General
Real property is complex because there are many different types, and because no two pieces of real estate are identical. Strategically, real estate can comprise a significant portion of a donor’s net worth, but it is illiquid, and there are often onerous taxes that come from selling. Some experts have estimated that real estate makes up nearly 40% of the wealth in the United States.
Convenience may be another reason a donor would prefer to give real estate; even when there may be no tax cost to selling, older donors may often appreciate being able to donate property rather than dealing with selling it themselves.
Contributing highly appreciated real estate to a public charity or charitable vehicle allows the donor to claim a full, FMV tax deduction for the donation while also eliminating capital gains tax on the sale.[1] When the property is donated to a private foundation, the donor’s deduction is limited to the lower of FMV or cost basis, whichever is less.[2]
Real estate that meets the specific criteria is most useful for the donor:
- Property is marketable and relatively easy and cost-effective to liquidate.
- The property has been held for more than a year and has appreciated significantly.
- Property is generally debt-free.
Income Tax Issues with Real Property
Long-term Gain Property
When the donated real estate held long by the donor term (i.e., longer than 12 months) to a public charity, the amount they may claim as a charitable contribution for federal income tax purposes is the property’s fair market value on the date of the gift. [3]
Depreciated real property
If the property for which depreciation has been claimed by the taxpayer is donated, their charitable contribution is typically reduced by the amount of depreciation that would be recaptured as ordinary income if the property were sold.[4]
Although if the depreciation claimed has been a straight line, the donor’s charitable contribution is typically not reduced (because straight-line depreciation for real property is recaptured under IRC section 1250 as capital gain rather than ordinary income). Donating depreciated property if straight-line depreciation has been used can be especially attractive, because the donor can still use the fair market value for their deduction, and avoid depreciation recapture. Under current law, the amount of straight-line depreciation taken could be subject to a tax rate of 25 percent if the property were sold.
Donated Real Property that Includes Debt
The bargain sale rules in Treas. Reg. § 1.1011-2, states that encumbered real estate donations will be divided between a sale (FMV representing the debt) and the donation (equity of the real estate). If the property is subject to a mortgage, a donor may recognize taxable income for all or a portion of the loan’s value.
Assets & Methods of Giving Real Estate
Ideally, the donor is willing to transfer the property irrevocably to a charity or charitable vehicle, which will negotiate the sale price and control the sale. When a possible deal is already under negotiation with a buyer, the negotiation must not have proceeded to the point at which the IRS would consider it a prearranged sale. That could result in the donor bearing the tax liability for any gain on the deal.
Most often a donor must transfer his or her entire interest in a donated property for the gift to be deductible, but there are exceptions to that general rule. For example, the donor may irrevocably contribute a remainder interest and retain a life estate in the property. Another exception is the donation of an irrevocable remainder interest in a personal residence (vacation home or primary residence) or a farm; an undivided fractional interest in the and finally a qualified conservation easement.
The following is an overview of the main types of real estate, with a quick review of some of the tax considerations that can prompt a donor to consider giving the property instead of selling.
Primary Residences
Most often a residence is viewed as the traditional single-family home, but a primary residence suitable for donating could also be a condo or a cooperative apartment. For purposes of the tax code, even an RV, mobile home, or boat may be considered a “principal residence,” so long as there are a kitchen, sleeping quarters and bathroom facilities. In contrast, it is typically a matter of state law whether a mobile home is considered real property or tangible personal property (e.g., a vehicle). In California, for example, mobile homes sold before July 1, 1980, are classified as vehicles; those sold on or after that date are considered real property. Most mobile homes are in parks where the homeowner rents a lot on which the home is placed; however, some are situated in parks where the homeowners own their lots.
Homeowners do not automatically face capital gains taxes when they sell, because the tax code excludes $250,000 of appreciation for a single person ($500,000 for a married couple) provided specific requirements are met for ownership and use of the home as a primary residence. While this exclusion will cover the gain on many homes, this may not be the case for higher-end properties. In some parts of the country, even modest homes may be highly appreciated and subject to capital gains tax.
Some homeowners who sell may face depreciation recapture. A recapture scenario includes periods in which the house was rented out or in which a depreciation deduction for a home office was taken. Since there is no exclusion from depreciation recapture, the federal tax rate is 25%.
Vacation/Second Homes
The IRC 121 exclusion from capital gains for sale of a primary residence applies only to a primary residence. That said, in some cases what is now a second home might qualify for the exclusion if it served as a primary residence in the past, and if specific tests are met for a length of ownership and duration and timing of that service. Attention should be given to possible depreciation recapture issues (see above).
