First there was the guy who wanted to donate his banana tree to charity–he insisted that it was worth $35,000, but demanded that the charity’s staff dig the “gift” up out of his yard. (They didn’t.) Then there was the lady who wanted to donate $5,600 worth of amethysts, which, upon appraisal, turned out to be worth about $50. (Oops.) Another gentleman wanted to donate a seat on a mercantile exchange–fortunately, the charity accepted this one, because the seat turned out to be worth a whopping $1.4 million. Yet these unusual gifts aren’t the half of it: Although you may hear more about charitable contributions of cash and securities, there are plenty of people eager to donate all kinds of things: antiques, stamp collections, beach houses, gun collections, wine cellars, horses, cars, timberland. “We even had people who tried to donate cemetery plots,” laughs Penny Marlin, a Miami-based planner who once worked as the endowment director for the Greater Miami Jewish Federation.
Giving non-cash, non-securities gifts can have immense benefits to your clients and their favorite charities; donations of real estate, although complicated, can be particularly effective. But these contributions can require some extra legwork on your part. Do you know how to help your clients make such gifts properly, and do you know what resources are available to help you do so?
Robert Reed admits he doesn’t know a thing about horses. So when one of his clients, an avid equestrienne, came to him asking for help in donating one of her older jumping horses to a local college, Reed’s first response was to panic. Then he started to do some research. “I’m a comprehensive planner, so all sorts of strange things cross my desk,” he says cheerfully.
Issue number one–whether or not the donation was a good idea at all–was fairly easy to answer. The client wanted to buy a new horse to replace the aging one, “and we’re talking forty grand here [to buy a new horse], so we were going to have to cash out some of her investments,” says Reed, an advisor with Reed Financial Planning in Columbus, Ohio. “It seemed smart to try to write off some of those gains with a charitable donation.” Besides, the client liked the idea that her horse would be looked after and ridden regularly at the college, rather than trucked off to a glue factory at the earliest possible opportunity.
The next step was to address whether the donation would be “for the use of” or “for the benefit of” the receiving organization. “A donation ‘for the use of’ has to have something to do with the charity’s purpose, whereas a donation ‘for the benefit of’ does not,” says Reed. “For instance, if I gave an oil painting to the Boy Scouts, they’re going to sell it and keep the money, so that’s ‘for the benefit of.’ If I gave them some land in the country where they could hold campouts–or if I gave my oil painting to the Metropolitan Museum of Art–then those gifts would be ‘for the use of.’” Why is this important? Clients making donations “for the use of” a charity can deduct the fair market value of their gifts, while clients donating gifts “for the benefit of” a charity can only deduct their original cost basis.
“This is a very big deal,” says Penny Marlin, currently of Lubitz Financial Group in Miami, “because if someone has a highly appreciated asset, they want to get a maximum deduction for their donation.” (This rule, she adds, only applies to gifts of “tangible property”–artwork, collectibles, horses, cars, etc–and not to gifts of cash, securities, or real estate.) In the eyes of the IRS, the “for the use of/for the benefit of” distinction is usually determined by how long the charity keeps the gift before selling it: If they keep it for more than two years, it’s “for the use of,” and if it’s sold within two years, it’s “for the benefit of.” The real lesson is that “if you’re going to donate something weird, donate to an organization that has a use for weird stuff,” says Reed with a laugh. “If you’re cleaning out Granny’s house after she’s died and you’re going ‘What the hell is this?’ don’t just give it to Goodwill: Google it, and find out if there is a museum of that item somewhere that would accept it. For one thing, they’ll be able to value it properly, and you’ll be doing something good, and you’ll get a full deduction for it, too.”
In the case of the horse donation, the charitable recipient, Otterbein College, planned to use the horse in its horseback riding classes for students. Since the primary purpose of the university is to educate students, the gift was deemed “for the use of” the institution, and the client got a tax deduction for the full fair market value of the horse. Still, just to be safe, Reed asked the college to confirm this in their thank-you letter. “My rule with the IRS is to back up everything with a piece of paper, so their thank-you note said, ‘Dear Mrs. Jones, thank for your donation of your horse to our horseback riding educational program,’” he says.
And who determines the fair market value of the horse? For any donation of tangible property worth more than $5,000, donors must get written appraisals from qualified, objective, non-interested parties, according to IRS Publication 526, “Charitable Contributions” (available for download at www.irs.gov). “The onus is on the donor, not the charity, to substantiate the value,” says Marlin. “The charity is obligated to issue a receipt that says they received the gift, but they don’t ascertain the value. If you donate a 1998 Lexus, the receipt will say, ‘Thank you for the 1998 Lexus, model number 123ABC,’ period–without any reference to its value.”
