87 T.C. 261">*265 A taxpayer may make a charitable contribution by selling property to a charity for less than its fair market value. The amount of the charitable contribution resulting from such a "bargain sale" generally is the excess of the fair market value of the property over its sales price. See Stark v. Commissioner, 86 T.C. 243">86 T.C. 243, 86 T.C. 243">255-256 (1986); Knott v. Commissioner, 67 T.C. 681">67 T.C. 681 (1977); Waller v. Commissioner, 39 T.C. 665">39 T.C. 665, 39 T.C. 665">677 (1963). Section 1011(b) provides as follows with respect to bargain sales:

SEC 1011(b). Bargain Sale to a Charitable Organization. -- If a deduction is allowable under section 170 (relating to charitable contributions) by reason of a sale, then the adjusted basis for determining the gain from such sale shall be that portion of the adjusted basis which bears the same ratio 1986 U.S. Tax Ct. LEXIS 70">*77 to the adjusted basis as the amount realized bears to the fair market value of the property.

In the present case, respondent does not deny that petitioners made a charitable contribution to a qualifying organization through the bargain sale of Weimar to Hewitt. In dispute is the amount by which petitioners' contribution must be reduced under section 170(e)(1). According to respondent, section 170(e)(1) precludes any deduction for the contribution of the Weimar capital gain property. As petitioners admit, this result is prescribed by the regulations under sections 170(e) and 1011(b), which provide in relevant part as follows:

Sec. 1.170A-4. Reduction in amount of charitable contributions of certain appreciated property.

(c) Allocation of basis and gain -- * * *.

* * * *

(2) Bargain sale. (i) If there is a bargain sale of property to the charitable organization and if section 1011(b) and sec. 1.1011-2 apply, then for purposes of applying the reduction rules of section 170(e)(1) and this section to the contributed portion of the property there shall be allocated under section 1011(b) to the contributed portion of the property the portion of the adjusted basis which is not allocated under 1986 U.S. Tax Ct. LEXIS 70">*78 section 1011(b) to the noncontributed portion of the property for purposes of determining gain from the bargain sale. The portion of the adjusted basis which is so allocated to the contributed portion of the property shall be that portion of the adjusted basis of the entire property which bears the same ratio to the total adjusted basis as the fair market value of the 87 T.C. 261">*266 contributed portion of the property bears to the fair market value of the entire property. For purposes of applying section 170(e)(1) and paragraph (a) of this section to the contributed portion of the property in such a case, there shall be allocated to the contributed portion the amount of gain which is not recognized on the bargain sale but which would have been recognized as ordinary income or long-term capital gain if such contributed portion had been sold by the donor at its fair market value at the time of its contribution to the charitable organization.

(ii) If there is a bargain sale of property to the charitable organization and if section 1011(b) and sec. 1.1011-2 do not apply, the taxpayer's adjusted basis of the entire property shall be allocated to the noncontributed portion of the property in accordance 1986 U.S. Tax Ct. LEXIS 70">*79 with paragraph (e) of sec. 1.1001-1 for purposes of determining gain from the sale. In such case, no portion of the adjusted basis shall be allocated to the contributed portion of the property.

(iii) The term "bargain sale", as used in this subparagraph, means a transfer of property which is in part a sale or exchange of the property and in part a charitable contribution, as defined in section 170(c), of the property.

[Emphasis supplied.]

Sec. 1.1011-2. Bargain sale to a charitable organization.

(a) In general. (1) If for the taxable year a charitable contributions deduction is allowable under section 170 by reason of a sale or exchange of property, the taxpayer's adjusted basis of such property for purposes of determining gain from such sale or exchange must be computed as provided in section 1011(b) and paragraph (b) of this section. If after applying the provisions of section 170 for the taxable year, including the percentage limitations of section 170(b), no deduction is allowable under that section by reason of the sale or exchange of the property, section 1011(b) does not apply and the adjusted basis of the property is not required to be apportioned pursuant to paragraph (b) 1986 U.S. Tax Ct. LEXIS 70">*80 of this section. In such case the entire adjusted basis of the property is to be taken into account in determining gain from the sale or exchange, as provided in sec. 1.1001-1(e). In ascertaining whether or not a charitable contributions deduction is allowable under section 170 for the taxable year for such purposes, that section is to be applied without regard to this section and the amount by which the contributed portion of the property must be reduced under section 170(e)(1) is the amount determined by taking into account the amount of gain which would have been ordinary income or long-term capital gain if the entire property had been sold by the donor at its fair market value at the time of the sale or exchange.

* * * *

(b) Apportionment of adjusted basis. For purposes of determining gain on a sale or exchange to which this paragraph applies, the adjusted basis of the property which is sold or exchanged shall be that portion of the adjusted basis of the entire property which bears the same ratio to the adjusted basis as the amount realized bears to the fair market value of the entire property. The amount of such gain which shall be treated as 87 T.C. 261">*267 ordinary income (or long-term capital 1986 U.S. Tax Ct. LEXIS 70">*81 gain) shall be that amount which bears the same ratio to the ordinary income (or long-term capital gain) which would have been recognized if the entire property had been sold by the donor at its fair market value at the time of the sale or exchange as the amount realized on the sale or exchange bears to the fair market value of the entire property at such time. The terms "ordinary income" and "long-term capital gain", as used in this section, have the same meaning as they have in paragraph (a) of sec. 1.170A-4. For determining the portion of the adjusted basis, ordinary income, and long-term capital gain allocated to the contributed portion of the property for purposes of applying section 170(e)(1) and paragraph (a) of sec. 1.170A-4 to the contributed portion of the property, and for determining the donee's basis in such contributed portion, see paragraph (c)(2) and (4) of sec. 1.170A-4. For determining the holding period of such contributed portion, see section 1223(2) and the regulations thereunder.

[Emphasis supplied.]

The regulations thus provide that, in the case of a bargain sale of appreciated property to which section 170(e)(1) applies, no deduction is allowable unless the 1986 U.S. Tax Ct. LEXIS 70">*82 contribution (i.e., excess of fair market value over sales price) exceeds the "appreciation reduction" (i.e., 50 percent and 100 percent of the inherent capital gain and ordinary income, respectively) for the entire property. Examples in the regulations confirm this rule. See secs. 1.170A-4(d), examples(5)-(6), and 1.1011-2(c), examples (4)-(7), Income Tax Regs.

