A Checklist for Gift Planning with Real Estate
Note: This Charitable Planning in Practice article is the second of two. Last quarter, gift options using real estate were explored. This quarter, the real estate checklist for evaluating charitable gifts of real estate is detailed.
In the Summer Advisor newsletter, we addressed the many ways in which real estate—including personal residences, vacation homes, rental properties, commercial properties, farmland, timber, oil and gas, or undeveloped tracts—can be used for charitable gifts. The article suggested that while there is great flexibility in gift planning, selecting the right gift form and the right vehicle is not always easy.
For donors, real estate may be one of the most difficult and expensive gifts to complete. To complicate matters, many charities do not accept real estate because they do not have the expertise to evaluate the transaction, manage the property after receipt, or are concerned about potential holding costs, realized sales proceeds, or potential liability. While there is no simple formula for donors, charities, or planners, the analysis is easier with a checklist.
The Donor’s Checklist
- Tax benefits and consequences. The donor will generally receive capital gains treatment for most real property held more than one year, but the tax benefits may be lessened because of depreciation, depreciation recapture, or factors creating ordinary income treatment (such as debt structure). The gift’s deduction value will also vary depending upon whether the gift is made to a public (50%) type charity, or a private foundation or charitable remainder trust that can benefit a private foundation (30% charity). Gifts to or for the benefit of public charities allow donor’s to deduct the gift’s market value, while gifts to 30% type organizations are limited to the property’s basis. Finally, if the donor contributes property to charity or to a charitable trust subject to a legal obligation/contract to sell, he will be personally responsible for the gains.
- Valuation, inspection, title, and transfer costs. Donors must bear the cost of a timely appraisal to substantiate the gift value on the tax return on which the deduction is claimed. In addition, many charities require that the donor assume financial responsibility for environmental inspection, a title policy, and other transfer costs. The donor’s obligations should be determined at the outset.
- Valuation realities. Many donors take the first wrong turn when they believe they can get a higher value from contributing the property to charity than selling it on the open market. To facilitate this result, they search for appraisers who “understand” their goals and objectives. Although the penalties on qualified appraisers are great, it is still possible to shop for appraisals, especially those without experience. The advisor should counsel the donor on the realities of valuation, and the increased IRS attention on non-cash gift contributions. Donors should never request—and charities should not honor requests—to hold the property beyond the three-year period in which a Form 8282 must be filed.
- Gift purpose. The advisor must also help the donor understand the goals of the gift and how those goals are affected by the gift asset. Many charities will not accept real estate to create charitable gift annuities, pooled income fund gifts, and gifts requiring specific dollar minimums because of the uncertainty of the ultimate sales price, the delay between gift and sale, and the costs associated with holding and sale.
The Issues for the Charity
1. The type of property. The charity should always determine the type of property being contributed (residential, commercial, rental, farmland, etc.) and how it is held (outright, joint, partnership, LLP, LLC, Sub-S corporation, C corporation). This may impact both the taxation on both the donor and the charity and the marketability of the property.
2. The tax and expense impact on receipt. The charity should have clear policies requiring an environmental assessment prior to contribution to ensure the property is not environmentally damaged. If the property is a part of an ongoing business, or a sub-S corporation, it may generate unrelated business taxable income (UBIT). Debt financed property, as well as certain types of business income will generate unrelated business taxable income to the charity. In a charitable remainder trust, UBIT income will be taxed at 100%. When the charity is the owner, the UBIT must be reported and the tax paid, meaning the charity must be able to cash-flow the tax payments. And finally, it should clearly assess the costs it will incur in the period it holds the property—from taxes, to maintenance, to insurance, and costs of closing.
3. The gift form and/or use. The charity’s gift acceptance policies should limit the use of real property in funding certain types of gifts. These include current-pay charitable gift annuities, pooled income fund gifts, and charitable annuity trusts where the charity is trustee. If real property is contributed to a charitable remainder unitrust where the charity is trustee, the trust should have a net income and/or flip provision, or there should be a plan to make annual payments in the event the property is not sold in the first year. Charities should also be hesitant to fund gifts requiring a minimum dollar value (such as chairs or scholarships) using real estate unless there is an agreement with the donor to make up the short fall.
Real estate is a widely-held and valuable gift option, but it is not right for every transaction. Ask the right questions to ensure your client uses the most effective asset that maximizes the donor’s tax deduction and the benefits to the charity.