CGNA: Chapter 1 - Real Estate | Advanced, Part 3 of 3

CGNA: Chapter 1 - Real Estate | Advanced, Part 3 of 3

Article posted in General on 20 September 2017| comments
audience: National Publication, Bryan K. Clontz, CFP®, CLU, ChFC, CAP, AEP | last updated: 22 September 2017
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Summary

Clontz and Raffin present alternative methods for charities to participate in gifts of real estate as well as describe alternative types of real estate gifts.

This article is an excerpt from Charitable Gifts of Noncash Assets, a comprehensive guide to illiquid giving by Bryan Clontz, ed. Ryan Raffin. Published by the American College of Financial Services for the Chartered Advisor in Philanthropy Program (CAP), with generous funding from Leon L. Levy. For a free digital copy, click here, and to order a bound copy from Amazon, click here.

Real Estate: Capturing More Gifts Directly and Indirectly

When marketing for real estate gifts, too many charities think the only way to receive the gift is to accept it directly. If they choose to decline the gift, they get nothing and have a disappointed donor. What follows is a new approach to noncash gift acceptance involving four levels of what could be called acceptance triage. The objective is to receive as many gifts as possible, while limiting risk; retaining the maximum net proceeds and keeping the donor as happy as possible. Below are four approaches to real estate gift acceptance:

Option 1—This is the traditional method of accepting real estate. Donor brings property to charity; charity completes due diligence and accepts property. Charity is on the chain of title and attempts to sell the property for the highest price possible as soon as possible.

Option 2—From the NCPG Survey on Real Estate Gifts, approximately ten percent of the respondents had created separate corporations or trusts to receive real estate. Almost always, a supporting organization is the structure that those respondents employed.

Option 3—These are the various legal strategies to reduce risk. See “Minimizing Risk Through Alternative Structures for Charitable Gift of Real Estate” for more on these strategies.15

Option 4—There are numerous public charities that can receive real estate, sell it within a donor-advised fund, and then allow the donor to grant some or all of the net proceeds to the charity of his or her choice (subject to the charity’s grant-making and donor-advised fund policies). So rather than declining a gift, or creating additional legal structures, community foundations and some national donor-advised funds can receive the property and take on all the aforementioned challenges directly. Generally, the total charitable fee these advised funds charge is between one and five percent of the proceeds. Since these organizations handle a large volume of real estate gifts, the charity can “outsource” many gifts that may be too complex, too risky or require a decision too quickly so that it still receives the gift proceeds indirectly.

As the charity uncovers real estate opportunities, it should consider the traditional straight acceptance as just one way to receive the gift. More often than not, three different real estate prospects might require three different “tiered” approaches of directly or indirectly receiving the gift. Remember, the goal is to maximize net real estate contributions while minimizing risks and internal direct/indirect costs.

Current Gifts16

A gift of an undivided interest in land is a percentage of every right the donor holds, for the entire term donor owns. This gift may decrease the overall fair market value of the remaining property given the split ownership. This type of gift qualifies for income, gift/estate tax deductions and escape of capital gains tax.17 This type of gift plan is helpful where a gift of 100 percent of the land would exceed the donor’s deduction limit. Rather, the gift can be spread over time.

Charitable lead trusts can be a valuable gift planning techniques for land and other property when the circumstances are right. Payments from a lead trust are made to one or more charities in either a unitrust or annuity trust format.18 These trusts do not require a minimum payout percentage and may make payments for life or any term of years. At the end of the payment term, the remainder or residual may be paid to the donor (reversionary trust) or loved ones chosen by donor (nonreversionary). 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.