In the present case, the amount of petitioners' contribution resulting from the bargain sale of the Weimar capital gain property before application of section 170(e)(1), $ 164,794, is less than 50 percent of the total inherent gain in such property, $ 451,846. Therefore, petitioners will be entitled to no charitable contribution deduction unless this aspect of the regulations is invalid.

In urging invalidation of the regulations, petitioners argue that, under section 170(e)(1), their contribution of the capital gain property should be reduced only by 50 percent of the gain inherent in the contributed portion of such property. Because the contributed portion of the captial gain property possessed a fair market value of $ 164,794 and a basis of $ 97,498 ($ 164,794/$ 1,106,478 X $ 654,632), petitioners' contribution under section 170(e)(1)1986 U.S. Tax Ct. LEXIS 70">*83 would be the "actual" contribution, $ 164,794, less one-half of $ 67,296 or $ 131,146. As is discussed further below, this method is 87 T.C. 261">*268 consistent both with the basis allocation rules of section 1.170A-4(c)(1), Income Tax Regs., which apply in all cases except bargain sales, ^{41986 U.S. Tax Ct. LEXIS 70">*84} and with the regulations' allocation provisions for bargain sales where the amount of the contribution exceeds the appreciation reduction under section 170(e)(1).

The Supreme Court has articulated the following standard for determining the validity of Treasury regulations:

regulations command our respect, for Congress has delegated to the Secretary of the Treasury, not to this Court, the task "of administering the tax laws of the Nation." United States v. Cartwright, 411 U.S. 546">411 U.S. 546, 411 U.S. 546">550 (1973); 1986 U.S. Tax Ct. LEXIS 70">*85 accord, United States v. Correll, 389 U.S. 299">389 U.S. 299, 389 U.S. 299">307 (1967); see 26 U.S.C. sec. 7805(a). We therefore must defer to Treasury Regulations that "implement the congressional mandate in some reasonable manner." 389 U.S. 299">United States v. Correll, supra at 307; accord, National Muffler Dealers Assn. v. United States, 440 U.S. 472">440 U.S. 472, 440 U.S. 472">476-477 (1979). To put the same principle conversely, Treasury Regulations "must be sustained unless unreasonable and plainly inconsistent with the revenue statutes." Commissioner v. South Texas Lumber Co., 333 U.S. 496">333 U.S. 496, 333 U.S. 496">501 (1948); accord, Fulman v. United States, 434 U.S. 528">434 U.S. 528, 434 U.S. 528">533 (1978); Bingler v. Johnson, 394 U.S. 741">394 U.S. 741, 394 U.S. 741">749-751 (1969). * * * [Commissioner v. Portland Cement Co. of Utah, 450 U.S. 156">450 U.S. 156, 450 U.S. 156">169 (1981).]

Respondent characterizes the regulations in issue as "legislative," i.e., emanating from a specific congressional grant of authority and not merely from the Treasury's general rule-making power under section 7805(a), a characterization which we shall assume correct for purposes of our 87 T.C. 261">*269 decision. ^{51986 U.S. Tax Ct. LEXIS 70">*87} Moreover, the regulations were issued soon after enactment of the statutory provisions and have survived numerous amendments to section 170(e). Although we have 1986 U.S. Tax Ct. LEXIS 70">*86 found no indication that Congress subsequently approved, or even considered, the aspect of these long-standing regulations that is in issue herein, the regulations are entitled to the highest standard of deference. See, e.g., United States v. Vogel Fertilizer Co., 455 U.S. 16">455 U.S. 16, 455 U.S. 16">24 (1982) (legislative regulation entitled to greater deference); Watt v. Alaska, 451 U.S. 259">451 U.S. 259, 451 U.S. 259">272-273 (1981) (contemporaneous interpretation by administrative agency that proposed the legislation); United States v. Correll, 389 U.S. 299">389 U.S. 299, 389 U.S. 299">305-306 (1967) (legislative reenactment doctrine).

However limited our standard of review, a regulation nevertheless is not valid unless it is reasonable and consistent with the statute's plain language, origin, and purpose. National Muffler Dealers Association, Inc. v. United States, 440 U.S. 472">440 U.S. 472, 440 U.S. 472">477 (1979). As we stated in State of Washington v. Commissioner, 77 T.C. 656">77 T.C. 656, 77 T.C. 656">675-676 (1981), 1986 U.S. Tax Ct. LEXIS 70">*88 affd. 692 F.2d 128">692 F.2d 128 (D.C. Cir. 1982):

even if a regulation is not "technically inconsistent" with the statutory language it seeks to interpret, if it is "manifestly inconsistent" with what Congress "surely * * * intended" to do, then it cannot stand. United States v. Cartwright, 411 U.S. 546">411 U.S. 546, 411 U.S. 546">557 (1973).

* * * See Helvering v. Stockholms Enskilda Bank, 293 U.S. 84">293 U.S. 84, 293 U.S. 84">93-94 (1934), where the Supreme Court stated --

"The intention of the lawmaker controls in the construction of taxing acts as it does in the construction of other statutes, and that intention is to be ascertained, not by taking the word or clause in question from its 87 T.C. 261">*270 setting and viewing it apart, but by considering it in connection with the context, the general purposes of the statute in which it is found, the occasion and circumstances of its use, and other appropriate tests for the ascertainment of the legislative will."

Virtually the only argument advanced by respondent in support of the regulations is based upon the language of section 170(e). Congress provided in section 170(e)(1) that the amount of any charitable contribution of appreciated property must be reduced by the 1986 U.S. Tax Ct. LEXIS 70">*89 relevant percentage (i.e., 50 or 100 percent) of "the amount of gain which would * * * [have been realized] if the property contributed had been sold by the taxpayer at its fair market value." (Emphasis supplied.) Respondent argues that "the property contributed" in the case of a bargain sale must refer to the entire property, not merely the contributed portion. He contends that Congress would have used "the contributed portion of the property" or a similar term had it intended the result advocated by petitioners.