Farms/Farmland
The definition of a farm comes from Reg. 1.170A-7(b)(4): “”¦the term “farm” means any land used by the taxpayer or his tenant for the production of crops, fruits, or other agricultural products or the sustenance of livestock. The term “livestock” includes cattle, hogs, horses, mules, donkeys, sheep, goats, captive fur-bearing animals, chickens, turkeys, pigeons, and other poultry. A farm includes the improvements thereon.” Thus, a farm may include a personal residence.
Even though “farm” is the all-inclusive term used by the tax code, it may be helpful for marketing and education to use terminology reflecting the culture and economy of the area. When the farm includes a house, the personal residence exclusion rules will apply to capital gain. Otherwise, all investment growth will be subject to federal capital gain taxes.
Selling a farm may give rise to issues related to the sale of ancillary assets such as crops, livestock, and equipment. The tax treatment of these assets is dependent on many underlying facts, and some of these assets are further discussed in Chapter 16 under tangigle personal property.
Depreciation recapture is also an issue with buildings and certain farm equipment.
Rental Properties
Many people own single-family homes, and sometimes small apartment buildings, as investments. The income from rents may provide most or all of the cash flow needed to service the mortgage (if any), while the owner receives a significant tax deduction for depreciating the building, which is claimed for 27-1/2 years. Once a property has been fully depreciated, however, owners have a strong incentive to divest of the property. Besides, since many people who own rentals as an investment act as their landlords for the property, as opposed to using a property manager as they grow older, it can become more onerous to receive a phone call at midnight from a tenant who has locked himself out.
Tax Considerations if contemplating a sale:
The capital gain will be due on any appreciation, taxed in the donor’s capital gain bracket.
The owner must recapture any depreciation, which will be taxed at the Sec. 1250 rate of 25%.
Commercial Real Estate
Technically farms, and single-family homes held for rentals, are “commercial property,” although the term generally is applied to non-residential property used for business purposes, such as retail space, office buildings, factories, and industrial parks, or large apartment complexes. Capital gains will be due on appreciation, and depreciation recapture is also a consideration.
Vacant Land
A typical scenario can be someone who buys lots in a community, intending to build a house later for retirement. It is also common to purchase lots in an undeveloped area that is considered to be in the path of future growth, which could give rise to considerable appreciation. Raw land does not usually generate income but does generate property taxes; thus, the owner may have a financial incentive to divest.
REIT’s
Real estate investment trusts (REITs) and most real estate limited partnerships usually are securities rather than real property and need not be reviewed under a real estate acceptance protocol (although counsel should review any pertinent documentation to ascertain whether accepting the gifts would create any liability for the charity). REITs receive deductions for dividends paid, so investors are taxed simply on their resulting income, similar to partnership tax treatment.
Charities should investigate whether a REIT may generate UBTI in the event of debt-financed income unless the entity has some type of UBIT blocker. Further, the terms of the REIT may not permit a charitable transfer.
Cemetery Plots
Cemetery plots are technically intangible personal property (i.e., the right to be buried in the plot).
Timeshares
Similarly, to cemetery plots, a timeshare is often merely the right to occupy a premises under conditions outlined in the purchase agreement or other legal documents. However, other timeshares are indeed, real property that is transferred by deed, in which case standard real estate acceptance procedures would apply.
Cemetery plots and timeshares have a reputation for not being worth the time required to close the gift from the charity’s point of view.
Mobile Homes
Reg. section 1.170A-4(b)(2) goes so far as to state that a “fixture” that is intended to be severed from the land will be treated as “tangible personal property.” Therefore a gift of a mobile home, without land, is likely to be only a gift of tangible personal property. If land is donated with the mobile home the transaction is likely to be treated as a gift of real property.
Types of Real Estate Gifts
Outright
The donor transfers his or her entire interest in the property to the charity, typically receiving a tax deduction equal to the fair market value of the property.
Undivided Fractional Interest
The donor transfers a percentage of his or her entire interest. Typically, the value of the deduction is slightly less than a percentage of the total value of the property because there is a discount for lack of marketability.
Retained Life Estate
The donor signs a special deed, making an irrevocable gift to the charity of the right to receive the property after the expiration of the intervening interest, which is typically for one or two lives. It is possible, however, to set up a retained estate for a term of years.
Bargain Sale/Installment Bargain Sale
A bargain sale as a gift type occurs when a donor sells the property to charity for less than its fair market value, with the gift being the reduced purchase price. Capital appreciation is allocated between the gift and sale portions, resulting in capital gains taxes only on the sale portion. A sale can be spread out in installments, which will defer recognition of gain. Typically, bargain sales happen when the charity wishes to acquire the property for its mission, although there is no reason why a charity could not purchase a property at a bargain price and then sell it.
