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Saturday March 28, 2015

Article of the Month

Donating Real Estate Part II

Real estate is an excellent asset to donate to charity. There are a number of planned giving strategies involving real estate that will entitle the donor to a charitable deduction, provide a bypass of capital gain and, in certain cases, increase the donor’s income.

NIMCRUT & FLIP Unitrusts

A Charitable Remainder Unitrust (CRUT) is an excellent option for donors with appreciated real estate. A donor that transfers appreciated real estate to a CRUT will receive a charitable income tax deduction for funding the trust and can bypass the payment of any capital gains tax when the trustee sells the real estate. The sale of the real estate without capital gains tax allows the trustee to reinvest the net proceeds from the sale, less closing costs, in a diversified portfolio of stocks and bonds. After the real estate is transferred to the trust, the trust will pay income to one or more beneficiaries for a life, lives or a term of years in accordance with the payout method required by the trust.

The trustee, however, may not be able to sell the real estate immediately. A standard CRUT must pay out the Unitrust percentage regardless of the trust’s actual income. If the trust is holding real estate that is generating little or no income then there may not be enough liquidity in the trust to make the CRUT payment. Consequently, a standard payout CRUT is not, at least initially, the recommended payout method for gifts of real estate.

To avoid this problem the donor should transfer the real estate to either a Net Income Plus Makeup Unitrust (NIMCRUT) or a FLIP Unitrust. A NIMCRUT distributes the lesser of the trust’s net income or the Unitrust percentage (the trust also includes a "make up" account, a mechanism that allows for the repayment of any shortfall or deficit in the initial years in later years). In cases where the real estate is generating little or no income, a trust with a NIMCRUT payout is only obligated to pay the income the real estate generates while the trust holds the property. Once the property is sold, the trustee can reinvest the proceeds of the sale in a diversified portfolio designed to produce income.

A FLIP Unitrust distributes the lesser of the trust’s net income or the Unitrust percentage before a trigger date or event stated in the Unitrust document. When a FLIP trust holds real estate the trigger event is most often the sale of the property. On January 1 following the sale, the trust “flips” to a standard Unitrust paying out the Unitrust percentage. Before the trigger event, a FLIP Unitrust is only obligated to pay out any income the real estate generates. Therefore, both a FLIP Unitrust and a NIMCRUT avoid the issue of liquidity faced by the standard Unitrust when funded with real estate.

Alex, age 60, owns an apartment complex worth $3 million. His basis in the property is $1 million. He would like to sell the complex, but does not want to pay tax on $2 million in capital gains. Alex gives quite generously to charity. Alex calls Joe, the gift planner at the charity, and asks about the possibility of making a charitable gift of the apartment complex. Joe explains that if Alex funds a FLIP Unitrust then he will be able to bypass the capital gain upon sale of the complex. The Unitrust will pay out rental income until the complex is sold. Once sold, it will “flip” to a standard Unitrust and pay out 5% of the trust value each year. Alex likes this plan and transfers the complex to the trust. Alex receives a deduction in the year of the gift of $1,142,000 and upon sale of the property he receives annual income beginning at $150,000 per year.

Unitrust and Sale

Combining a Unitrust and a sale is a very popular plan when donating real estate. For example, a donor may want to recoup the value of his or her initial investment in the property to reinvest in a different piece of real estate or some other asset. Combining a Unitrust and sale is a great way to provide the donor with up-front cash in addition to the other benefits of the Unitrust discussed above.

Under a Unitrust and sale, the donor will transfer an undivided percentage of the property to the Unitrust and retain the remaining undivided percentage. After the transfer, the trustee of the Unitrust and the donor will proceed to sell the property together. This is called a “joint sale.” The proceeds of the sale are apportioned between the donor and the Unitrust based on the portion of the property each owns.