Consistent with the regulations in issue, respondent's argument requires reduction of a charitable contribution, which in the case of a bargain sale equals the contributed portion of the property, by the gain inherent in the entire property, including the portion sold and not contributed. If "the property contributed" is considered not in isolation but in its proper context, however, section 170(e)(1) does not yield such an anomalous result.

The introductory language in section 170(e)(1) provides, "The amount of any charitable contribution of property otherwise taken into account under this section shall be reduced by * * *." (Emphasis supplied.) In the case of a bargain sale, 1986 U.S. Tax Ct. LEXIS 70">*90 only the contributed portion of the property is taken into account under section 170. Indeed, only that portion constitutes a "charitable contribution of property"; the remainder is sold by the taxpayer. Cases involving bargain sales to charity in taxable years before enactment of present section 170(e) confirm this interpretation. See Mason v. United States, 513 F.2d 25">513 F.2d 25, 513 F.2d 25">29 (7th Cir. 1975) ("only the difference between the value of the transferred 87 T.C. 261">*271 asset and the value of the consideration received could even arguably be characterized as the 'amount of the gift'"); Waller v. Commissioner, 39 T.C. 665">39 T.C. 665, 39 T.C. 665">677 (1963) ("The amount of the gift is the difference between the fair market value of the property and the amount which the * * * [recipient] paid therefor * * *.") Thus, in using the term "the property contributed," Congress must have referred to only the contributed portion of bargain sale property.

The unreasonableness of the regulations based solely upon the language of section 170(e)(1) is further illustrated by the distinction drawn in section 1.170A-4(c), Income Tax Regs., between bargain sales and the paradigm contributions of "less than the taxpayer's entire interest" in the 1986 U.S. Tax Ct. LEXIS 70">*91 property. See supra notes 4 & 5. If "the property contributed" in section 170(e)(1) means the entire property, then where the taxpayer contributes a partial interest in property for which a deduction is allowable under section 170(f), the unrealized appreciation on both the contributed and the noncontributed portions should be used in computing the section 170(e)(1) reduction. Unlike the special rules for bargain sales in regulations section 1.170A-4(c)(2), however, the general rules in section 1.170A-4(c)(1), Income Tax Regs., do not prescribe such a result. The statute provides no basis for this distinction between a bargain sale, where the noncontributed portion is sold, and a contribution of a partial interest, where the noncontributed portion is retained by the taxpayer. As is indicated below in our discussion of the purpose behind section 1011(b), Congress provided in that section, not in section 170(e)(1), for the special situation where the noncontributed portion is sold, not retained.

An even more fundamental problem with the regulations in light of the language of section 170(e)(1) is that the regulations define "the property contributed" inconsistently even in the sole 1986 U.S. Tax Ct. LEXIS 70">*92 context of bargain sales. Where, as in the present case, the reduction for appreciation under section 170(e)(1) (computed using the unrealized gain in the entire property) exceeds the contribution element of the bargain sale, "the property contributed" refers to the entire property. Where, however, the amount of the contribution exceeds the section 170(e)(1) amount, the regulations ultimately 87 T.C. 261">*272 define the statutory term as only the contributed portion of the property.

This result in the latter case is best illustrated by an example from the regulations:

Example (4). In 1970, B, a calendar-year individual taxpayer, sells to a church for $ 2,000 stock held for not more than 6 months which has an adjusted basis of $ 4,000 and a fair market value of $ 10,000. B's contribution base for 1970, as defined in section 170(b)(1)(F), is $ 20,000 and during such year B makes no other charitable contributions. Thus, he makes a charitable contribution to the church of $ 8,000 ($ 10,000 value - $ 2,000 amount realized). Since without regard to this section B is allowed a deduction under section 170 of $ 2,000 ($ 8,000 - [$ 10,000 value - $ 4,000 adjusted basis]) for his charitable contribution of 1986 U.S. Tax Ct. LEXIS 70">*93 $ 8,000 to the church, under paragraph (b) of this section the adjusted basis for determining gain on the bargain sale is $ 800 ($ 4,000 adjusted basis X $ 2,000 amount realized/$ 10,000 value of stock). Accordingly, B has a recognized short-term capital gain of $ 1,200 ($ 2,000 amount realized - $ 800 adjusted basis) on the bargain sale. After applying section 1011(b) and paragraphs (a)(1) and (c)(2)(i) of sec. 1.170A-4, B is allowed a charitable contributions deduction for 1970 of $ 3,200 ($ 8,000 value of gift - [$ 8,000 - ($ 4,000 adjusted basis of property X $ 8,000 value of gift/$ 10,000 value of property)]). [Sec. 1.1011-2(c), example (4), Income Tax Regs.]

In computing an initial deduction of $ 2,000, the example reduces the contribution by the entire inherent gain of $ 6,000 and thus defines "the property contributed" in section 170(e)(1) as the entire property. In ultimately allowing a deduction of $ 3,200, however, the example reduces the contribution only by the gain inherent in the contributed portion and thus defines the statutory term as the contributed portion of the property. (The gain inherent in the contributed portion is $ 6,000 X $ 8,000/$ 10,000 or $ 4,800, 1986 U.S. Tax Ct. LEXIS 70">*94 which is the difference between the $ 8,000 contribution and the $ 3,200 ultimate deduction.) Thus, the regulations require use of two inconsistent interpretations of "the property contributed" to compute the deduction in such a case, and the ultimate interpretation is inconsistent with that mandated by the regulations in the present case. There exists no indication that Congress intended the term to possess more than one meaning, and only if "the property contributed" means the contributed portion is a uniform definition applicable to all cases. ⁶

Respondent intimates that the introductory clause of section 1011(b), "If a deduction is allowable under section 170 (relating to charitable contributions) by reason of a sale," supports the methodology prescribed by the regulations. The provisions of section 170, 1986 U.S. Tax Ct. LEXIS 70">*95 including section 170(e), must, of course, be applied to determine whether a charitable contribution deduction is allowable before application of section 1011(b). Section 1011(b) provides no rules, however, for the manner in which section 170 is to be applied. Thus section 1011(b) does not, as respondent and the regulations apparently assume, require application of section 170(e)(1) using the unrealized gain on the entire property. Petitioners' method of computing the section 170(e)(1) amount based upon the appreciation inherent in only the contributed portion likewise requires application of section 170(e) before section 1011(b). ^{71986 U.S. Tax Ct. LEXIS 70">*96} Although petitioners' method results in a charitable contribution deduction, and hence application of section 1011(b), in more cases than do the regulations, this result is mandated by the history and purpose of both section 170(e) and section 1011(b), to which we now turn.

