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November 21, 2022 - In our real estate series, we have explained why owners of appreciated property may consider donating their real estate to receive an income tax deduction and avoid capital gains tax. In Part 1, we considered various giving vehicles, and in Part 2, we discussed the implications of the property interest donated.

But when explaining the complexities of overlapping trust, estate, property, and tax law, things aren’t always straightforward. Here, we discuss some of the exceptions to the rules when it comes to charitable donations of real estate.

Exceptions to the Partial Interest Rule

In Part 2, we discussed how achieving a charitable tax deduction is dependent on donating your entire interest in a property. Usually, you can’t hold anything back if you want a deduction. However, there are some exceptions to the partial interest rule.

• LIFE ESTATE IN PERSONAL HOME OR FARM
  As mentioned in Part 1, you can donate your personal home or farm to a charity while retaining a life estate in the property. This means that you deed your home to a charity and receive a charitable deduction for the gift, but you continue living in and maintaining your home for the remainder of your life. A life estate can run for multiple lives, such as the life of your spouse or child, before the charity’s remainder interest entitles it to possession of the property.

• SPLIT-INTEREST GIFT
  Instruments such as a Charitable Remainder Trust (CRT) allow for a gift of real estate to benefit both charitable and non-charitable beneficiaries. When you donate real estate to a CRT, you or another non-charitable beneficiary receive income for a term, and the charity receives the remainder interest at the expiration of the term. While a split interest gift using a CRT can qualify for a charitable deduction, you must still convey your entire interest in the property.

• UNDIVIDED PARTIAL INTEREST
  You don’t have to own the entire property to gift your portion to charity, but to receive a charitable deduction, you must convey an undivided interest in the portion you own. For instance, if you and your two siblings inherit your parents’ home as tenants in common, you only own a 1/3 share in that property. However, you can gift the entire interest of your 1/3 share in the home to charity. The charity would then own a 1/3 share in the home, while your siblings retain their 2/3 share.
  
  Likewise, you could give a charity an undivided partial interest in your property. For instance, you could deed a 1/2 interest in your property to charity. When you and the charity sell the property, the charity would receive 1/2 of the proceeds and you would avoid 1/2 of the capital gains tax. In this case, you are conveying ½ of your entire interest—surface and minerals—in the property.

• QUALIFIED CONSERVATION EASEMENT
  You can protect natural or historic land and receive a tax deduction by donating a portion of your interest in the property to a conservation organization, commonly known as a land trust. In this case, you donate some of your rights to use of the land. You agree to restrict use of the land by avoiding activities that would be counter to conservation efforts.

Bargain Sales

Another special circumstance occurs when you sell a property to a charity for less than its fair market value, called a bargain sale. In this situation, the donor’s charitable contribution is the difference between the property’s fair market value and the sale price.

To determine your charitable deduction on a bargain sale, you first need to calculate the charitable contribution by assessing the fair market value of the property. Tax courts view fair market value within a context of the highest and best use of the property, and this must be determined by means of a qualifed appraisal. 

Next you apply any reduction rules, such as reducing your deduction by the amount of any short-term capital gain. Then, you allocate basis between the sale and gift portions of the transaction. If your basis is greater than the property’s fair market value, you will be unable to claim a deduction. In that case, you could maximize your tax savings by selling the property to a third party, deducting the loss, and then donating the proceeds to charity.

A bargain sale also occurs when you gift a property that is encumbered by debt. In that situation, even if you receive no payment for the transfer, the amount of debt the charity assumes from the transfer is counted as income to you. A donor of a property encumbered by debt will deduct sales proceeds (the amount of debt) from the fair market value to yield the charitable contribution deduction.

Sometimes, a bargain sale occurs when a person sells a property that is under threat of condemnation for less than fair market value. However, you should proceed cautiously, obtaining documentation of the value of the property and the government’s intent to use it for public purposes, to justify a bargain sale deduction in this situation. 

In any case, donors seeking a charitable contribution deduction for a bargain sale must show donative intent. Donors should document in communications to the charity their intent to contribute the full market value of the property.

A gift of real estate can make a profound impact on a charity's important work. With the information in this series, we hope you feel even more equipped to make or receive such a gift. Call us at 214.978.3300 to learn more or to partner with us.

Real Property: Real Philanthropy - Part 1
Real Property: Real Philanthropy - Part 2