A qualified charitable remainder unitrust, annuity trust or pooled income fund. Gift Planning with Real Estate
Income, Gift and Estate Tax Deductions for Gifts of Real Estate
For a current outright gift of real estate, the donor can receive an income and gift tax charitable deduction equal to the full fair market value of the property if it is held for more than twelve months and not subject to a reduction for potential depreciation recapture. Further, the donated real estate is removed from the donor's taxable estate for estate tax purposes. Of course, a planned gift of real estate to a charitable remainder trust, pooled income fund, or a charitable gift annuity (where permitted) provides a charitable income tax deduction for the discounted present value of the charity's future interest in the property.
If the real estate is appreciated in value, the income tax deduction is generally limited to 30% of adjusted gross income (AGI), with a five-year carryover for any excess deduction. Of course, a donor may elect a deduction limit of 50% of AGI by reducing the size of the gift by the amount of appreciation.
Gifts of appreciated real property to private non-operating foundations are deductible up to only 20% of AGI. The amount of the deduction is reduced to the lesser of donor's basis or the property's fair market value (FMV). Gifts by C corporations are deductible for the fair market value of the real estate up to 10% of taxable income. Deductions for gifts of real estate by S corporations and limited liability corporations accrue to the shareholders.
If real estate is held by a donor for 12 months or less prior to the gift, or if it is subject to depreciation recapture (e. g. , due to the use of accelerated depreciation), then the deduction amount is reduced to the donor's cost basis--or by the amount of the recapture.
Note: A donor's principal residence is specifically excluded from the recapture rules.
All inventory property held in the course of a donor's trade or business is also ordinary income property. Land lots or homes owned by a real estate developer in the course of his/her business are examples of inventory property. The deduction for a gift of such inventory by the developer would be limited to the cost basis.
Capital Gains Tax Savings for Gifts of Real Estate
An outright donation of appreciated real estate to a qualified charity escapes any capital gains tax on the amount of appreciation.
Capital Gains & Appreciated Real Property
The treatment of capital gains tax liability for a gift of appreciated real estate in exchange for a gift annuity, or to a charitable remainder trust or pooled income fund, would be the same with any other type of appreciated asset such as stock. In the case of a gift annuity where the donor is the current income beneficiary, the capital gains tax liability is ratably spread over the donor's life expectancy. If another person is the current income beneficiary, then the capital gains tax is immediately due and payable.
No long-term capital gains tax is owed for a gift of appreciated property to a pooled income fund.
For outright and planned gifts of real estate, establishing fair market value is essential for determining the charitable deduction and measuring the lifetime income interest of planned gifts. All donations of $5,000 or more require a qualified appraisal.
In calculating the tax liability, appraisal fees are income tax deductible by the donor as an expense. These fees are not a part of the charitable gift and are subject to the income tax limitations on miscellaneous itemized deductions. Your charity's policies should state that the charity will not pay these fees for several reasons:
1. Pursuant to IRS regulations, it is the donor's responsibility to substantiate the deduction amount.
2. The donor may disagree with the appraised value which could present an awkward position for the charity if the appraiser is hired by the charity.
3. A charity may obtain its own appraisal should it question the accuracy (or objectivity) of the donor's valuation.
The appraisal must be made not earlier than 60 days before the date of the contribution, and before the filing of the tax return on which the deduction is first claimed.
To be a qualified appraiser, an individual must hold him/herself out to the public, as such, or perform appraisals on a regular basis, and have qualifications to make appraisals of the type of property being donated. Plus, the state law governing appraisers should be consulted for the state where the real estate is located.
Qualified appraisers may be located through national/local real estate broker firms, appraisal associations, etc. A qualified appraiser may not be the donor, a party to the gift transaction, and/or a party not sufficiently independent of the donor or donee to be considered objective and neutral.
The donor must complete IRS form 8283 and file this form with his/her tax return for the tax year in which the gift is claimed. A copy of the qualified appraisal should be attached to the 8283 form, which is also signed by the appraiser.
If the charity sells the property within two years of the date of the gift, then it is obligated to complete and file the IRS 8282 form which reports the sale price of the property. If the sale price of the property is substantially less than the claimed amount of deduction, then the donor may risk an IRS audit.
A charity must have complete freedom to select the buyer and negotiate the price of donated real estate. While a donor may suggest interested buyers, the donor and/or charity should not enter into any binding legal contract of sale prior to donation. Otherwise, the IRS may attribute to the donor the gain on the sale. Thus, be careful with written letters, memos, contracts, and even oral agreements which may be construed as pre-gift binding contracts.