A key consideration for land donated to a charitable lead trust is to determine ahead of time whether the land will be sold with the cash funding the lead trust payments. If the trustee does not sell the land, with the intent that loved ones ultimately inherit the land from the lead trust, then it must produce income from leasing or agricultural production to fund the lead trust payments to charity. A qualified nongrantor lead annuity trust leverages attractive savings on gift and estate tax for the ultimate transfer to loved ones. On the other hand, a qualified grantor lead trust can generate a significant income tax deduction for high income years. The IRS provides sample forms, annotations and alternate provisions for inter vivos and testamentary grantor and nongrantor charitable lead annuity trusts and unitrusts.19

Deferred Gifts

Bequests in a will or revocable living trust are the most popular form of planned gift. These gifts are popular since they are usually revocable. Donors can specifically bequeath land to a charity by reference to its legal description or perhaps a mailing address. 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 pursuant to applicable 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. The donor retains a life estate and donates the remainder interest. This technique is available for a principal residence, vacation home, condominium, co-operative. The gift can include fixtures but not equipment, furnishings, or crops. When calculating the present value of the remainder interest for the charitable deduction, the donor discounts the value to reflect depreciation and factors in a salvage value.20 This technique is particularly helpful where the donor wants to use the property for life but charity wants to ultimately use the property or sell value property to fund its programs. As Adjusted Federal Rate (AFR) decreases, the income tax charitable deduction value increases for this technique. The donor and charity must sign an agreement stipulating respective rights and responsibilities relative to property tax, insurance, and maintenance. It must also address the potential for subsequent leases, sales, or gift of the donor’s remaining life estate interest.

Life Income Plans

Charitable remainder trusts and charitable gift annuities may both be considered for gifts of land. A charitable gift annuity is a contract between the donor and the charity. The donor contributes assets such as land and the charity provides fixed and guaranteed income for one or two lives per the terms of the contract. The American Council on Gift Annuities recommends rates of return which leave a 50 percent ultimate residual for the charity.21 If land is donated, then either the charity 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 to fund the annuity as well. An income tax deduction subject to the 30 percent of AGI limit is available for long-term property. Capital gain is ratably spread over life expectancy if the donor is the annuitant.22 If donor is not the annuitant, a portion of the capital gains tax is owed immediately. The balance of payments is taxed as a combination of ordinary taxable income and tax-free return of principal.

Charitable remainder trusts are tax-exempt trusts that 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 in a diversified and personalized portfolio 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 deter- mined by multiplication of the stated fixed percentage (5 percent or more) by the value of assets donated to trust. No additional gifts are allowed. If the donor gives real estate to an annuity trust either it must produce income to satisfy the fixed payment amount or the land must be sold to invest the cash to fund the annuity payments.

The unitrust format pays a fixed percentage (at least five percent) of the trust value, paying from income and principal (standard unitrust) or paying from the lesser of the fixed percentage amount or net income (net income unitrust or net income with make-up unitrust). The net income format is attractive for gifts of land since this allows time to sell the land to fund the payment obligation. However, the standard unitrust format is popular as it allows for maximizing income payments over time through a total return investment strategy. As a result, a popular option for gifts of land is the flip unitrust. This trust “flips” from a net income type unitrust to a standard unitrust after the land sells. The qualified appraisal when the property is donated to the trust determines the value of the donor’s income tax deduction. However, since the trust is a net income type, no income need be paid until the trust sells the land and receives cash. Once it reinvests the sale proceeds, the trust “flips” and now is a standard unitrust paying a fixed percentage from income and principal.23

All charitable remainder trusts require the calculated income tax deduction to be at least ten percent of the value of the donated assets at the time of transfer to the trust. Annuity trusts require an additional test that the potential of exhaustion of the trust be five percent or less. The IRS provides sample “safe harbor” charitable remainder unitrust and annuity trust documents, including the flip provision.24

Conclusion

Given the enormous wealth in the private real estate market, and the fact that real estate can be the ideal asset from a charitable income tax perspective, clearly it should represent a much greater share than two to three percent of total contributions. Most importantly, if charities confidently market real estate gifts and “shake the proverbial tree,” they can handle almost any kind of “fruit” that falls directly or indirectly using a multitude of risk management strategies. In the end, the donor will be happy from both a giving and a tax perspective and the charity will receive more and larger contributions because of a sound real estate marketing/acceptance program designed on their unique risk tolerance.

