In Barney v. Commissioner, T.C. Memo. 2025-133, the United States Tax Court addressed complex issues surrounding the conversion of for-profit entities into nonprofit organizations via a bargain sale. The case serves as a critical study for tax professionals regarding the valuation of distressed assets, the substantiation requirements for charitable contributions under Internal Revenue Code section 170, and the calculation of the amount realized under section 1001 when consideration takes the form of promissory notes.

Factual Background and the Transaction

The petitioner, Carl B. Barney, owned five S corporations that operated for-profit colleges participating in federal student financial aid programs under Title IV. Following the Great Recession, the for-profit college industry faced significant regulatory headwinds, including investigations by the U.S. Senate HELP Committee and new "Gainful Employment" rules proposed by the Department of Education. Facing a decline in enrollment and increased scrutiny, Mr. Barney sought to transition the colleges to nonprofit status.

In 2012, Mr. Barney transferred the S corporations to the Center for Excellence in Higher Education (CEHE), a section 501(c)(3) organization. The transaction was structured as a merger where Mr. Barney transferred his interests in exchange for two secured promissory notes (Purchase Notes) with a total stated principal amount of $431 million.

On his 2012 return, Mr. Barney treated the transaction as a bargain sale. Relying on an appraisal by Barrington Research Associates, Inc., he reported the S corporations had a fair market value (FMV) of approximately $608 million. Consequently, he claimed a charitable contribution deduction of roughly $180 million (the difference between the asset value and the face value of the notes), limited by Adjusted Gross Income to a deduction of $132,428,708 for the year.

Procedural History and Taxpayer Request for Relief

The IRS issued a Notice of Deficiency determining a deficiency of over $31 million and imposing accuracy-related penalties of over $12 million. The IRS disallowed the entire charitable contribution, arguing Mr. Barney failed to establish the requirements of section 170 were met.

In his petition, Mr. Barney disputed the deficiency and affirmatively claimed an overpayment of tax. He argued that subsequent events—specifically a 2015 settlement with CEHE reducing the debt—should retroactively reduce the purchase price for 2012, or alternatively, that the Purchase Notes were contingent debt instruments worth significantly less than their face value. Mr. Barney contended that because the true value of the consideration received was lower than reported, his charitable contribution (and thus his refund) should be larger.

The Court’s Analysis of Bargain Sales and Donative Intent

The Tax Court first addressed the mechanics of a bargain sale. The Court noted that a deduction is allowed under section 170 for a part-sale, part-gift to a charity. The essential inquiry is whether the transaction was a quid pro quo exchange. As the Court stated, "If it is understood that the property will not pass to the charitable recipient unless the taxpayer receives a specific benefit, and if the taxpayer cannot garner that benefit unless he makes the required ‘contribution,’ the transfer does not qualify the taxpayer for a deduction under section 170."

However, a deduction remains available if "(1) the value of the property transferred . . . exceeds the [FMV] of any goods or services received in exchange and (2) the excess payment is made ‘with the intention of making a gift.’".

The Respondent argued that Mr. Barney lacked donative intent and retained too much control over the colleges post-transaction, pointing to his role as the sole member of CEHE and restrictive covenants in the Note Purchase Agreement. The Court rejected this, holding that "the term ’charitable contribution’ as it is used generally in section 170 and the regulations thereunder is synonymous with the term ’gift.’"

The Court found Mr. Barney’s testimony credible regarding his desire to convert the entities to nonprofits. Regarding the retained rights, the Court distinguished between ownership control and creditor protection: "We view Mr. Barney’s role within CEHE as not conclusive of his continued ownership, but rather, as meeting his goals for the Colleges to continue as nonprofit entities, while equally retaining creditor rights."

Valuation of the Transferred S Corporations

A central dispute was the FMV of the colleges at the time of transfer. The taxpayer’s expert (Barrington) valued the entities at approximately $621 million, relying heavily on management’s financial projections. The IRS expert (Saba) valued them at $289 million, and a rebuttal expert (Gilson) placed the value between $200 million and $300 million.

The Court dismissed the taxpayer’s original appraisal as "excessive and self-serving," noting that the conclusions "were based in part upon management’s unreasonable optimistic projections." The Court found the Respondent’s experts more reliable because they accounted for the "struggles facing the for-profit college industry," including "economic struggles and political headwinds" such as the HELP Committee investigations.

Exercising its judgment, the Court adopted the rebuttal expert’s upper-range value, holding: "We will therefore adopt Professor Gilson’s highest value of $300 million as the overall FMV for the S Corporations."

Determining the Amount Realized: Section 1001 vs. Section 108

Having reduced the value of the donated assets to $300 million, the Court had to determine the value of the consideration Mr. Barney received to calculate the charitable contribution component.

Mr. Barney argued that under section 108(e)(5), a 2015 settlement reducing the debt owed by CEHE should be treated as a purchase price reduction for the 2012 tax year. The Court firmly rejected this, citing the annual accounting concept. "Each tax year stands on its own, and we find it entirely inappropriate to apply a purchase price adjustment for 2012 on the basis of events occurring in 2015."

However, the Court accepted the taxpayer’s alternative argument regarding the valuation of the notes under section 1001. While the IRS argued the taxpayer realized the face value of the notes ($431 million), the Court agreed that under section 1001(b), the "amount realized is the sum of money received plus the FMV of property (other than money) received."

The Court agreed with expert testimony that discounts for lack of marketability and liquidity were appropriate for the notes. The Court adopted Professor Gilson’s conclusion that the FMV of the Purchase Notes was $267 million. Crucially, the Court agreed with the Respondent that the transfer was "a single integrated Transaction" and that the "entire contractual arrangement" must be assessed.

Substantiation and Qualified Appraisals

The IRS contended that Mr. Barney’s deduction should be disallowed entirely because the Barrington Appraisal was not a "qualified appraisal" under Treasury Regulation § 1.170A-13(c)(3)(ii)(D). The IRS argued the appraisal failed to account for specific restrictions in the Note Purchase Agreement.

The Court ruled in favor of the taxpayer on this procedural issue. While the appraisal relied on unreasonable estimates, the Court could not conclude "that the report, as a whole, is unqualified and lacks substantial compliance with the applicable Treasury regulations." The Court distinguished this case from others where appraisers omitted easements or permanent restrictions, noting that the "contractual limitations facing CEHE. are ordinary restrictions facing any seller-financed arrangement."

Conclusions and Ruling

The Court’s analysis resulted in a significant adjustment to the figures but a preservation of the bargain sale characterization.

FMV of Assets Transferred: Redetermined to be $300 million (down from ~$621 million).
Amount Realized (Consideration): Redetermined to be $267 million (down from $431 million face value).
Charitable Contribution: The difference between the FMV of the assets ($300 million) and the consideration received ($267 million) resulted in a valid charitable contribution deduction.

The Court held: "Having determined that the amount realized, $267 million, is less than the FMV of the S Corporations transferred under the Transaction, $300 million, we hold the Transaction qualifies as a bargain sale; albeit for an amount less than originally reported."

Consequently, the Court disallowed the originally claimed deduction of $132,428,708 but allowed a recomputed deduction based on the new valuation spread. The Court reserved judgment on whether an underpayment penalty applies or if an overpayment exists until updated computations are furnished by the parties.

Prepared with assistance from NotebookLM.