Ian, age 65, purchased property twenty years ago. The property has a current fair market value of $500,000 and his cost basis is $250,000. Ian would like to receive cash up front so that he can reinvest the proceeds in another property. After talking with Pam, the gift planner at a local charity, Ian transfers 70% of the property to a Unitrust and retains the remaining 30%. Ian and the trustee of the Unitrust then sell the property for $500,000. The Unitrust receives $350,000 (70% of $500,000) and Ian receives $150,000 (30% of $500,000). Ian’s original $250,000 basis in the property is apportioned between the $150,000 cash received by Ian and the $350,000 received by the Unitrust based on the percentage of the total property owned by the Unitrust and Ian. So, $75,000 of the cost basis (30% of $250,000) is apportioned to Ian's share of the property and $175,000 (70% of $250,000) is apportioned to the Unitrust's share of the property. This means that Ian can use his share of the cost basis against his sales proceeds. He would recognize $75,000 in capital gains ($150,000 cash received minus $75,000 in basis) in the year he sells the property. At his rate of 18.8%, Ian would pay $14,100 in capital gains tax. However, Ian is also entitled to a deduction for his charitable gift that funded the Unitrust. That deduction is $157,000 which, at Ian's income tax rate of 33%, will produce tax savings of $51,810 for Ian in the year of the gift. The charitable income tax deduction will offset the tax that Ian must pay on the capital gain he recognizes in the year of the joint sale.

Another option for the combined sale and Unitrust is to allocate the sale and Unitrust portions to determine the maximum amount of cash the donor can receive. This strategy will result in the charitable deduction for the Unitrust gift completely offsetting the capital gains tax consequences from the sale.

Ian has discovered a property that he sees as a great investment opportunity. He still wants to make a gift to fund the Unitrust but would like to make an offer on the other portion of the property and needs as much cash as possible. Ian calls Pam and asks how much cash he can receive and still pay zero tax. She tells Ian that based on his specific situation he can retain 56% of the property and still offset the capital gain tax with the charitable deduction for funding a CRUT with the remaining 44% of the property. Ian likes the idea of recouping slightly more than his original investment with no net tax. So, he transfers 44% of the property to a Unitrust and retains 56% of the property. Then, Ian and the trustee of the Unitrust sell the property for $500,000. Ian receives $284,400 and the Unitrust is funded for $215,400. The charitable deduction that Ian receives of $96,704 is just enough to offset the tax Ian must pay on the capital gain recognized as part of the cash received. Now Ian has enough to make an offer on the new investment property. In addition, he receives income of $10,700 per year from the Unitrust. When Ian passes away, the charity will receive the Unitrust remainder.

One important note for practitioners. Because the real estate is appreciated property, Ian's deduction for the transfer to fund the unitrust will be subject to 30% of his AGI in the year of the gift. Ian will be able to carry-forward the unused deduction for up to an additional five years. It may take several years for Ian to fully utilize the deduction from the gift. At the same time, however, Ian will have to pay 100% of the capital gains due when he files his individual income tax return related to the year of the sale. Consequently, the sale and Unitrust is a tax-free plan but it may take Ian a few years to use the gift deduction before the capital gains tax consequences are fully "zeroed out."

Life Estate Reserved

Section 170(f)(3)(B)(i) of the Internal Revenue Code allows a person to transfer a remainder interest in a personal residence or farm to charity and reserve the right to live on the property for one or two lives.

Harry, age 75, would like to donate his home to charity, but wants to continue to live in the home for the rest of his life. He talks to Joe, the gift planner at a local charity, about setting up a life estate. Joe explains that with a life estate plan Harry will transfer the remainder interest in the home to the charity and reserve the right to live in the home for life. A qualified appraiser determines the home has a fair market value of $300,000. Harry purchased his home 35 year ago for $150,000. He transfers the remainder interest to charity and receives a tax deduction of $213,000 in the year of the gift. If needed, Harry can carry forward this deduction for an additional five years. Harry executes a Maintenance, Insurance and Taxes (MIT) Agreement with the charity. Under the MIT Agreement, Harry is responsible for continuing to pay the regular costs of maintenance, insurance and taxes during his life. Harry was fine with the MIT Agreement. He reasoned that he would have incurred those costs each year if he had not made the gift so this was not a "new" obligation on his part. When Harry passes away, the entire home is transferred to the charity. This plan allows Harry to live in his home until he passes away and provides nice tax savings over a number of years as well as a gift to charity.

In many cases, the advisor of a donor contemplating the gift of real estate while retaining a life estate will ask: "What if my client sets up a life estate, but then their circumstances change? What if they can't continue to live independently and they need to move to a retirement community or an assisted living facility?" Fortunately, there are a number of "life estate rollover options" that will allow the life estate holder to use the life estate to meet their needs as their circumstances change.

One future option for the life estate holder is to approach the charity with the life estate and ask whether the charity would agree to a joint sale of the property. Under the life estate arrangement, the donor owns the right to live in the property for life. This is a valuable real property interest. The life estate holder's life estate is a "current interest" and the charity's remainder interest is a "future interest.” Taken together, the donor and the charity own all interests in the property. Therefore, they can work together and sell the property jointly, dividing the proceeds based on the value of each owner’s interest.

