Chances are you’ve seen a video or two of someone strolling along a busy sidewalk, so engrossed by whatever is on their phone—a work email, a breaking news update, a shocking social media post, or the latest cat video—that they are oblivious to the world around them.
When a donor approaches your organization with a plan to donate real estate, it may be easy to act like the people in those videos, narrowly focused on the gift agreement, title changes, and excitement at how the donation will help further the organization’s important work. However, it’s important to keep your eyes up and be aware of several issues that may affect the gift’s success, including the following items. (This is not an exhaustive list.)
1. Has the property had a qualified appraisal?
To claim a charitable income tax deduction for the gift, the donor must obtain a qualified appraisal. For property valued between $5,000 and $500,000, the donor must include an appraisal summary with his or her federal income tax return. For real estate worth $500,000 or more, the taxpayer must attach a copy of the appraisal itself (not just an appraisal summary) to the income tax return for that year. The value of the real estate is based on its “highest and best use,” which may be different from the donor’s purpose or how your organization would actually use it.
2. Is the donor in the business of real estate?
If the donor regularly buys and sells real property for profit, the donated property might be considered inventory, which is ordinary income property. A gift of real estate inventory will be valued at fair market value minus any amount that would be considered ordinary income to the donor if the property were sold. In this circumstance, the transfer of the property will be subject to recapture of depreciation deducted by the owner, with the recapture amount considered ordinary income property.
3. Is a fee simple transfer the best way to make the gift?
The most common gift is one in which the donor owns the land and all property on the land (called fee simple ownership) and donates all ownership rights. However, there may be circumstances where the charity and donor want to consider another type of transfer, like a bargain sale or retained life estate. For example, if the property is a working family farm but will eventually be redeveloped to directly serve the charitable purpose, the charity may want to allow the donor to retain a life estate in the farmhouse to live there throughout his or her lifetime.
4. Is the property subject to a mortgage?
Ideally, the gift property will be free of debts, liens, or mortgages. A donor who intends to transfer a property subject to a mortgage should understand that the amount of a charitable contribution is limited to the donor’s equity in the property. The value of the real property donated is reduced by the mortgage or any other encumbrance on the property. In addition, federal tax regulations provide that in a gift of real estate, the mortgage is treated as an amount realized by the donor, even if the charity does not assume or agree to pay the debt.
If property is transferred subject to an indebtedness, the amount of the indebtedness must be treated as an amount realized for purposes of determining whether there is a sale or exchange to which section 1011(b) and this section apply, even though the transferee does not agree to assume or pay the indebtedness.
5. Does the property have any potential environmental issues for the charity?
Some properties have obvious issues. If the donor was an amateur physicist who built a do-it-yourself nuclear reactor, the property will need an environmental study (and more!). Other situations may not be as clear-cut. A donation of a mom-and-pop corner store may come with the unwelcome surprise of forgotten gas tanks from when great-grandma also sold gas from the store in the 50s. Or perhaps the cabin property with acreage the donor used for outdoor recreation actually contains protected wetlands that prevent its use for the charity’s purposes.
6. Is there a waiting buyer?
Sometimes, a coveted piece of real estate will have someone who is already eyeing the property. An interested buyer is not a problem. However, it becomes problematic if the donor takes steps to sell the property, such as already having a written contract to sell the real estate before the donation occurs. If the charity is not free to sell the property to any buyer because of the donor’s prior agreement, there may be issues with the assignment of income doctrine—a Supreme Court ruling that states that income is taxed to the person who earned it and cannot be attributed to or assigned to another party. A prearranged sale will leave the donor paying tax on the real estate—something the donor is certainly looking to avoid through the charitable gift.
Eyes on the Successful Gift
There is clearly a time and place to look at Maru the Cat or Keyboard Cat, but focusing solely on a talented internet feline while walking along a busy street is not the best course of action. Similarly, wise charitable giving professionals know that, especially for more complex gifts like real estate, keeping a narrow focus can impact the gift’s success.