As initially codified by the Revenue Act of 1962, Pub. L. 87-834, sec. 13(d), 76 Stat. 960, 1034, section 170(e) simply provided:

SEC. 170(e). Special Rule for Charitable Contributions of Section 1245 Property. -- The amount of 1986 U.S. Tax Ct. LEXIS 70">*97 any charitable contribution 87 T.C. 261">*274 taken into account under this section shall be reduced by the amount which would have been treated as gain to which section 1245(a) applies if the property contributed had been sold at its fair market value (determined at the time of such contribution).

The scope of the provision was subsequently expanded to include inherent recapture gain under sections 1250(a) and 617(d) by the Revenue Act of 1964, Pub. L. 88-272, sec. 231(b)(1), 78 Stat. 19, 105, and Act Relating to the Income Tax Treatment of Exploration Expenditures in the Case of Mining, Pub. L. 89-570, sec. 1(b)(1), 80 Stat. 759, 762 (1966), respectively. Congress prescribed the present application of section 170(e)(1) to all unrealized non-long-term capital gain and to unrealized long-term capital gain in specified situations as part of the fundamental revision of section 170 in the Tax Reform Act of 1969, Pub. L. 91-172, sec. 201(a), 83 Stat. 487, 549 (hereinafter the 1969 Act).

Section 1011(b) was first enacted in section 201(f) of the 1969 Act (83 Stat. 564). Prior to the effective date of section 1011(b), the taxpayer who made a bargain sale to charity realized gain equal to the excess of the 1986 U.S. Tax Ct. LEXIS 70">*98 amount realized over the entire basis in the property. See, e.g., Potter v. Commissioner, 38 T.C. 951">38 T.C. 951 (1962).

Both the expansion of section 170(e) and the enactment of a bargain sale provision like section 1011(b) were initially recommended to Congress by the Treasury Department. The Treasury proposal with respect to section 170(e) would have applied only to potential ordinary income or short-term capital gain and, instead of requiring the taxpayer to reduce the amount of the contribution, would have allowed a deduction for the full value of the property but required recognition of the gain. See 2 U.S. Treasury Dept., Tax Reform Studies and Proposals, 21, 38, 179-182 (Comm. Print of House Ways and Means Comm. and Senate Finance Comm. 1969). The bill initially passed by the House included a bargain sale provision identical to section 1011(b) and allowed the taxpayer who donated appreciated property to elect either recognition of inherent gain (as would be required by the Treasury proposal) or reduction of the contribution (as required by section 170(e)). Under the House bill, the appreciated property rules applied to inherent long-term capital gain in specified situations. See 1986 U.S. Tax Ct. LEXIS 70">*99 H.R. 87 T.C. 261">*275 13270, 91st Cong., 1st Sess., sec. 201(c), (d) (Aug. 2, 1969). The Senate deleted the bargain sale provision from the House bill and eliminated the option of the taxpayer contributing appreciated property to recognize gain instead of reducing his contribution. ⁸ See H.R. 13270, 91st Cong., 1st Sess., sec. 201(a) (Nov. 21, 1969). As ultimately codified by Congress in the 1969 Act, sections 170(e)(1) and 1011(b) were substantially identical to present law.

The Ways and Means Committee report accompanying H.R. 13270 described the purpose and operation of the appreciated property and bargain sale rules as follows:

3. Charitable contributions of appreciated property (sec. 201(c) and (d) of the bill and secs. 170 and 83 of the code)

Present law. -- Under present law, a taxpayer who contributes property which has appreciated in value to charity generally is allowed a charitable contributions deduction for 1986 U.S. Tax Ct. LEXIS 70">*100 the fair market value of the property. A special rule (sec. 170(e)) applies, however, to gifts of certain property so that the amount of charitable contribution is reduced by the amount of gain which would have been treated as ordinary income under the recapture rules of sec. 617(d)(1) (certain mining property), sec. 1245(a) (certain depreciable tangible personal property), and sec. 1250(a) (certain depreciable real property) if the property contributed had been sold at its fair market value. Other than these exceptions, a deduction is allowed for the full value of the property and tax is not imposed on the appreciation at the time of the gift.

General reasons for change. -- The combined effect, in the case of charitable gifts of appreciated property, of not taxing the appreciation and at the same time allowing a charitable contributions deduction for the appreciation is to produce tax benefits significantly greater than those available with respect to cash contributions. The tax saving which results from not taxing the appreciation in the case of gifts of capital assets is the otherwise applicable capital gains tax which would be paid if the asset were sold. In the case of many 1986 U.S. Tax Ct. LEXIS 70">*101 other types of assets, this tax saving is at the taxpayer's top marginal rate. Thus, in some cases it actually is possible for a taxpayer to realize a greater after-tax profit by making a gift of appreciated property than by selling the property, paying the tax on the gain, and keeping the proceeds. This is true in the case of gifts of appreciated property, which would result in ordinary income if sold, when the taxpayer is at the high marginal tax brackets and the cost basis of the ordinary income asset is not a substantial percentage of the fair market value. For example, a taxpayer in the 70-percent tax bracket could make a gift of $ 100 of inventory ($ 50 cost 87 T.C. 261">*276 basis) and save $ 105 in taxes (70-percent of the $ 50 gain if sold, or $ 35, plus 70-percent of the $ 100 fair market value of the inventory, or $ 70).