Even if the gift isn’t worth $5,000, other documentation is generally needed, according to IRS Publication 526. For donations of more than $250, the donor must get a written acknowledgment of the gift, including a description of the donation. For gifts of more than $500, the donor must fill out Section A of Form 8283 and file it with his tax return.
Who Is the Recipient?
Another issue to consider is the type of organization that is receiving the donation: i.e., is it a public charity, or a private (family or corporate) foundation? Donors of tangible property (such as Reed’s client’s horse) given to a public charity (such as the college) can deduct up to 30% of their adjusted gross income (AGI) each year, while donors of tangible property to private foundations can only deduct up to 20% of their AGI in a given year, says Neil Brown of Burkett Financial Services in West Columbia, South Carolina. (By contrast, donors of cash or securities to public charities can deduct up to 50% of AGI, and donors of cash or securities to private foundations can deduct up to 30% of AGI.)
Donors can carry over their tax deductions from year to year, but deductions can only be carried for a total of five years, and the most recent deductions get “used up” first. For instance, explains Brown, if you have an income of $100,000 per year and you donate a $50,000 painting to a public charity this year, you can deduct 30% of your AGI this year ($30,000) and carry over the remaining $20,000 to next year. However, if you donate another $50,000 painting to a public charity next year, your $30,000 deduction for next year has to be used first, and your $20,000 from this year gets carried over for another year. “You’ve only got five years to use it, and if you’re not paying attention and you keep making charitable contributions, you have a possibility of losing that carryover,”
Donors should also be aware that a donation of tangible property to a public charity yields a deduction equal to the fair market value of the item, while a donation of the same item to a private foundation will yield only a cost basis tax deduction for the donor, says Bryan Clontz, a planner with Bryan Clontz and Associates and a consultant with Charitable Solutions, LLC, both based in Atlanta. “That’s why you’ll never see anyone giving those items to a private foundation,” he says. “It never happens.”
For truly large gifts, donors can consider making a “split-interest gift,” in which the gift is sold by the charity and the proceeds are split into two pots: one to support the charity’s work, and one to pay a lifetime income stream to the donor. To determine the donor’s tax deduction, the future value of the gift must be calculated using a formula involving the donor’s life expectancy, the rate of income the donor wishes to receive, and the Adjusted Federal Rate, says Marlin. True, making this type of gift will decrease the donor’s tax deduction, both because of the income stream coming out of the gift and the fact that the charity has to sell the item to fund that income stream, making it a donation “for the benefit of” the charity. “But on the other hand, this is a way to turn a non-income producing asset–say they have a lot of valuable jewelry and no one to leave it to–into an income, and they’ll get income based on the value of the jewelry, even though the deduction may be less,” says Marlin. “From a planning perspective, you have to ask: What is more important to them? Do they need the tax deduction? Or do they need an income stream for life?”
Getting Specific: Land Donations
Donating land has its challenges, but the benefits to both the charity and the donor often make it worth the extra legwork. “There is more wealth in privately held real estate than in any other asset category,” says David Csira, president of Donation Exchange, an Irvine, California-based consulting firm that facilitates the donation of non-cash gifts to charitable institutions. “Real estate is generally a highly appreciated asset, so by donating it, you can avoid capital gains taxes and make a more substantial gift.” Besides, adds Clontz of Charitable Solutions, “from a planning point of view, real estate is the donor’s most illiquid asset, so donating it doesn’t hurt the donor’s cash flow.”
Still, be aware that many charities are hesitant, at least initially, to accept gifts of real estate, so your client may get a “no” before they get a “yes.” Why the wariness?
Environmental issues are a major concern, says Marlin. “Somebody may try to donate a piece of property with a gas station next to it and they’ve had runoff from fuel that’s seeped into the soil, or they’ll try to donate a piece of vacant land that used to have a chemical plant on it that polluted the ground,” she says. “If the problems are found after the charity accepts it, someone can sue the charity without limit.” Says Clontz, “The charity is risking all its assets if something goes wrong. If the charity finds something glowing in a well somewhere on the property, it’s responsible.” As a result, charities generally conduct extensive environmental testing before accepting any gifts of real estate, and such tests require time, effort, and money.