If real estate subject to a mortgage, debt or other encumbrance is donated, the gift is considered a bargain sale. The charitable contribution is reduced by the amount of outstanding debt, regardless of whether the charity assumes the debt, and even if the donor agrees to pay off the debt after the gift. However, if the donor continues to pay off the debt following the gift, these payments may be deductible gifts.
Any debt assumed by the charity is considered an amount realized by the donor who is taxed on the gain allocated to the sale portion. The donor's tax or cost basis is allocated between the sale and the gift.
Unless the charity puts the encumbered real estate to a "related use", it will likely have debt-financed income. The charity will have to pay unrelated business income tax on net income and capital gains tax if sold. However, these debt-financing rules do not apply for the first ten years after receipt if received by a bequest. The debt-financing rules also do not apply for ten years if the donor is alive but only if the donor owned the real estate for more than five years and the debt was placed on the property more than five years prior to the gift.
The Partial Interest Rule is one of the most important in planned giving--and especially so with gifts of real estate. In general, this rule prohibits a charitable deduction (income, gift and estate tax) for a gift of less than the donor's entire interest in the property (i.e., a "split interest" gift). Certain tightly construed exceptions to this rule are permitted:
A qualified charitable remainder unitrust, annuity trust or pooled income fund.
A gift of all or a portion of the income interest from a qualified charitable remainder trust. Note: A donor cannot deliberately establish a charitable remainder trust with the intent at the inception to donate the income interest.
A qualified charitable lead trust.
A remainder interest in a personal residence or farm.
An undivided portion (not in trust) of the donor's entire interest in the property. Note: A donor can segregate real property into different interests and claim a charitable deduction for donating all or some of the separate interests to charity.
A limited partial interest in real property donated for conservation purposes.
Real estate may be donated to a charitable remainder unitrust or annuity trust. The primary concern with a gift of real estate to a charitable remainder trust is whether the property will produce sufficient income (i.e., rental income) to sustain the income payment obligation of the trust. Further, one may be concerned whether the real estate is readily marketable.
If the property is not marketable, it cannot be sold quickly and the proceeds reinvested to create an income flow. However, for such a difficult property, an "income only" unitrust with a "makeup" feature (i.e., a NIMCRUT) will allow the income payment obligation to wait until the property is sold. A NIMCRUT also allows future contributions to cover any real estate carrying costs, etc.
For more information on these trusts, see the Charitable Remainder Trust section.
"Flip" Charitable Remainder Trust
A "flip" charitable remainder trust is initially in the form of a "net income" charitable remainder trust to which an asset such as real estate may be donated. If the asset remains unsold or does not produce income, then the trustee is not obligated to pay any current income.
However, upon the occurrence of a pre-defined date, event (such as the sale of the real estate), etc. , then the trust changes or "flips" from a net income trust into a regular or standard unitrust which pays a fixed percentage of the trust asset value as revalued annually.
For more information on these trusts, see the Charitable Remainder Trust section.
Obviously, the flip trust offers many unique advantages for gifts of real estate. For example, the donor may contribute real estate to a flip trust in one year and claim a deduction for that year. However, the trust will not be obligated to pay any income until the real estate is sold and the proceeds reinvested to earn income, which may occur in a subsequent tax year.
Funding a charitable remainder trust with encumbered real estate is not advisable. Several problems may arise such as:
Loss of the trust's tax-exempt status (due to imposition of the grantor trust rules)
Excise tax (due to self-dealing or receipt of unrelated business taxable income)
Capital gains tax liability (due to bargain sale treatment)
Alternatives to funding a trust with encumbered property may include payment of the debt by the donor prior to the gift, shifting the debt to other property which will not be given to the trust, and/or converting the debt to personal debt.
Once real estate is donated to a charitable remainder trust, the donor and immediate relatives (e.g., spouse, children, etc.) cannot live on or use the property. To do so would be considered an act of self-dealing and likely result in loss of the charitable deduction, elimination of the trust's tax exempt status and/or imposition of excise tax.
Real estate may be exchanged to a charity for a fixed and guaranteed income pursuant to a gift annuity contract. Any capital gain is ratably spread over the annuitant's life expectancy if the annuitant is the donor (and spouse if jointly owned property is donated).