In addition, if property is sold to a charity at a price less than its fair market value -- a so-called bargain sale -- the proceeds of the sale are treated as a return of the cost and the seller is allowed a charitable contributions deduction for the appreciation in excess of the sale price. If the sale price is above his cost basis, the taxpayer pays a tax on the difference. 1986 U.S. Tax Ct. LEXIS 70">*102 However, if the sale price is equal to his cost basis, the entire appreciation is taken as a deduction and no tax is paid on the gain. In either case, the taxpayer is not required to allocate the cost basis between the sale part of the transaction and the gift part of the transaction. If this were done, the taxpayer would be required to pay tax on the portion of the gain attributable to the sale part of the transaction.

The tax saving available in the case of a bargain sale of property to a charity may be illustrated by the example of a taxpayer in the 70-percent tax bracket who makes a sale of inventory with a value of $ 200 to a charity at its cost of $ 100. The taxpayer in this case would save $ 140 in taxes with respect to his $ 100 charitable gift (70 percent of the $ 100 gain if sold, or $ 70, plus 70 percent of the $ 100 of appreciation taken as a charitable deduction, or $ 70).

Your committee does not believe the charitable contributions deduction was intended to provide greater -- or even nearly as great -- tax benefits in the case of gifts of property than would be realized if the property were sold and the proceeds were retained by the taxpayer. In cases where the tax 1986 U.S. Tax Ct. LEXIS 70">*103 saving is so large, it is not clear how much charitable motivation actually remains. It appears that the Government, in fact, is almost the sole contributor to the charity. Moreover, an unwarranted benefit is allowed these taxpayers, who usually are in the very high income brackets. Your committee, therefore, considers it appropriate to narrow the application of the tax advantages in the case of gifts of certain appreciated property.

Explanation of provisions. -- In order to remove some of the present tax advantages of gifts of appreciated property over gifts of cash, the bill provides that taxpayers making contributions of appreciated property are to be required, at their option, either (A) to reduce their charitable contribution deduction to the amount of their cost or other basis in the property or (B) to take a charitable deduction based on the fair market value of the property but to include in their tax base the untaxed appreciation with respect to the property involved. * * *

* * * *

(v) Bargain sales. -- In the case of so-called bargain sales to charities -- where a taxpayer sells property to a charitable organization for less than its fair market value (often at its cost 1986 U.S. Tax Ct. LEXIS 70">*104 to the taxpayer) -- the bill provides that the cost or basis of the property is to be allocated between the portion of the property "sold" and the portion of the property "given" to the charity on the basis of the fair market value of each portion. For example, if a taxpayer sold land with a fair market value of $ 20,000 to a charitable organization (which was not a private foundation) at his cost of 87 T.C. 261">*277 $ 12,000, he would be required to allocate 60 percent of the cost ($ 7,200) to the portion "sold" to the charity ($ 12,000) and 40 percent of the cost ($ 4,800) to the portion "given" to the charity ($ 8,000). Thus, this taxpayer would be required to include $ 4,800 as gain from a sale of a capital asset in his tax return, and as under present law would be allowed a charitable contributions deduction of $ 8,000.

[H. Rept. 91-413 (1969), 1969-3 C.B. 200, 234-236.]

The committee's explanation of the bargain sale rule (i.e., the final paragraph in the above excerpt) does not support the approach of the regulations in issue. The report simply indicates that basis must be allocated between the portion "given" and the portion "sold." It contains no indication that Congress intended a special 1986 U.S. Tax Ct. LEXIS 70">*105 rule similar to that in the regulations to apply where the property is subject to section 170(e)(1).

The Ways and Means Committee nevertheless illustrated the operation of the bargain sale rule using an example to which section 170(e)(1) would not apply, as the taxpayer in the example sold a capital asset to an organization "which was not a private foundation." Indeed, the entire explanation provides almost no explicit guidance with respect to the interaction of section 170(e)(1) and the bargain sale rule but instead describes each rule as if it existed in isolation. The bargain sale example appearing in the "General reasons for change" section states that the taxpayer selling inventory for less than fair market value would, but for the bargain sale rule, avoid taxes on and obtain a deduction with respect to the inherent gain. If the House's appreciated property rule were in effect, however, this presumably would not be the case, as the taxpayer would be required either to reduce his contribution or to recognize gain on the contributed portion.

The report also generally indicates that the appreciated property and bargain sale rules possess a common purpose of preventing the taxpayer 1986 U.S. Tax Ct. LEXIS 70">*106 from obtaining a deduction attributable to untaxed appreciation ("in excess of the sale price," in the case of bargain sales). Such statements do not specify the respective element of appreciation to which the two rules apply. The Finance Committee and Conference reports preserve this ambiguity by describing both the bargain sale rule and the various applications of section 170(e) as "[taking] the appreciation in value into account for 87 T.C. 261">*278 tax purposes in gifts of appreciated property." S. Rept. 91-552 (1969), 1969-3 C.B. 423, 476; H. Rept. 91-782 (Conf.) (1969), 1969-3 C.B. 644, 654. Certain language in the legislative history thus blurs the respective parameters of section 170(e)(1) and section 1011(b).

Although describing the two rules in isolation, more specific statements of purpose contained in the Ways and Means Committee report nevertheless allow us to infer congressional intention with respect to the interaction of the sections. The report indicates that section 170(e)(1) was designed to prevent a taxpayer from realizing a windfall by giving appreciated property to charity instead of selling the property and donating the proceeds. As illustrated by the election contained in 1986 U.S. Tax Ct. LEXIS 70">*107 the initial House bill to recognize the appreciation and deduct the full fair market value, reduction of the contribution under section 170(e)(1) is a functional substitute for a deemed sale of the property before contribution of the proceeds. Where a transaction constitutes an actual sale, however, this "deemed sale substitute" of section 170(e)(1) is inappropriate. Moreover, Congress recognized that a bargain sale to charity included an actual sale. This recognition is implicit in the Ways and Means Committee statement that the bargain sale rule requires "the taxpayer * * * to pay tax on the portion of the gain attributable to the sale part of the transaction" and explicit in the initial Treasury proposal, which quantifies precisely the element of appreciation taken into account:

Under existing law a donor may unduly magnify the tax advantages already inherent in giving appreciated property to charity by selling the property to a charity for less than its fair value.