Logistics are also an issue. If the charity accepts a parcel of land and then is unable to sell it promptly, it suddenly has a whole host of new responsibilities. “Who’s paying for the lawn care? Who makes sure the termite inspection is being done?” says Clontz. “If there are tenants on the property, are they up to date on their leases? Now, all of a sudden, the charity is a landlord, which they’ll undoubtedly love–and in a lot of situations, the land may be four states away.”
Donors themselves may be an obstacle. If they have a piece of property worth $1.5 million, notes Csira, what are the chances that they want to donate the entire parcel to a single institution?
Fortunately, several organizations have sprung up to help facilitate the donation of real estate to charity in a way that benefits both parties.
One such organization is the Dechomai Foundation (www.dechomai.org), a national donor-advised fund that Clontz founded in January 2003 for the sole purpose of receiving non-cash assets–usually real estate, but not always–liquidating them, and distributing the proceeds. (Clontz’s firm, Charitable Solutions LLC, works as a consultant for the foundation; the foundation has a separate board of directors.) Donors who wish to split their real estate donation among various organizations can do so by donating their land to the Dechomai Foundation first. “They [the donors] make the gift, get the full deduction, and then once we liquidate it, it goes into a donor-advised fund, and the donor can say, ‘Okay, cut this into seven different pieces for the seven charities I want to support,’” says Clontz. That’s a more efficient way to handling the donation than “deeding over one-seventh of the real estate to each of the charities, which would be very, very cumbersome.”
Charities like the setup, says Clontz, because they’re kept out of the chain of title to the land, thus protecting them from financial risk if an environmental problem is found on the land. The Dechomai Foundation, of course, does take on this risk, but since the foundation’s sole purpose is to accept non-cash assets, “there are no deep pockets,” says Clontz. “It’s not like the American Cancer Society’s $200 million endowment is sitting there for somebody to get at, and we did that on purpose.”
Many community foundations are also experienced in accepting such gifts, says Clontz. On a national level, the National Real Estate Foundation (www.nationalrealestatefoundation.org) of Carlsbad, California, operates much like the Dechomai Foundation, but as its name suggests, accepts only gifts of real estate.
An alternative to these passthrough-style charities is a unique option technique offered by Csira’s consulting firm, Donation Exchange (www.dnxllc.com), based in Irvine, California. Like the Dechomai Foundation and the National Real Estate Foundation, the Donation Exchange option technique allows donors to split the proceeds of their non-cash gift among multiple charities, and it also keeps the recipient charity out of the chain of title to the land. However, it achieves these ends in a different way.
How does it work? If the donor has a $500,000 property and wants to gift $300,000 of it to charity, the donor grants a nonprofit organization an option to acquire the property for $200,000, explains Csira. Donation Exchange then begins marketing the property to find a buyer willing to pay the fair market value. “The option, which is married to the purchase and sale agreement, is exercised at the time of sale,” says Csira. “When the sale takes place, the charity gets $300,000, and the donor gets $200,000, as well as a $300,000 deduction for her gift.” After this transaction, the donor owes capital gains taxes only on the amount proportional to the amount she retains–in this case, 2/5 of the initial cost basis.
Clontz argues that this technique is less beneficial for the donor, since the donor’s deduction is determined not by an appraiser, but by the price for which the property sells at auction.
“The more valuable the property, the less comfortable the donor is with the option strategy,” says Clontz, “since the sale price pegs the value of the tax deduction for the donor.” But many donors actually like the idea of an auction, counters Csira. “Auctions are a seller-driven process: You don’t have people making conditional offers, where one person says, ‘I’ll pay $300,000, but first you have put a fence around the pool,’ and another offers $250,000 contingent on the sale of his own house and that you fix the stairway. [With an auction], it’s an apples-to-apples comparison between bids.” In addition, potential buyers can get caught up in the excitement of a bidding war, thus increasing the final sale price. “A buyer may have thought, ‘I was only going to go to $490,000,’ but in the heat of the moment, he’ll say, ‘Oh, what the heck, I’ll go to $495,000,’” says Csira. “It’s been fairly well documented that you get higher prices in that kind of frenzy.”
Whether your client wants to donate a horse, a house, or a banana tree, you can provide a valuable service to your clients by helping them channel their resources to the causes they care about. They’ll gain satisfaction knowing that they’re aiding worthy causes–and by helping them do so, you’ll have made the world a little bit better yourself.
Assistant Managing Editor Karen Hansen Weese can be reached at firstname.lastname@example.org.