Updated November 2016 — Give a piece of property to charity; take a tax deduction. It seems so simple. And yet there are a number of advanced strategies that could help you achieve even more of your financial goals. At the same time, a number of pitfalls can gum up your plans.
Real estate assets represent more than half the wealth in the United States; approximately twice as much capital is concentrated in real estate than in stocks. And yet real estate makes up a minimal amount of charitable giving.
"Real estate offers the most opportunity as an untapped asset class," says Liza Hentz, Senior Planned Giving Advisor for the Wells Fargo Philanthropic Services group.
Methods for donating real estate
An outright gift is the best-known and simplest means of making a charitable donation of real estate. The deed or title of the property is transferred from the owner to the nonprofit organization.
As long as the donor has owned the property for at least a year, the donor may be eligible for an income tax deduction that is equal to the property's fair market value. With an outright gift, donors also avoid the capital gains taxes they would have incurred by selling the property.
In addition to gifts, there are other types of transfer strategies that may be attractive choices for your individual situation and the nonprofit you hope to help. With any of them, it's wise to bring together a team of specialists in key areas, such as tax advising and wealth planning, to help you make sound decisions and prepare accurate financial statements.
A bargain sale occurs when the donor agrees to sell real estate to a nonprofit for less than the property's fair market value. The tax-deductible gift is equal to the difference between the sale price (which includes the value of any debt on the real estate) and the market value.
Charitable gift annuities are designed to allow opportunity for the donor to give property to a charity, take a charitable deduction, and receive fixed payments for life.
Nonprofits have an immediate obligation to make annuity payments to the donor, Hentz says. That may make deferred payment charitable gift annuities a more desirable alternative for the nonprofit receiving the property. In this structure, the donor agrees to defer the first annuity payment for at least a year, giving the nonprofit more time to sell the property — keeping in mind, however, that if the property does not sell before the deferral date, the charity must begin making annuity payments from their own operating assets.
A charitable remainder unitrust, often referred to by the acronym CRUT, is another way to make a donation and receive an income stream for life or for a fixed term of years. The property goes into a trust; a governing document outlines how the trust will make payments to the donor or beneficiary (such as the donor's children).
Depending on the terms of the agreement, the CRUT may be structured to make a payment based on a percentage of the market value each year, but the variability of income from the property presents increased risk for both sides of the agreement, Hentz notes: The donor may have to add assets to the trust if the income from the property is not sufficient to allow for payments.
More common is for the CRUT to employ a net income with make-up approach; in this case, the trust pays out the lesser of these two amounts each year:
- The standard unitrust amount, which is the set percentage specified in the document times the fair market value of the assets in the CRUT.
- The annual net trust income for the CRUT.
If the net trust income is greater than the standard unitrust amount for a particular tax year, the trustee can distribute a "make-up amount" from the trust's income up to the amount of the unitrust percentage.
Another option to deal with property is a hybrid version of the two CRUT formats, referred to as a "FLIP CRUT." With this type of trust, payment is structured according to a triggering event — the sale of the property, for example (note: other triggering events can apply). Each year until that event occurs, the FLIP CRUT can pay either 1) net income or 2) the lesser of net income or a fixed amount. Then the first day of the next calendar year following the sale of the real estate (or other triggering event occurs), the CRUT "flips" the payment method to a straight rate thereafter.
"A Flip CRUT is perhaps the most effective way to structure a charitable remainder trust in dealing with the challenges of the sale of real property," Hentz says.
Potential scenarios for real estate donors to consider
As you can see, giving real estate to charity can become complex. Chris Spaugh, Philanthropic Sales Strategist for Wells Fargo, says there are additional considerations for donors.
Some real estate investors enter into an agreement to sell a piece of property, and then balk when they realize they are creating a large taxable capital gain.
"We've been told, 'I have some real estate that's under contract, it'll sell next month, and we want to give it to charity or put it into a charitable remainder trust,'" Spaugh says.
"It's too late at that point. The IRS is going to deem you've sold that property — even though the sale hasn't gone to closing — because you've already got a contract." It is important whether the contract is in writing or committed to in a general conversation. Discussion on the sale may be permissible prior to funding the charitable trust but no agreements can be arranged ahead of time. Donors should be sensitive to letting the trustee negotiate the sale.
Another potentially problematic situation Spaugh sees is when a donor tries to retain some ownership rights or to retain some use of the property. Examples are continuing to live in a residential property or occupying an office while paying rent to the nonprofit. These may fall into a gray area as far as the sale or the gift qualifying as a charitable donation and can also give rise to tax problems for the participating charity as well if they knowingly participate.
"There are a number of situations that could lead to self-dealing or excess benefit transactions," Spaugh cautions. Another potential problem is what the IRS calls "unrelated business taxable income."
Suppose the donated property is a commercial building with a tenant paying rent not at a fixed rate, but based on some fluctuating measure, like a percentage of gross sales or of profits.
"That would look like the charity is running a business, and that would be taxable under the concept of unrelated business taxable income," Spaugh says. The charity's mission may be totally unrelated to anything dealing with commercial real estate. "The IRS is trying to level the playing field, since charities don't pay income tax and they have placed extra scrutiny on any unrelated business income situation."
Issues for nonprofit organizations to consider
"Compared to cash, many charities view real estate gifts as being too risky and the liability is too great," says Hentz — and, as a result, "many charities are willing to turn away donors that wish to support their causes in a meaningful way rather than figure out a solution."
It doesn't have to be so. "The payoff can be well worth the effort for both donors and charities if charities are willing to evaluate the opportunities to loosen up this gridlock," Hentz says.
Both Hentz and Chase Magnuson, CCIM, a real estate consultant who is Director of Planned Giving, Real Estate, at George Washington University, agree that the first steps are to create a clear real estate gift acceptance policy and a board committee to handle the donations.
Some of the issues to consider for the policy: What is the smallest-size property the charity will consider? Will the charity immediately sell the property or keep the property? Is the property's ability to generate income a factor in the keep/sell decision? Will the charity keep — or even accept — a property that's well outside its geographic area?
The gift acceptance committee should also consider smaller, but still important, questions of zoning, environmental issues, existing mortgages and ongoing maintenance expenses, to name a few.
Magnuson says environmental hazards can easily become a significant problem in a real estate donation if the charity accepts title to the property — and responsibility for cleaning up a problem. The charity should understand the legal ramifications of taking on these assets and what their responsibilities are.
Magnuson also cautions nonprofits against entertaining gifts of properties with equity of less than $100,000 to $200,000. "By the time you pay for your attorneys, you pay staff time, and you sell the property at a slight discount, you may be eating into the gift."
Some charities are simply too small to engage in some of the more complex real estate transactions, such as annuities, Magnuson says, as many states set minimum requirements for a nonprofit's years in existence and net worth. They may want to explore using "shared gifting charities" that have the capability to take the real estate, issue the annuity, and share the proceeds with the otherwise noncertified charity.