Note: bargain sale treatment comes into play with any gift type when the property has outstanding debt. Even if the donor agrees to remain personally liable rather than having the charity assume the liability, the IRS regards this as though the property were “sold” for the amount of the outstanding debt. However, the bargain sale rules for the debt-encumbered property are not to be confused with the bargain sale as a gift type.
Charitable Remainder Trust (CRT)
The donor transfers assets to a charitable remainder trust; the trust sells the property without incurring capital gains taxes, and the full net value goes to work to pay an income to the donor. When funded with real estate, the trust is typically structured as a so-called “Flip-CRUT,” which function as a net income trust until Jan. 1 of the year after the property is sold (or other triggering event).
Donors may give their entire interest in a property, or if the property is of sufficient value, they may opt to give an undivided fractional interest in the property. There are two common scenarios involving fractional interests:
When a donor plans to sell a personal residence that has appreciated more than the appropriate exclusion (i.e., $250,000 for a single person/$500,000 for a married couple), the donor may give
A fractional interest to the trust, while keeping the appropriate ratio to allow her to “cash out” using the exclusion.
Similarly, donors may sometimes opt to give only a percentage interest in a property to have some cash in hand. The percentage that is given to the CRT is sheltered from capital gains, while at the same time generating a deduction that will reduce or eliminate the tax due to the capital gain on the portion that is not donated.
Charitable Gift Annuity (CGA)
In theory, just as donors might give cash or securities in exchange for a gift annuity, they can give real estate if the charity allows the transaction. Charities should approach agreeing to an annuity contract from real estate with caution. When a charity wishes to acquire a property that would be important for its mission, a CGA can be a mutually beneficially alternative to a bargain sale (or an installment bargain sale) as a vehicle for a philanthropically motivated individual to transfer the property.
When the real estate is an asset destined for sale, the charity should consider the gift plan closely:
- What would be the projected time-frame for sale, in current market conditions? Also, what if the property does not sell quickly?
- Many charities will negotiate with the donor to create a deferred gift annuity to allow time to liquidate the property before payments begin.
- Charities may try to identify potential buyers before the gift is closed, but be careful to avoid a pre-arranged sale.
- What if the property does not sell for the anticipated price?
Many charities creating a CGA in exchange for real estate negotiate a lower-than-standard the payout, though state regulations may be a complication.
Whether the charity intends to sell the property or hold it permanently, check with the relevant state(s) to determine any reserve requirements. Often, the charity must deposit cash in the reserve fund on the day that the annuity is issued, meaning that the charity must have some source of unrestricted funds to cover the reserve until the property is liquidated. In essence, the charity is providing a bridge loan to its reserve fund.
CGA in exchange for a Retained Life Estate (RLE)
Many charities offer gift annuities in exchange for a retained life estate, although not all state permit this gift technique.[5] To determine the amount of the annuity, first, calculate the charitable remainder value of the gift of the property. This figure is then the value upon which the annuity is calculated.
As with all gift annuities funded with real property, review the relevant statutes to determine any reserve requirements. When a charity is making a loan to the reserve fund, it should be recognized that the funds will be restricted for the rest of the annuitant’s lifetime.
Conservation Easements
Another form of real estate gift is a conservation easement, i.e., a voluntary restriction on land preventing development on the property to retain its natural condition (or, on buildings in the case of façade easements). The restriction will remain on the property for all subsequent property owners unless it can be successfully removed by court order or by agreement of all affected parties.
Deed Transfer
Most charitable organizations will have some guidelines as to what type of deed transfer they might be comfortable accepting.
A warranty deed is a deed when the grantor (donor) guarantees that he or she holds clear title to a piece of real estate and has a right to gift it or sell it. By contrast, a quitclaim deed is used when the donor does not guarantee they hold title to a piece of real estate.
A general warranty deed protects the charity or buyer against title defects arising at any point in time, extending back to the property’s origins. A special warranty deed protects the charity or buyer only against title defects arising from the actions or omissions of the grantor/donor.
Some organizations will pay for title insurance to ensure a good title on the gifted property. Other organizations take the position that the insurance isn’t worth the risk since the property, after all, is a gift in most cases.
Conclusion
GiftWizard Chapter 18 provides for a comprehensive review of real estate gifts. There are other sections in Chapter 18 beyond the basics that over different general ways to gift real property:
| Section 2: Land & Buildings |
| Section 3: Primary Residence |
| Section 4: Conservation Easements |
| Section 5: Facade Easements |
| Section 6: Mineral Rights |
| Section 7: Timeshares |
[1]IRC § 170(b)(1)(C)
[2]IRC § 170(e)(1)(B)(II)
[3]See IRC 170(b)(1)(A)
[4]See IRC section 170(e)(1)(A)
[5]New York, for example, does not allow this type of arrangement