Technically, this is not a partial interest gift. However, the charity may want to be sure the real estate can be sold or will earn sufficient income to support the annuity income obligation of the charity. The payout rate offered to the donor for the gift annuity may be discounted to reflect carrying costs, taxes, etc. which the charity will bear until the property is sold. Also, establishing a deferred payment gift annuity may allow the charity adequate time to sell the property.
A bargain sale occurs when the charity purchases real estate from a donor at a price less than fair market value as determined by a qualified appraisal. The difference between the sale price and fair market value is a tax deductible gift to charity. The donor's cost basis is allocated proportionally between the sale and gift portions, allowing the donor to escape capital gains tax on the part attributed to the gift. Advantages include a current income tax deduction to offset any gain owed on the "sale" portion, as well as receipt of cash by the donor to reinvest, use as a down payment on other property, etc. The intention to make a gift must be well documented in accompanying correspondence, deed of transfer, etc. The IRS 8283 form must be filed to claim the charitable deduction, with copies of the qualified appraisal, transfer deed, etc. attached.
The installment bargain sale is a variation of the bargain sale in which the payment made by charity is made in installments rather than all at once. As with the typical bargain sale, the donor receives a charitable deduction for the proportion of the property that is donated. Any capital gains are allocated proportionally between the sale and gift portions of the transfer, with capital gains tax owed only on that portion allocated to the sale. The capital gains are reported ratably as the installments are received.
The structure of the payments may be approached with a great deal of flexibility. In fact, the installment bargain sale may be considered when a gift annuity or charitable remainder trust are not feasible. Examples of the flexible uses of this gift planning alternative include:
The installment payments may be any frequency or amount negotiated with the donor. The dollar amounts can vary in size. For example, donors may prefer less income in some years to allow less tax liability. The installment bargain sale income may also be deferred to later year(s).
The installment bargain sale income may be paid to more than two persons, unlike a gift annuity contract. Also, the income from an installment bargain sale may be paid for a term of years exceeding twenty years, unlike a charitable remainder trust.
The donor may continue to live on or use the property after the installment bargain sale has been established, unlike a gift of real estate to a charitable remainder trust.
A donor may contribute a remainder interest in certain real estate to charity, retaining a life estate. To obtain a charitable deduction, the remainder interest must be in a personal residence or farm, but not the proceeds from the sale thereof.
Personal residence includes the principal residence, a vacation home, or condominium. Household furnishings are not included, but fixtures are included.
A farm consists of land used to produce crops, agricultural products or livestock sustenance. It includes barns, farmhouses and improvements.
Under this arrangement, the donor may "live on" and/or "use" the real estate during life, with the property irrevocably being transferred to charity upon death.
The donor receives an income tax charitable deduction for the discounted present value of charity's future interest. This remainder value is determined using the value of the land and improvements, but must be reduced by the value of the life use of the property by the donor.
If the donor decides that he/she no longer needs the personal residence or farm, he/she may donate the existing life estate and receive an additional charitable deduction. The donor must not preplan this alternative. In addition, the donor should use caution with pre-gift documentation to avoid the appearance of pre-gift planning of this alternative.
Other options include leasing or selling the life estate to a third party. The charity and donor could simultaneously sell the life estate and remainder interest to a third party. Also, the charity may consider offering the donor an annuity income in exchange for the life estate.
Prior to accepting a gift of a remainder interest subject to a life estate, a charity and the donor should have separate legal counsel prepare a contract to be signed by both parties to define and describe respective responsibilities. Important components of this agreement include who is responsible for property taxes. If the donor/life estate holder is responsible, then annual verification of payment should be sent to the charity.
Further, the agreement should specify who is responsible for continual maintenance of the property, including a specific schedule of maintenance responsibilities to assure that the property is sufficiently maintained. Finally, the responsibility for property insurance should be assigned, including agreement of coverage amount, special provisions (e.g., earthquake coverage, etc.), and annual verification of premium payment to all parties.
A charitable lead trust is a type of trust arrangement to which an asset such as real estate is donated, earning income for charity during the term of years for which the trust is to operate. At the end of this trust term, the assets in the trust (e.g., real estate) may revert to the donor (grantor) or pass to loved ones such as children or grandchildren depending on the type of lead trust. Gift planning with charitable lead trusts is particularly complex and should always involve legal counsel.
Typically, such a gift would be made to a particular type of lead trust called a qualified nongrantor (nonreversionary) lead trust so that gift tax is currently paid on the value of the remainder interest to children or grandchildren. Ideally, the real estate donated to the lead trust would appreciate in value during the term of the trust.
