Real Estate from a Tax Perspective

It is hard to imagine why holding substantial equity in a piece of highly appreciated California real estate could cause a dilemma. But often it does, especially with respect to tax and estate planning considerations. After years of depreciation over the life of the asset, many investors have a very low tax basis in their property as well.

What do you do?

An outright sale of the property can result in a 25% to 35% tax for a California resident. Trading the property may not be in your client’s best interest with many buyers competing for quality properties in the market.

A solution can be in the fulfillment of an individual’s charitable and philanthropic passions while at the same time obtaining considerable tax benefits in the process. The present market environment creates considerable appeal for gifts of appreciated real estate.

Putting a charitable vision into motion can be simple. A gift can result in an immediate deduction equal to fair market value of the donated asset, as well as avoidance of all taxes on the property; in effect, generating a double advantage for the charitable investor.

Advancing Philanthropy through Real Estate Equity

The process begins by identifying the asset to be donated and the qualified recipient organization. The tandem use of Silicon Valley Community Foundation’s Real Estate Trust and a donor advised fund results in the donor having the flexibility to use any income generated by the property and the proceeds from the sale of the property to support charitable organizations important to the donor.

The seasoned development staff of the community foundation, experienced in the nuances of accepting real estate gifts, allows the Real Estate Trust to accept gifts of raw land or commercial, industrial and residential properties. Their efforts, in concert with the donor’s own professional advisers, can affect the donation in a simple, straightforward manner. To plan properly for a significant gift, the donors should allow themselves three to four months to completely wrap up all details.

Depending on the type of property being donated, the donor’s will need to assemble the following documents:

  • An appraisal consistent in substance and principles with the Uniform Standards of Professional Appraisal Practice (USPAP) dated no earlier than 60 days before the date of the gift and no later than the due date of the tax return reporting the gift
  • A clean Phase One environmental report
  • Current deeds and legal description of the property
  • Property leases, if the property is leased
  • Property tax bill
  • A signed donor statement
  • Property insurance policies
  • A preliminary title report

A new requirement imposed with the passage of the Pension Protection Act of 2006 requires that all donors making gifts to donor advised funds receive affirmation from the charity that upon their contribution, the charity has full control over the asset it receives.

Generally, it is simplest to donate unencumbered property because the tax treatment of encumbered real estate gifts can be problematic and may result in a “bargain sale” to the extent of the debt on the property. The charitable gift will trigger the due-on-sale clause found in most mortgages, resulting in the requirement for an immediate debt repayment. This further complicates the transaction from a tax and real estate financing perspective.

The Charitable Partner

An alternative to an outright gift, particularly if the donor wants to retain control of the property, is to create a limited partnership in the real estate asset with the charitable organization. In this case, the Real Estate Trust receives a limited partnership interest and the donor receives a charitable deduction equal to the fair market value of the share donated.

Creating an Income Stream for Life or a Legacy

Interests in real estate can also be used to fund charitable trusts: either a charitable remainder unitrust or a charitable lead unitrust. Each meets a different estate and tax planning objective.

Income producing property can be used to fully or partially fund either a charitable remainder unitrust designed to provide an income stream for the donor, or any income beneficiary the donor chooses. At the end of the donor’s life, the remainder interest transfers to the institution of his or her choice.

A similar approach can be used to fund, either fully or partially, a charitable lead unitrust, which first provides income to a charity, then provides a lump-sum payment to the donor, their children, grandchildren or any other beneficiaries they choose.

Lead trusts can substantially mitigate gift and generation-skipping taxes, making it easier to establish legacies for children or grandchildren.

Donations of appreciated real property are becoming an increasingly attractive vehicle to achieve life time charitable and estate planning objectives. For those of you with clients who are sophisticated and successful real estate entrepreneurs, these gifts can become the capstone of a career by providing for communities in which the wealth, the successes and the passions have been spawned.

Originally appeared in Silicon Valley Community Foundation Professional Advisor News of May 2008

Authored by Bryan Polster.