With contributions from Mimi Nguyen
It was Mark Twain who said All generalizations are false, including this one. If he didn’t have a gift for writing, he could have been a tax or real estate advisor.
Donating appreciated real estate to charity — or accepting real estate if you’re a charity — is one of those things that’s difficult to generalize about but critical to understand.
Maybe you are thinking of donating to charity, but lack the liquid assets to meet your philanthropic goals. Or you’re looking for a way to downsize your real estate portfolio without a huge tax bill. Perhaps you’re a charity considering accepting noncash donations.
Whether you are planning to donate appreciated real estate to charity or you’re a charity thinking about accepting donations of real estate, there are important tax, business and financial considerations involved.
Donors: The Benefits of Donating Appreciated Real Estate
Your donations qualify for an income tax deduction equal to the fair market value or the cost basis of the property.
The amount of your deduction generally depends on whether the real estate is a short-term asset (held one year or less) or a long-term asset (held more than one year).
For short-term assets, the deduction is equal to the lesser of the property’s fair market value or its cost basis. The exception: This limitation applies to all donations to private foundations, even if the donated assets have been held long-term.
Long-term appreciated assets qualify for a deduction equal to the fair market value of the property. The deduction is generally limited to 30 percent of the donor’s adjusted gross income (AGI).
As an option, you may elect to deduct the cost basis of long-term appreciated assets instead of the fair market value, but your deduction will be limited to 50 percent of your AGI. This allows for a larger current-year deduction (50 percent of AGI rather than 30 percent), but if any of the deduction is carried over, the cost basis and 50 percent AGI limit will apply to those carryovers.
By donating rather than selling the property, you avoid capital gains taxes
Capital gains on short-term assets are taxed at the ordinary income tax rates.Capital gains on long-term assets are taxed between 0 percent and 23.8 percent, depending on your income level. For capital gains on the sale of highly appreciated property, the resulting tax bill can be quite substantial.
Donors: Methods to Donate Real Estate
A direct gift is the simplest method of donating real estate. The deed or title is transferred from the donor to the charity.
As the donor, you generally receive a tax deduction equal to the fair market value of the property and that deduction may be carried forward for five years. You also avoid paying the capital gains tax that would otherwise accrue as a result of the sale of the property.
Charitable Remainder Trust (CRUT)
The use of a CRUT is a great way for donors with highly appreciated property to accomplish their philanthropic goals while also preserving income for future generations. This trust is tax exempt, so it is not taxed when it sells property and all of the proceeds from the sale can be fully reinvested.
Distributions from the CRUT to its beneficiaries are determined annually based on a fixed percentage (at least five percent) of the value of the CRUT’s assets. At the end of the CRUT’s life, the remaining assets are distributed to designated charitable organizations.
Contributing real estate to a CRUT provides the donor with an immediate charitable deduction (equal to the present value of the remainder interest that will ultimately pass to charity), and also provides future cash flows to the beneficiaries.
There are several factors to consider when contributing real estate to a CRUT, so it is important to seek legal and financial advice prior to using this vehicle for donating property.
In a bargain sale, the donor sells property to a charity for less than the property’s fair market value.
As the donor, you are taxed on your gain, which is the selling price less a pro-rata share of the cost or basis of the property. In this case, your basis in the property is allocated between sale and gift portions of the transaction.
You may claim a tax deduction equal to difference between the property’s fair market value and its selling price.
Donors: What to be Aware of When Donating Real Estate
As donations of appreciated property are subject to greater scrutiny from the IRS, it is important to consult with a tax advisor before donating real estate. Below are several situations to consider:
Charitable Substantiation Requirements
To prevent over-valuation, real estate donations over $5,000 require a qualified appraisal of the property, performed by a qualified appraiser. If the value of the real estate you donate is $500,000 or more, the appraisal must be attached to your tax filing.
Your deduction may be disallowed if you don’t have the appropriate documentation.
If you, as donor, enter into a binding contract/agreement to sell a piece of property, you may not subsequently donate that property (prior to completion of the contract) in order to avoid capital gain taxes.
Since the contract exists, you are deemed to have sold the property. When the charity subsequently sells this property, you are still responsible for paying capital gain taxes as if you had sold the property yourself.
If you have claimed accelerated depreciation on the property you donate, your tax deduction will be reduced by the amount of depreciation you’ve taken that exceeds the depreciation allowed under the straight line method.
This concept is similar to the ordinary income recapture that occurs on a gain from the sale of property where accelerated depreciation was claimed.
It is important that you clearly identify the donation element of the sale when entering into a bargain sale transaction with a charity.
If the donation element is not clearly stated at the time of the sale, you can lose the tax deduction. You will not have an opportunity to identify the donation element at a later date.
Donating property that is subject to a mortgage may cause recognition of income to you, as donor. Bargain sale rules apply, as the property is treated as if it were sold for the balance outstanding on the mortgage.
The fact that you are still responsible for making mortgage payments after the donation does not preclude the recognition of taxable income.
Charities: Potential Concerns in Accepting Donations of Real Estate
For charities, the decision to accept a donation of real estate is not always easy. It must review the costs and benefits of each potential donation before deciding to accept the real estate.
As with other transactions involving real estate there are many legal fees associated with accepting a donation of real estate, such as environmental clean-up or legal liabilities.
Charities must ensure that a donated property has enough equity that potentially high legal costs will not significantly reduce the benefit received from the donation.
Resources required to manage the property
If your charity plans to keep the donated property, it should have adequate resources to maintain the property.
This type of resource allocation may prove difficult for a charity with limited resources. Adding more responsibilities for a small staff may dilute their ability to achieve the charity’s primary mission and objectives.
Unrelated Business Taxable Income (UBTI)
UBTI is taxable income derived from activities that don’t align with your charity’s mission.
To avoid UBTI, it’s important that you don’t use property to generate income if the resulting income doesn’t align with your goals and mission. Such income is taxable.
For example, collecting rent from tenants in a donated commercial building that falls outside of your charity’s mission will be subject to tax as UBTI.
Do you have any property you’d like to donate?