Real Estate       Additional Resources

Below are further details on gifts of real estate. Real estate topics are based on the following paper I co-authored with Dennis Bidwell, “Converting Real Estate Wealth to Gifts – Opportunities and Challenges.” For quick take-aways on gifts of real estate, see Real Estate Quick Take-Aways. For a review based on that article, see Real Estate Intermediate. For an in-depth examination adapted and excerpted from the article, see Real Estate Advanced. For further details, see Real Estate Additional Resources or cross reference to the asset’s ownership entity (e.g., LLC, Limited Partnerships, etc).

For a technical analysis of real estate donation transactions, see Newman, D.W. (September 30, 2015), “Charitable Gifts of Real Property,” Planned Giving Design Center, http://www.pgdc.com/pgdc/charitable-gifts-real-property.

For a discussion of real estate gift administration (particularly trusts), see Prosser, T. (October 15, 2014), “Are You Prepared for the Recovery in Real Estate Gifts?,” Partnership for Philanthropic Planning, http://my.pppnet.org/library/92847/1/Prosser_FINAL.pdf.

For results and analysis of a survey on this topic, see Bidwell, D. (October, 2008), “Charitable Gifts of Real Estate – Findings from a National Survey,” Journal of Gift Planning, http://my.pppnet.org/library/000/000/2c/s3.pdf.

For a gift acceptance policy with a particular emphasis on gifts of real property, see New York Agricultural Land Trust (October 22, 2009), “Policy on Gifts, including the Receipt, Ownership, Sale and Transfer of Marketable Assets,” http://www.nyalt.org/NYALT%20Gift%20Acceptance%20Policy-APPROVED-10-22-09.pdf.

For IRS discussion on conservation easements, see Conservation Easement Audit Techniques Guide (January 3, 2012), https://www.irs.gov/businesses/small-businesses-self-employed/conservation-easement-audit-techniques-guide#_Toc124.

IRC §§ 170(f )(3), 170(h) (partial interests gifts and qualified conservation contributions)

IRC § 514 (debt-financed property)

Rev. Rul. 79-326, 1979-2 C.B. 206 (installment method bargain sale of real property to charity)

Rev. Rul. 85-99, 1985-2 C.B. 83 (valuation in light of restriction on use)

Internal Revenue Manual 4.48.6 (July 1, 2006), “IRS Real Property Valuation Guidelines” (IRS policy on land valuation)

Ivey v. Comm’r, TC Memo, 1983-273 (combined value of multiple real estate gifts)

Douglas v. Comm’r, TC Memo, 1989-592 (timing of transfer for deduction purposes)

Irby v. Comm’r, TC Memo, 139 T.C. 14 (2012) (real estate donation case involving bargain sale, conservation easement, appraisal, and substantiation issues)

  • 15. See Kallina, E. (2008), “Minimizing Risk Through Alternative Structures for Charitable Gift of Real Estate,” Journal of Gift Planning 14.
  • 16. The “Current Gifts,”“Deferred Gifts,” and “Life Income Plans” sections courtesy of Phil Purcell.
  • 17. See IRC § 170(f )(3)(B)(ii) and § 2522(c)(2).
  • 18. IRC §§ 2055(e)(2)(B) and 2522(c)(2)(B).
  • 19. Rev. Proc. 2007-45 and 2007-46; Rev. Proc. 2008-45 and 2008-46.
  • 20. IRC § 170(f )(3)(B).
  • 21. See American Council on Gift Annuities at www.acga-web.org.
  • 22. IRC § 1011(b).
  • 23. Reg. § 1.664-3(a)(1)(i)(c).
  • 24. Rev. Proc. 2003-54 to 60; Rev. Proc. 2005-52 to 59.

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