By Bryan K. Clontz, CFP®, CLU®, ChFC®, CAP®, AEP®
Most donors have more of their wealth in real estate than in any other asset type. Despite this, in 2012 (the most recent year for which data is available), the IRS reports that donors gave only $4.5 billion worth of real estate. That may seem significant, but securities donations topped $22.3 billion, while clothing exceeded $9.3 billion. Indeed, real estate gifts were not quite 10% of the fair market value (FMV) of all noncash donations reported on IRS Form 8283—not even including cash contributions.
This may be because the risks and complications that often accompany gifts of real estate require a different expertise to accept, manage, and liquidate—a key aspect as real estate can often be less liquid than other assets.
This article highlights the magnitude of the real estate gift opportunity, reviews types of real estate assets, summarizes key issues organizations and donors face with real estate gifts, and reviews various mechanisms for receiving real estate gifts.
Tax implications of real estate gifts.
Real estate comes in many types, and each type has a number of ownership forms, which can create an array of tax consequences. As the most efficient charitable gift nearly always comes from the lowest adjusted cost basis, highest capital appreciation property held for the long term, real estate is clearly tailor made for charitable giving.
When owners sell real estate, tax rules generally require that any appreciation in value is taxed at capital gains rates-short term for property held less than a year, and long term for over a year. State taxes may apply as well. Additionally, depreciation recapture rules may apply. This means that the proportion of sale proceeds which can be donated to charity is lowered by amounts the donor pays for taxes. Essentially, only after-tax dollars can be donated if the property is sold by the donor.
If the owner donates the real estate directly to the charity, the result can be much more favorable. A direct gift to a public charity means a deduction of fair market value (FMV), limited to 30% of adjusted gross income with a 5-year carry-forward. If the owner instead donates to a private foundation, he or she would receive a deduction based on the lesser of the FMV or the adjusted cost basis. Regulations limit the deduction to 20% of adjusted gross income with a 5-year carry-forward. Note that real estate may be conducive for testamentary funding of a private foundation to the extent the property receives a stepped-up basis. Additionally, the deduction is reduced for any ordinary income elements, and may receive bargain sale treatment if there is debt on the property.
From the charity's perspective, the main tax issue is unrelated business taxable income (UBTI), which gives rise to unrelated business income tax (UBIT). The charity can trigger this treatment if the real estate represents an unrelated business (such as a golf course), or if the property has debt financed income. Charitable remainder trusts are subject to UBTI as well, in the form of a 100% excise tax on the unrelated income.
Risks, challenges, and solutions.
A general risk continuum can be an important starting point for gift acceptance discussions. It can indicate the potential complexity from the donor's perspective—the commitment of dollars, time, and effort. It also may help to identify certain challenges and possible solutions. A common concern is the time needed to explore proposed real estate gifts, especially when the charity may conclude, after many months, that it does not wish to accept the gift.
To avoid this result, the donor's team and the charity should discuss basic and essential information on the gift as early in the process as possible. Similarly, tax and legal questions should be addressed head on, and exposure to potential environmental liability also must be investigated, as it may involve multi-phase assessments.
From a practical perspective, all of the expenses and headaches of real estate ownership-taxes, insurance, utilities, tenant issues, and so on-will simply transfer from the donor to the charity and will continue until the charity can sell the real estate, so lack of marketability can exacerbate or extend these issues.
Ways to donate real estate.
Options abound when it comes to the structure of a real estate gift. There are three general categories that these donations fall into:
- Current gifts,
- Deferred gifts, and
- Life income plans.
Depending on the donor's wishes and needs, some donation structures may be more appropriate, e.g., whether the donor would like income or wants to continue living on the property.
The most intuitive real estate donation is a form of current gift, donating the entirety of the property outright to charity. Donors also can give a smaller proportion of an undivided interest in their land. This means the donor can give some proportion of their interest that is less than 100%—half, a quarter, or any amount that is a "full slice" of the ownership interest. For example, a donor should not donate half of their mineral rights in property they otherwise own outright.
Another current gift is the charitable lead trust, which puts the real estate in a trust with income to be paid to the charity for life or a term of years. At the end of the payment term, the remainder or residual may be paid to the donor or to loved ones chosen by the donor. Inter vivos or lead trusts established during life offer no step-up in basis of the land received for heirs, whereas a testamentary lead trust permits a step-up in basis when the heirs inherit the assets.
Deferred gifts can be intuitive as well, after all, bequests in a will or revocable living trust are the most popular form of planned gift. Of course, prior to acceptance upon the death of the donor, the charity must conduct due diligence pursuant to its policies and procedures as explained above. An alternative to a bequest in a will or trust is a transfer on death (TOD) deed that may be allowed under state law.
Another type of deferred gift of land is the irrevocable gift of a remainder interest in a personal residence or farm with a life estate retained by the donor. This technique is particularly helpful where the donor wants to use the property for life but the charity wants to ultimately use or sell the property. The donor and charity must sign an agreement stipulating respective rights and responsibilities relative to property tax, insurance, and maintenance.
Finally, there are life income options such as charitable remainder trusts and charitable gift annuities. A charitable gift annuity is a contract where the donor contributes assets such as land and the charity provides fixed and guaranteed income for one or two lives. If land is donated, then the charity either may sell the land to fund the annuity or it may draw from its budget or endowment to fund the annuity payments. A deferred payment gift annuity can permit time for the charity to sell the land.
Charitable remainder trusts allow the donation of highly appreciated property, such as land, that the trustee may then sell without payment of capital gains tax. The cash proceeds can then be invested to earn income for the named beneficiaries. The trust can either pay a unitrust or annuity trust format. An annuity trust pays a fixed dollar amount; real estate must either produce income or be sold to satisfy the fixed payment amount obligation.
The unitrust format pays a fixed percentage of the trust value, either from income and principal or from the lesser of the fixed percentage amount or net income. The net income format is appealing since this allows time to sell the land to fund the payment obligation. It can even "flip" from a net income type unitrust to a standard unitrust after the land sells.
Real estate offers many ways to leave a lasting legacy to a charitable organization. To learn more about the benefits and concerns of gifting real estate, consult with an experienced financial services provider.
About Bryan K. Clontz, CFP®, CLU®, ChFC®, CAP®, AEP®Bryan is the founder and president of Charitable Solutions, LLC, specializing in non-cash asset receipt and liquidation, gift annuity reinsurance brokerage and risk management consulting, emergency assistance funds, and life insurance appraisals/audits. He also serves as a senior consultant to Ekstrom & Associates, a community foundation consulting firm in New Haven, CT.
Revoking the Irrevocable