Five years ago, Sally and her husband, Dale, transferred the remainder interest in their large home to charity. They reserved a two-life interest in the property. The home had a fair market value of $800,000 and provided them with a deduction of $493,000. However, Dale passed away last year and Sally does not feel capable of taking care of the upkeep that Dale previously handled. At age 78, Sally would like to move into a retirement community where she can participate in social activities with peers. Sally calls the charity that owns the remainder interest in the home and speaks to Pam. Pam explains that a joint sale might be a good option. The charity, Pam explained, would welcome the ability to sell the future interest in the property in order to receive the cash. Sally would also receive cash from the sale of her percentage of the property. Sally is thrilled because it would give her the down payment she needs to purchase a unit in the retirement community to which Sally wants to move. An appraisal of the property determines that the fair market value is $830,000. Sally’s life interest is worth $200,000 and the charity’s interest is worth $630,000. Sally and the charity engage in a joint sale of the property. Sally receives the $200,000, less Sally's share of the closing costs, and uses her one-time $250,000 capital gain exclusion from the sale of a principal residence to avoid paying any capital gains tax. She uses the net proceeds to purchase a home in the retirement community. The charity receives the remaining proceeds from the sale, $630,000 less charity's sale of the closing costs.

Another life estate rollover option provides life estate holders with increased income. If a life estate holder would like to move out of the home and needs additional income on a regular basis then the life estate holder may want to use the life estate to fund a charitable gift annuity (CGA) or a CRUT.

Sally decides that instead of receiving a lump sum payment from a joint sale of the property that she would like fixed payments for the rest of her life. She has enough saved that she can put a down payment on a small home in a retirement community but would benefit from regular income, with fixed payments, to cover her month-to-month expenses. Sally makes a gift of the life interest in her home worth $200,000 to charity in exchange for a charitable gift annuity. As allowed by Rev. Rul. 84-43, she uses her $250,000 capital gain exclusion for the sale of a principal residence to cover any gain allocated to her life interest. So, for tax purposes it is as if she funds the gift annuity with cash. She receives a deduction of $97,300 for funding the annuity and a payout of $12,800 annually for the remainder of her life. Once Sally transfers her life interest to charity in exchange for the annuity, the charity owns the entire property. The charity can then sell the property and reinvest a portion of the sales proceeds to fund Sally’s annuity.

Gift Annuity for Home

The donor may like the idea of a life estate, but may also need income during the period of time he or she is living in the home. This can be accomplished by setting up a gift annuity for home. The gift annuity for home combines a life estate reserved with a charitable gift annuity. The donor reserves the right to live in his or her home for life and transfers the remainder interest in the home to charity in exchange for a charitable gift annuity. The donor will live in the home and receive annuity payments for life. In addition, the donor is entitled to a charitable deduction in the year the annuity is funded.

Hannah, age 80, wants to donate her home to charity, but would like to remain in her home until she passes away. She originally purchased the home 30 years ago for $120,000 and it now has a fair market value of $300,000. In addition to living in her home she would like to increase her income. Hannah speaks with Jane, the gift planner at the charity where Hannah worked until she retired. Jane suggests funding a charitable gift annuity with the remainder interest in her home while retaining a life interest. Jane explained that based on Hannah’s age and the value of her home she would receive a deduction of $116,600 for funding the CGA and annual annuity payments of $16,150. Hannah likes the benefits of this plan. She can live in her home and increase her income while providing a gift to support charity.

A word of caution: Certain states place restrictions on gift annuities funded with real estate. For example, California, while allowing gift annuities funded with real estate, prohibits investing annuity reserves in real estate. This means, if a charity wants to move forward with a gift annuity for home in California it must make sure there is enough in their reserve to comply with California’s requirements.


A donor has many options when considering a gift of real estate. The available options include using charitable remainder unitrusts, life estates and charitable gift annuities in creative ways to meet the donor's short and long term tax and financial goals. Depending on the specific gift strategy, a planned gift can maximize a donor's charitable deduction, provide tax-free cash from the sale of real estate, allow the donor to continue to live in their home and, in these cases, provide needed flexibility as the donor's goals and circumstances change.

Published March 1, 2015
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Donating Real Estate

2015 Charitable Tax Planning

Gifts of Pass-Through Business Interests

Applying for Tax-Exempt Status Under Sec. 501(c)(3)

Donor Advised Fund or Private Foundation?