For example, an individual in the 50 percent tax bracket owning $ 125,000 worth of stock which cost him $ 25,000 may wish to make a $ 100,000 gift to charity. If he donates $ 100,000 of stock to charity he 1986 U.S. Tax Ct. LEXIS 70">*108 is entitled to a $ 100,000 deduction against other income and the net cost of his gift is $ 50,000 (50 percent of $ 100,000). He simply ignores the fact that a portion of the value of donated stock ($ 80,000) represents gain which has never been included in income. On the other hand, were he to follow the bargain sale method, he would sell $ 125,000 of stock to the charity for the cost basis of that amount of stock, $ 25,000. Under the present law the $ 25,000 sales proceeds would first be allocated to a return of his cost, or tax basis, and, since that basis is $ 25,000, there would be no tax. His gift to the charity would remain a $ 100,000 gift, 87 T.C. 261">*279 and his deduction would remain a $ 100,000 deduction. However, by following this procedure, instead of being left with $ 25,000 of stock with a cost basis of $ 5,000 (which if he later sold would cost him $ 5,000 in tax thus leaving him $ 20,000 in cash) he has $ 25,000 in cash. Thus, his $ 100,000 gift to charity has permitted him to recover his investment in the property while at the same time securing a deduction for the appreciation in value without imposition of tax.

The rule permitting the nontaxable donation of appreciated 1986 U.S. Tax Ct. LEXIS 70">*109 property clearly should not be permitted to shield from tax what is essentially a functionally unrelated sale of an additional amount of stock. The taxpayer intends to benefit the charity only by the net amount of the gift. He should not be allowed to enlist the charity as a buyer of his stock to save him a tax liability.

In such cases it is recommended that a contributor be required to allocate the basis of the property between the gift element and sale element on the basis of the fair market value of each part. If this rule were applied to the example above, since one-fifth of the total value of the stock is being sold, one-fifth of the taxpayer's basis in the stock would be allocated to the sale element of the transaction. Thus, he would be deemed to have a $ 5,000 basis in the stock sold to the charity for $ 25,000, and would be subject to tax on the resulting $ 20,000 gain. Under the proposal the individual would therefore be in precisely the same position he would have been in had he donated $ 100,000 worth of stock to charity and simultaneously sold $ 25,000 more on the open market.

[2 U.S. Treasury Dept., Tax Reform Studies and Proposals 181-182 (Comm. Print of House1986 U.S. Tax Ct. LEXIS 70">*110 Ways and Means Comm. and Senate Finance Comm. 1969). Emphasis supplied.]

Section 1011(b) was thus designed to recognize the sale element of a bargain sale for what it is -- a sale. This section, not section 170(e)(1), ensures that the taxpayer receives no contribution deduction without realizing inherent gain on the portion of the property sold. Most importantly, the mechanism by which section 1011(b) accomplishes this result is realization of such gain, not reduction of the deduction. ^{91986 U.S. Tax Ct. LEXIS 70">*111}

87 T.C. 261">*280 The regulations therefore understate both the deduction and the realized gain by the amount of the taxpayer's basis in the contributed portion of the property where the section 170(e)(1) amount (computed with respect to the entire property) equals or exceeds the amount of the contribution. If the property is capital gain property, the regulations also improperly reduce the contribution by 100 percent of the gain on the contributed portion. The regulations thus both preclude section 1011(b) from its intended operation and place the taxpayer in a less favorable position than would result if he sold the property at fair market value and then donated the excess over the bargain sales price. The latter effect distorts and unduly extends Congress' manifest purpose in enacting the "deemed sale substitute" through section 170(e)(1). ^{101986 U.S. Tax Ct. LEXIS 70">*112 1986 U.S. Tax Ct. LEXIS 70">*113}

Moreover, this distortion arises immediately and arbitrarily depending upon the bargain sales price. If, for example, the amount of the contribution (excess of fair market value over sales price) is $ 1 more than the section 170(e)(1) amount, the regulations prescribe the proper basis and gain allocations between the contributed and sold portions of the property. If the sales price is increased by $ 1, however (in which case section 170(e)(1) as interpreted by the regulations reduces the contribution to zero), the distortion occurs in full. Certainly this is an "arbitrary and capricious" effect, and Congress could not have intended 87 T.C. 261">*281 that such insignificant economic differences would result in such dramatic differences in tax liability.

Given the respective roles of the Treasury Department in administering the tax laws and of this Court in interpreting such laws, we do not invalidate Treasury regulations unless unreasonable and inconsistent with the language, history, and purpose of the statute. As previously discussed, the regulations in issue in this case are entitled to the highest standard of judicial deference. 1986 U.S. Tax Ct. LEXIS 70">*114 If the regulations constituted a reasonable interpretation of sections 170(e)(1) and 1011(b), we would be compelled to uphold them, even if petitioners' interpretation were more reasonable. See Long v. United States, 652 F.2d 675">652 F.2d 675, 652 F.2d 675">679 (6th Cir. 1981), and cases cited therein. "The choice among reasonable interpretations is for the * * * [Treasury], not the courts." National Muffler Dealers Association, Inc. v. United States, 440 U.S. 472">440 U.S. 472, 440 U.S. 472">488 (1979). In the present case, however, petitioners' position represents the only rational statutory interpretation. Respondent has not raised, nor have we discovered, a single rational basis for the allocation provisions in issue other than enhancement of tax revenues. That purpose, however, cannot be applied in an arbitrary manner and is inconsistent with both allowance of charitable contribution deductions and reduced effective rates of taxation of capital gain. The disputed regulations conflict with the language and purpose of the statutory provisions and lead to anomalous and inequitable tax results. Cf. State of Washington v. Commissioner, 77 T.C. 656">77 T.C. 656 (1981), affd. 692 F.2d 128">692 F.2d 128 (D.C. Cir. 1982). To the extent inconsistent with our 1986 U.S. Tax Ct. LEXIS 70">*115 opinion herein, sections 1.170A-4(c) and 1.1011-2, Income Tax Regs., are invalid. ¹¹

To reflect concessions by petitioners,

Decision will be entered under Rule 155.

