross revealed in the Tax Court RERI Holdings I decision is stunning.
The Plan
The bare bones of the plan are that RERI, whose principal investor was Mr. Ross, bought an asset (call it “the thing”) which it donated to the University of Michigan toward a $5 million pledge that Mr. Ross had made. Under the gift agreement, UM had to hold onto “the thing” for two years, then sell it. The amount that UM received would be credited to Mr. Ross’s pledge. Round numbers RERI acquired “the thing” for $3 million. When it came time to sell it UM had it appraised at $6 million. UM sold it to a partnership for $2 million under pressure from Mr. Ross who threatened to count that amount towards his pledge, if they ended up getting less. How large was the charitable deduction taken by RERI, of which Ross was the principal investor? That would be $33,019,000.
Mr. Ross is a prominent philanthropist. It is tough to characterize this particular transaction as philanthropic as the claimed tax savings dwarf the amount out of pocket or the amount netted by the University of Michigan. You have to wonder to what extent University development officers knew what was going on. ]Was University of Michigan seeking charitable donations or renting its brand to a tax avoidance scheme?
That’s Not All
The partnership that bought “the thing”, sold it to another “charitable” individual for $3 million. That individual gave it to another charity and took a deduction of $30 million. So “the thing”, which seems to have been worth around $3 million in 2003 generated $60 million in charitable deductions. Who knows? Maybe there was another lather, rinse repeat in 2007.
And it appears that “the thing” was not the only thing that Mr. Ross marked up for donation purposes in fulfilling his $5 million pledge.
As a result of(1) petitioner’s donation of the SMI to the University and (2) other donations to the University of similar properties arranged by Mr. Ross, the University realized $4,276,604 from sales of the donated properties which it credited to Mr. Ross’ $5 million pledge. Respondent alleges that, at least with respect to some ofthose sales, the amounts realized by the University were far less than the appraisals of the properties for which the donors, presumably, claimed sec. 170 deductions.
Early in the litigation, the Tax Court had noted that there might be more to look into.
That chain of events suggests the presence of a scheme to generate large deductions, through application of the sec. 7520 tables, for multiple charitable contributions ofthe same asset, in which each ofthe donors made a small investment. Such a scheme at least suggests tax shelter aspects that the parties may want to address at trial and on brief.
What Was The Thing?
The asset that was used as charitable monopoly mone is described in some detail in one of the appraisals that came up with a value in the vicinity finally accepted by the Tax Court. An entity owned a building, a data center triple net leased to AT&T that was built in 1963 and close to 100% leveraged. The AT&T lease ran to 2016 with three five year renewal options. The holding company had two interests. One was for a term of years and the other was called a Successor Member Interest. The SMI got nothing until 2021 at which point it got everything, assuming there was anything. The SMI was “the thing”.
I am way too conservative and paranoid. My thinking in 2003 would have been “HMMM. A data center built in 1963 that I get in a couple of decades. If Moore’s law keeps working, I’ll be able to fit all that data in a file cabinet. Who is going to need a data center?”. Turns out I was wrong. The data center bought for $43 million in 2002 sold for $79.5 million in 2016. It probably will be worth something in 2021. Of course that didn’t do UM any good, since it was required to sell its interest in 2005.
I have a classmate who rails a lot on facebook about the 1% picking up the tab for all the slackers. He might have a little bit of a point, but I have to wonder how much of the “hard work” that enriches people is the sort of financial engineering embodied in “the thing”, that does not seem to do anything for the real economy.
How It Worked Out
As I noted in a previous post, the IRS won on something of a “gotcha”. The entire deduction, not just the phony marked up part, was disallowed because Form 8283 was not properly filled out. That is an illustration of Reilly’s Fourth Law of Tax Planning – Execution isn’t everything, but it’s a lot.
It Was A Long Haul
This was a 2003 transaction. The Tax Court petition was filed in 2008. There were three separate decisions, with the final one being a couple of weeks ago. How many of these things slid by? And you have to wonder whether even with a 40% penalty on this particular transaction, the strategy work overall.
Of greater concern, is that the IRS ability to root out this sort of stuff continues to erode.
The “Charitable Sector”
Considering this particular scheme, the nonsense that goes on with conservation easements, President Trump’s favorite type of charitable deduction and the trend towards Donor Advised Funds, which can end up being pools of capital that never have to be used for feeding the hungry and giving drink to the thirsty, I’m getting kind of disgusted with the charitable sector. Current tax reform proposals are threatening to scale it back. Maybe that would not be such a bad thing. Abusive transactions like the one caught in the RERI decision might be curbed by limiting the amount of the deduction to basis unless it has a very long holding period or restricting the marked up deduction to marketable securities. Unless the IRS has enough resources, though, even schemes that don’t work legally will work.
Why It Was Supposed To Work
The appraisal that supported the $33,019,000 deduction took the ultimate maturing of the SMI as a virtual certainty. This allowed the use of a very low discount rate under Section 7520 in valuing the future interest. Code Section 7520 is not really meant for interests such as this as the Tax Court noted.
Stephen Gardner of Cooley LLP, attorney for RERI indicated to me that no decision has been made on whether there will be an appeal.