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GIFTS OF MONEY AND PROPERTY§ 4.8 STEP TRANSACTION DOCTRINEThis chapter has stated throughout the general rule that a contribution of appreciatedcapital gain property to a public charitable organization is deductible onthe basis of the fair market value of the property and the capital gain element isnot taxable to the donor. 65If, however, the donee charitable organization sells the property soon afterthe contribution is made, the donor may be placed in the position of having torecognize, for federal income tax purposes, the capital gain element. This canhappen when, under the facts and circumstances surrounding the gift, the doneewas legally obligated to sell the gift property to a purchaser that was prearrangedby the donor. In this situation, the law regards the transaction as a sale ofthe property by the “donor” to the third-party purchaser and a gift of the salesproceeds to the charitable organization. 66This is the step transaction doctrine, under which two or more ostensibly independenttransactions (here, the gift and subsequent sale) are consolidated andtreated as a single transaction for federal tax purposes. The key to avoiding thistax-adverse outcome is to be certain that the charitable organization was notlegally bound at the time of the gift to sell the property to the prospective purchaser.67The step transaction rule has been, and continues to be, the subject of considerablelitigation. Several court opinions illustrate the nature of this controversy. Inone, the court ruled that a gift to a charitable organization of the long-term capitalgains in certain commodity futures contracts gave rise to a charitable contributiondeduction, and that the gifts and subsequent sales of the contracts were not steptransactions within a unified plan. 68The case concerned an individual who formed a private operating foundationin the early 1970s and had been president of it since the date it was established.From time to time, he contributed futures contracts to the foundation andclaimed charitable contribution deductions for these gifts. In 1974, he obtained aprivate letter ruling from the IRS that the charitable contributions deductionswere proper and that no gain need be recognized when the foundation sold thecontracts.In 1981, however, the federal tax law was changed. Beginning that year, allcommodities futures contracts acquired and positions established had to be65 See § 4.2.66 E.g., Martin v. Machiz, 251 F. Supp. 381 (D. Md. 1966); Magnolia Dev. Corp. v. Commissioner, 19 T.C.M.(CCH) 934 (1960).67 This sidestep of the step transaction doctrine has its basis in Palmer v. Commissioner, 62 T.C. 684 (1974), aff’don another issue, 523 F.2d 1308 (8th Cir. 1975), to which the IRS agreed in Rev. Rul. 78-197, 1978-1 C.B. 83.In Palmer, a gift of stock in a closely held corporation to a charitable organization, followed by a prearrangedredemption, was not recharacterized as a redemption between the donor and the redeeming corporation and alater gift of the redemption proceeds to the charity. This was the outcome, although the donor held voting controlover both the corporation and the charitable organization. The IRS lost the case because the charity was notlegally bound to redeem the stock, nor was the corporation in a position to compel the redemption.68 Greene v. United States, 806 F. Supp. 1165 (S.D.N.Y. 1992). This case also involved application of the rulesconcerning anticipatory assignments of income (see § 3.1(g)). This case was affirmed in an opinion containingan extensive discussion of the step transaction doctrine as it applies in the charitable giving setting. 13 F.3d577 (2d Cir. 1994). Also see § 3.1(g), last sentence of note 196. 138