However, in lieu of accepting this 30-percent limitation for contributions of capital gain property, a taxpayer may make an election under section 170(b)(1)(C)(iii) to apply 87 T.C. 261">*291 section 170(e)(1)1986 U.S. Tax Ct. LEXIS 70">*134 to all contributions of capital gain property (to which subsection (e)(1)(B) does not otherwise apply) made by the taxpayer during the taxable year. ⁵ If the election is made, the taxpayer must reduce the amount of the charitable contributions deduction otherwise allowable under section 170(b)(1)(C) by 50 percent of the gain that would have been long-term capital gain if the contributed property had been sold by the taxpayer at its fair market value determined at the time of such contribution. ^{61986 U.S. Tax Ct. LEXIS 70">*135} The effect of the election is twofold: First, the election removes the otherwise allowable charitable contribution from the 30-percent limitation under section 170(b)(1)(C) and removes the capital gain property taint from the contribution. ⁷

With respect to a bargain sale 1986 U.S. Tax Ct. LEXIS 70">*136 transaction, to accept the position that an election under section 170(b)(1)(C)(iii) requires the application of section 170(e)(1)(B) in accordance with section 1.1011-2(a)(1), Income Tax Regs., is simply, in my opinion, an erroneous application of the statute and the regulations. Both section 170(b)(1)(C)(iii) and section 1011(b) (and section 1.1011-2(a)(1), Income Tax Regs.) require reductions under section 170(e)(1). However, when interpreted and applied in the proper sequence within the entire statutory and regulatory framework, these two reductions operate in different spheres and are, in my opinion, mutually exclusive. I will demonstrate below what I believe to be the proper sequence and proper application of the statute and regulations.

87 T.C. 261">*292 In a bargain sale transaction, section 170(e)(1) is applied under section 1.1011-2(a)(1), Income Tax Regs., to reduce the amount of the charitable contribution (fair market value - amount realized). The purpose of this initial application is to determine whether or not any charitable contributions deduction is allowable so that the basis of the property must be apportioned as provided in section 1011(b) and section 1.1011-2(b), Income Tax Regs.1986 U.S. Tax Ct. LEXIS 70">*137 This is what is referred to above as the allowability test for the particular piece of property. Indeed, section 1.1011-2(a)(1), Income Tax Regs., by clear and unambiguous language specifically limits the application of section 170(e)(1)for such purposes. After this initial allowability determination has been made for the particular piece of property, section 1.1011-2(a)(1), Income Tax Regs., has no further applicability. In contrast, the reductions contemplated by section 170(e)(1)(B) pursuant to an election under section 170(b)(1)(C)(iii) apply to all contributions of capital gain property made during the taxable year. The position advanced by the parties as their litigating position and accepted by the majority necessitates a different treatment for contributions of capital gain property to which the election applies depending on whether such contributions were outright gifts or were made in connection with a bargain sale. I do not think that the election under section 170(b)(1)(C)(iii) was ever intended to draw such a distinction. Indeed, in the absence of an election, the amount of the contribution of capital gain property that is not otherwise subject to section 170(e)(1)(B)1986 U.S. Tax Ct. LEXIS 70">*138 (and the only capital gain property to which an election could apply) is fixed and ascertained and is otherwise allowable under section 170(b)(1)(C) subject only to the percentage limitations contained therein. The interpretation accepted by the majority requires a quantum leap backward from section 170(b)(1)(C)(iii) back to section 1.1011-2(a)(1), Income Tax Regs., which I do not think is mandated either by the statute or the regulations. Having once satisfied section 1011(b) and section 1.1011-2(a)(1), Income Tax Regs., in the initial determination that some charitable contribution is allowable and that basis must be allocated, there is no need to return to section 1.1011-2(a)(1). I think the election under section 170(b)(1)(C)(iii) requires the application 87 T.C. 261">*293 of section 170(e)(1)(B) computed under section 1.170A-4(c)(2) and (3), Income Tax Regs., and not under section 1011-2(a)(1), Income Tax Regs. Thus only the property contributed in the bargain sale is taken into account in that computation. Accordingly, I would analyze the instant case in the following manner.

Petitioners in the instant case sold capital gain property to a section 170(b)(1)(A) organization for the amount of 1986 U.S. Tax Ct. LEXIS 70">*139 $ 941,684. The fair market value at the time of the sale was $ 1,106,478, resulting in a charitable contribution of $ 164,794. The taxpayer's basis in the property was $ 654,632 that reflected the potential recapture of depreciation in the amount of $ 43,392. However, since neither the majority opinion nor the parties' briefs otherwise indicate, it is assumed that no portion of this depreciation will be treated as ordinary income on disposition of the property.

My analysis begins with section 1.1011-2(a)(1), Income Tax Regs., since the transaction was a bargain sale to a charitable organization. Under section 1.1011-2(a)(1), Income Tax Regs., it must be determined whether or not any charitable contributions deduction is allowable under section 170. If a deduction is allowable under section 170, then the basis of the property must be allocated between the sale portion and the contributed portion of the bargain sale. In making this initial determination, the contribution of property must be reduced under section 170(e)(1), determined as if the entire property had been sold by the donor at its fair market value at the time of the sale. This is the mandatory reduction under section 170(e)(1). 1986 U.S. Tax Ct. LEXIS 70">*140 The taxpayer made a charitable contribution in the amount of $ 164,794 (1,106,478 fair market value - 941,684 amount realized). If the property had been sold at its fair market value at the time of its contribution, $ 451,846 of gain would have been realized. However, since no part of this gain would have been ordinary income, no mandatory reduction is required under section 170(e)(1)(A). Moreover, at this stage, no mandatory reduction is made under section 170(e)(1)(B) since that section does not otherwise apply. ^{81986 U.S. Tax Ct. LEXIS 70">*141} Accordingly, after applying 87 T.C. 261">*294 section 1.1011-2(a)(1), Income Tax Regs., a charitable contributions deduction in the amount of $ 164,794 is allowable under section 170 subject only to the percentage limitations of section 170(b), and the basis of the property must be apportioned. At this point, section 1.1011-2(a)(1), Income Tax Regs., has no further applicability and the provision in regard to the gain on the entire property has served its limited purpose. Petitioners have passed this initial allowability test, and basis of the particular property must now be allocated.