As a result, the donor pays less in gift taxes when the trust is established as compared to what would have been paid if the donor had waited until years later (or at death) to transfer the property to the children or grandchildren.
The real estate given to the lead trust should produce income (e.g., rental income) to allow for payments to the charity during the term of the lead trust. Unlike a charitable remainder trust, the lead trust is a taxable entity that pays income tax. However, an unlimited charitable income tax deduction is allowed to the trust for its annual distributions to charity.
Depending on applicable state law, income from a lead trust may be defined by the trust document to expressly include realized gain upon the sale of all or a portion of the real estate. This planning technique would be most helpful when the real estate may not earn sufficient income to cover the annuity or unitrust payment obligation of the lead trust.
Qualified Conservation Contribution
A qualified conservation contribution is the contribution of a qualified real property interest to a qualified organization exclusively for conservation purposes, protected in perpetuity [IRC §170(h)(1)]. Such contributions are governed by applicable federal and state law (e.g., Uniform Conservation Easement Act as adopted by some states).
What Is a Qualified Real Property Interest?
A qualified real property interest consists of one of three interests: an entire interest in real property (even if the donor retains a qualified mineral interest), a remainder interest in real property, or a perpetual conservation restriction (including an easement, conservation restriction, restrictive covenant or other similar state law provision).
A qualified organization includes governments and publicly supported charities. Conservation purposes include public recreation or education, protection of environmental systems, and/or preservation of open space.
The Tax Court has ruled that charitable gifts of conservation easements on undeveloped lakefront property to a nature conservancy organization were qualified conservation contributions [Glass v. Comm'r, 124 T.C. 258 (2005) aff. 471 F.3d698 (2006); see also Kiva Dunes Conservation, LLC (T.C. Memo 2009-145)].
Computing the Charitable Deduction
A qualified appraisal is necessary to substantiate a deduction value greater than $5,000. As stated in IRS Publication 561, Determining the Value of Donated Property, the method of valuation depends on the type of qualified real property interest donated. A gift of an entire interest would equal the fair market value of the property.
If the mineral interests are not given, then the fair market value of the surface rights is the amount of the contribution. If only a remainder interest is donated, the fair market value of the property multiplied by the appropriate IRS factor adjusted for depreciation or depletion is the amount of the contribution.
If a restriction is given and no comparable sales of other properties are available as a benchmark, then the restriction is valued as the difference between the fair market value of the property before and after the grant of the restriction.
An undivided interest consists of a fraction or percentage of every substantial right that the donor has in the property. A gift of this type of interest is deductible for income, gift and estate tax purposes. The gift must be for the entire term the donor owns. The gift should carry all proportional rights of use and possession. However, such a gift generally reduces the fair market value of the entire property.
This technique may be most useful in a case when the donor gives all of the property at once. In a case like this, the available charitable deduction would far exceed the donor's charitable income tax deduction limits.
Instead, the donor could contribute undivided portions in different years until all of the real estate is donated. Further, some undivided interests could be donated outright with others donated in exchange for a gift annuity to provide additional lifetime income.
Natural resources which may be donated to charity include oil, gas, cut timber, timber rights, timberland, minerals, mineral rights, water, water rights, waterways, and other objects of the earth subject to depletion. State and federal laws apply varied rules as to their characterization of these natural resources as real property, tangible or intangible personal property, etc.
A qualified appraisal is necessary for the donor to substantiate the amount claimed for a deduction. Of course, the recipient charity is likely interested in marketability of the natural resource interest. Donors and charities should consult specialists to assure proper transfer:
Valuation (qualified appraiser)
Transfer of legal ownership (attorney)
Sale (specialized vendors or markets)
Often such specialists are located where such a resource is most plentiful (e.g., Texas for oil interests, Oregon for timber interests, etc.).
A gift of real estate into a pooled income fund is generally not advisable. Similar to a charitable remainder annuity trust, the primary concern for the charity would be the ready marketability of the real estate to assure the timely sale and reinvestment of the proceeds to produce sufficient income to assist with the income payment obligation.
If the property donated to the pooled income fund is not sold, or is sold for less than the fair market value when donated to the fund, problems will ensue. The fund's per unit value is distorted, reflecting greater value than actually represented by the assets in the fund. The fund has added another income beneficiary without any additional income production from the new beneficiary's gift. Therefore, the income paid to each prior beneficiary is less than it would have been otherwise.
If real estate is donated to a pooled income fund, then a depreciation reserve must be established to account for depreciation on the real estate held by the fund.
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