By Colin P. McHugh, and Associate at Archer & Greiner; and a member of Samaritan’s Planned Giving Committee, a group of the region’s leading financial advisors, volunteering their time and expertise to raise awareness of the impact and advantages of charitable tax and estate planning.
When the average person thinks about donating to charities, they typically think of cash donations. Although this is a common form of donation, and perfectly acceptable, there are other forms of charitable gifts, for instance, gifting real estate, which may have greater benefits to the donor than simply donating cash. There are several potential benefits to donors when gifting real estate that simultaneously allow one to make a charitable impact. Some of the benefits are: (1) avoiding capital gains tax; (2) income tax deductions; and (3) the ability to make a larger charitable impact at a lower cost. There are also avenues allowing a donor to make a charitable impact while retaining an interest in the real estate, as opposed to an outright gift where the interests is completely relinquished to the charity.
5 Options for Donating Real Estate Property
Outright Gift of Real Estate & Capital Gains
If someone is considering making a charitable gift with the proceeds of the sale of real estate, pause for a moment and consider the following hypothetical example. If Sarah wanted to sell her home, which she has owned for 20 plus years, and then donate the proceeds to charity, Sarah would be responsible for capital gains tax on the value of the appreciation (as adjusted for any principal residence exclusion that might apply). In other words, if the house was purchased for $100,000 dollars (Sarah’s basis), sold for $500,000 dollars, and the principal residence exclusion did not apply, Sarah would be subject to a capital gains tax on $400,000 dollars. Assuming a federal capital gains tax of 15%, Sarah would owe $60,000 dollars in capital gains tax, reducing the realized dollar amount of the sale to $440,000 dollars. (Note this does not account for the other taxes and costs someone may incur when they sell real estate).
An alternative option for Sarah, would be to gift the real estate outright to a charity of her choosing, and in essence make a charitable gift equal to $500,000 dollars. This allows Sarah to donate more by simply changing the manner in which she made her donation.
Outright Gifts of Real Estate & Income Tax Deductions
When someone donates real estate, they qualify for an income tax deduction for either the fair market value or the cost basis of the real estate depending on if the property was held long term (more than a year) or short term (less than a year). The income tax deduction for real estate held long term is the fair market value of the property at the time of the gift. While real estate held short term qualifies for a deduction equal to the lesser of the fair market value of the property or your basis in the property (generally speaking, what you paid to buy and improve the property). Note, there are restraints on the amount an individual can deduct annually, which is generally 30% of your adjusted gross income for non-cash appreciated assets held for longer than a year and 50% of your adjusted gross income for non-cash appreciated assets held for less than a year. (Consult a Tax Expert for more specifics). But, real estate deductions can carryover for 5 years.
To illustrate, let’s continue with our above scenario involving Sarah. Let’s assume Sarah has owned the real estate for more than a year and the fair market value of the house at the time of contribution was $500,000 dollars. Sarah would be able to make a charitable income tax deduction, subject to the ceiling limitation discussed above, for the next 5 years up to $500,000. Conversely, if Sarah owned the home for less than a year, then the deduction total would only be equal to what Sarah paid for the house, $100,000, Sarah’s cost basis.
Therefore, in order to maximize the donor benefits of gifting real estate, it is in the donor’s interest to gift real estate which was owned for more than a year to receive a deduction equivalent to the fair market value rather than the cost basis at which the property was purchased.
Gifts to Charity While Retaining an Interest in the Property
Some individuals may want to have a charitable impact but retain an interest in the property during their lifetime. There are a several options available to individuals with such a desire, but the two we will discuss are: (1) a gift via deed retaining a life estate or (2) a gift to a charitable remainder trust.
Gift of Real Estate via Deed
If someone wanted to retain use of the property, but gift real estate to charity, they could make a gift with a retained life estate. This would allow for them to transfer ownership, but continue to live and use the property until their death. There are also tax advantages available to the donor when gifting real estate in this manner, for instance a tax deduction that is dependent on several factors. (Consult a tax professional for specifics).
Charitable Remainder Trust: Another Way to Retain an Interest in the Property
If you have no desire or need to retain a piece a real estate, and intend to make a gift to charity with the proceeds from the sale of a piece of real estate at death, you could consider a charitable remainder trust.
A charitable remainder trust allows for the piece of real estate to be owned and sold by the trust, while income is paid to designated beneficiaries for an allowed term. (There are IRS minimum distribution requirements to the beneficiaries each year, but that is not within the purview of this article, consult a legal professional or accountant). At the end of the term, the remaining property (remaining proceeds from the sale by the trust of the real estate) within the charitable remainder trust is distributed to charity.
The benefits of a charitable remainder trust are twofold: there is an income tax deduction that varies depending upon the present value of the charity’s interest and the charitable remainder trust’s exemption on capital gains tax from the sale of the property. (Consult a tax professional for specifics).
Conclusion
If someone is considering making a gift to a charitable organization, a donor could consider real estate as an effective cash alternative for the following reasons: (1) the potential capital gains advantages of gifting real estate instead of cash, and (2) the potential income tax deductions afforded to the donor (dependent on the length the real estate was owned). Additionally, the donor could contemplate other means of gifting real estate, such as a charitable remainder trust or retaining a life estate in the real estate. In sum, a charitable impact does not always need to be in the form of cash.
This material is provided for informational purposes only. The material provided herein is general and is not intended to constitute legal, tax, or accounting advice. Nothing herein should be relied upon or used without consulting a lawyer or tax professional to consider your specific circumstances, possible changes to applicable laws, rules, and regulations and other legal issues. Receipt of this material does not establish an attorney-client relationship.