Pursuant to section 1011(b) and section 1.1011-2(b), Income Tax Regs., petitioners have an adjusted basis of $ 552,133 for the part of the property constituting the sale (adjusted basis X amount realized/fair market value of entire property) (654,632 X 941,684/1,106,478), resulting in a total gain of $ 384,551 (941,684 - 557,133), all of which is long-term capital gain. Under section 1.170A-4(c)(2)(i), Income Tax Regs., petitioners' adjusted basis for the property contributed is $ 97,498 (adjusted basis X fair market value of contributed property/fair market value of entire property) (654,632 X 164,794/1,106,478). Basis having now been allocated, the next step is to compute the amount of the charitable contributions deduction to be allowed.

The charitable contribution of $ 164,794 (fair market value - amount realized) is now treated essentially in the same manner as an outright gift of capital 1986 U.S. Tax Ct. LEXIS 70">*142 gain property to an organization described in section 170(b)(1)(A). Accordingly, the fair market value of the contributed property must be reduced by the amounts required under section 170(e)(1). If the contributed property had been sold at its fair market value, the taxpayer would have realized a total gain of $ 67,296 (164,794 - 97,498) all of which would have been long-term capital gain. Sec. 1.170A-4(c)(3), Income Tax Regs. Since no part of this gain attributable to the contributed property would have been ordinary income, no reduction is required under section 170(e)(1)(A). Moreover, no reduction is necessary under the express language of section 170(e)(1)(B), since that section does not otherwise apply. At this stage, petitioners are otherwise allowed a 87 T.C. 261">*295 charitable contributions deduction of $ 164,794 subject to the 30-percent limitation under section 170(b)(1)(C). However, petitioners have elected to have section 170(e)(1) apply to all of their contributions of capital gain property made in the year 1977, and the only contribution of capital gain property is this amount of $ 164,794.

Accordingly, the amount of $ 164,794 is reduced under section 170(e)(1)(B) by 50 percent 1986 U.S. Tax Ct. LEXIS 70">*143 of the gain that would have been long-term capital gain if the contributed property had been sold at its fair market value at the time of the contribution. However, at this stage we do not go back to section 1.1011-2(a)(1), Income Tax Regs., because basis has already been allocated. Thus, the $ 164,794 is reduced by the amount of $ 33,648 (50 percent of 67,296) (451,846 X 164,794/1,106,478) (long-term capital gain X fair market value of contributed property/fair market value of entire property). This gives petitioners a deduction in the amount of $ 131,146 for the contributed portion of the bargain sale, subject to the percentage limitations of section 170(b)(1)(A). ^{91986 U.S. Tax Ct. LEXIS 70">*144} This charitable contributions deduction can be carried over from the year of the bargain sale (1977) to the years before the Court (1978 and 1979). This would also mean that an adjustment would have to be made to the sale portion since respondent in the statutory notice of deficiency allocated all of the basis to the sale portion, thus decreasing the amount of petitioners' taxable gain.

I would hold for petitioners by applying the pertinent statutory and regulatory provisions in the sequence indicated above, thus pretermitting any determination of the validity of the regulations. Accordingly, while I agree with Judge Whitaker's views, I concur with the majority solely as to the result the majority reached. However, since the majority has chosen to invalidate the regulations, I join in Judge Whitaker's dissent.

87 T.C. 261">*296 Whitaker, J. concurring and dissenting: I agree with Judge Parker's well-reasoned concurrence. The application of the statute and the regulations which she advocates is reasonable, well justified under the ambiguous statute here involved, and responds to our obligation to so interpret regulations as to uphold their validity. See United Telecommunications, Inc. v. Commissioner, 589 F.2d 1383">589 F.2d 1383, 589 F.2d 1383">1390 (10th Cir. 1978); 1986 U.S. Tax Ct. LEXIS 70">*145 Miller v. Commissioner, 84 T.C. 827">84 T.C. 827, 84 T.C. 827">845 (1985), on appeal (10th Cir., Nov. 20, 1985). However, the majority has apparently concluded that Judge Parker's analysis is incorrect. Thus, without, in my judgment, an adequate basis therefor, the Court invalidates these long-standing regulations. I must respectfully dissent from the majority's reasoning. Were it necessary to reach the opposite result in order to avoid invalidation of the regulations, I believe we should do so.

When called upon to interpret respondent's regulations, we have been charged by the U.S. Supreme Court time and again to refrain from substituting our judgment as to reasonableness for that of the Secretary. See, e.g., United States v. Correll, 389 U.S. 299">389 U.S. 299 (1967); Bingler v. Johnson, 394 U.S. 741">394 U.S. 741 (1969); National Muffler Dealers Association, Inc. v. United States, 440 U.S. 472">440 U.S. 472 (1979). The majority recognizes that the congressional intent is far from clear, that the regulations were issued "soon after enactment of the statutory provisions" (specifically in 1972) and that Congress has revisited this area on a number of occasions without any adverse comment with respect to the regulations. I have no disagreement with 1986 U.S. Tax Ct. LEXIS 70">*146 the majority's enunciation of the proper standard to apply; I simply disagree that the majority has correctly applied that standard.

In 440 U.S. 472">National Muffler Dealers Association, Inc. v. United States, supra at 477, Justice Blackmun said:

In determining whether a particular regulation carries out the congressional mandate in a proper manner, we look to see whether the regulation harmonizes with the plain language of the statute, its origin, and its 87 T.C. 261">*297 purpose. A regulation may have particular force if it is a substantially contemporaneous construction of the statute by those presumed to have been aware of congressional intent. If the regulation dates from a later period, the manner in which it evolved merits inquiry. Other relevant considerations are the length of time the regulation has been in effect, the reliance placed on it, the consistency of the Commissioner's interpretation, and the degree of scrutiny Congress has devoted to the regulation during subsequent re-enactments of the statute. [Citations omitted.]

The majority's interpretation may well be a more reasonable interpretation of the statute than respondent's, but that is immaterial. In my judgment, since the majority declines 1986 U.S. Tax Ct. LEXIS 70">*147 to accept Judge Parker's analysis, the Court should exercise judicial restraint and look to Congress for clarification of the statute.